Wednesday 31 July 2013

Uralkali and the Potash Industry


The Canadian government scotched BHP Billiton's proposed takeover of Potash Corp in 2010, largely due to the mining giant's plans to withdraw from Canpotex, the marketing arm through which Canada's producers sell and distribute their products.  The Saskatchewan government feared that a weakened Canpotex would mean a weakened price for potash, reducing royalties and income taxes for the province.  Today, the potash world saw that those fears were indeed valid.

Potash producers in Russia and Belarus have sold over 40% of the world's capacity via BPC, an institution similar to Canpotex, until Uralkali, a large Russian producer, abruptly announced that it will withdraw from the marketing body.  Instead, the company plans to market its own products, with an emphasis on maximizing volume, rather than withholding supply for a better price.  The company itself acknowledges that this move could reduce potash prices by 25%, to around $300 a tonne, at least in the short-term.  The share prices of all publically traded potash producers instantly fell by 15-25%. 

In the long-term, the supply-demand equation is likely to remain favorable to producers: in fact, $300 a tonne pricing will render any greenfield capacity uneconomic, and will reduce the number of proposed brownfield expansions that go forward, as well.  Interestingly, Uralkali itself has confirmed that it will put one of its own expansions on hold because of the move.  At the same time, lower prices will increase volumes, eventually raising the price of potash.  In addition, an industry where only three sellers - Canpotex, a smaller BPC and a stand-alone Uralkali - account for 70% of capacity remains a heavily consolidated industry (there's additional, though less visible, consolidation, as well, since Potash Corp holds significant sway with the company’s that it holds minority interests in, all of which operate outside of the main two marketing bodies).  

Still, the industry's future doesn't appear as bright today as it did yesterday.  If the marketing arrangement is permanently weakened, the average price of potash is likely to be lower than it otherwise would've been, and will crash harder in down markets than it has in the past, a dismal fact of life for producers of most other commodities.  Not only will producers be less profitable, it will force them to hold more cash - or take on less debt - than they would have under the status quo, which will increase a range of opportunity costs.
 
There are still many unanswered questions.  For one: Why?  It's possible that Uralkali is merely maneuvering against its Belarusian partner, due to reports that one or both parties have sold product outside of the arrangement.  Indeed, Uralkali appears no better off in this brave new world of its own making.  Its stock, too, fell by about 20%, and even selling at all-out capacity, the company predicts flat earnings, suspended its stock buyback, and, as mentioned, put at least one planned expansion on hold.   

Economists often use the classic "prisoner's dilemma" as a model to help explain - and predict - how players in this sort of situation will behave.  Uralkali is behaving in a way undreamed of in this formulation: it "squealed" on the others, but did so with no benefit to itself.  The prisoner’s dilemma assumes rational people making informed, disinterested decisions, however.  In this case, Uralkali may be attempting to correct a perceived lack of fairness (experiments show that people sometimes act counter to their own interests in the name of fairness) or it could simply be behaving foolishly.  Or the company may in fact be acting rationally, after all, with the explanation to be found not in an economics textbook, but at the poker table: this could be a bluff.

In any case, the industry appears less attractive than it once was – although it’s also more appealingly priced.  

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Friday 26 July 2013

Potash Corp - 2013 Second Quarter Update


Potash Corp's second quarter was somewhat weak, and the softness is expected to continue for the remainder of 2013.  Indeed, EPS fell from $0.99 (as adjusted) to $0.72 in the quarter, and full-year guidance was lowered to $2.45-2.70 from $2.75-3.25.  However, some perspective is in order: even at the low end of that range, the company's return on equity will still be around 20% for the year, despite steadily growing assets, as its capital expansion continues, and moderate amounts of debt (an immoderate amount of debt reduces equity, and artificially boosts ROE).
At about 56 million tonnes, global shipments of potash are expected to be in line with last year.  However, because it's requiring a lower price to keep volumes steady, it cannot be denied that the market has weakened since last year.  Realized potash prices fell significantly in the quarter, from $433 to $356, an 18% drop.  Nitrogen and phosphate prices fell, as well.  Also contributing to the weak second half forecast is the lack of a potash contract with China, which will stall sales in the third quarter, though CEO Bill Doyle predicts an agreement will be forged before the fourth quarter.  In addition, currency headwinds are affecting results: a weaker rupee is part of the reason Indian demand has been soft (the major cause remains a domestic subsidy that punishes potash purchases relative to nitrogen), just as a weaker real has offset some of the strength in Brazil.  In the latter case, because Brazil is a major exporter, the economics roughly balance out, since a weaker real means higher US dollar prices for goods sold.
While the softness in the potash market has lingered longer than many investors and analysts had expected - and may persist for the short or even medium-term - the industry's long-term strength remains intact.  People must eat.  In fact, the latest estimate of how many people are going to be eating in the decades to come was recently revised upward, from 10 billion, to a staggering 11 billion, by 2050.  While eventually there will be greenfield supply to meet growing demand, little is likely to come on-stream over the next decade.
Potash Corp shares trade for under $40, but the company's stock market investments are worth $8 per share.  Even after adding back a little over $3 per share in debt (net of cash), the "all in" cost of a POT share is $34-35.  This means that Potash Corp shares are trading at just 13-14 times 2013 earnings, using the mid-point of the newly announced guidance.  Happily for shareholders, management announced a $2 billion share repurchase that will retire up to 5% of shares outstanding over the next year.  This may be increased next year, management noted, as capital expenditures fall, and the already significant dividend could be upped, too.  Investors may want to follow the company’s lead and buy some Potash Corp stock at today’s low prices.
Disclaimer: The host of this blog shall not be held responsible or liable for, and indeed expressly disclaims any responsibility or liability for any losses, financial or otherwise, or damages of any nature whatsoever, that may result from or relate to the use of this blog. This disclaimer applies to all material that is posted or published anywhere on this blog.

Saturday 13 July 2013

Leucadia National - 2012 Letter to Shareholders


The end of an era at Leucadia National was announced late last year and made official earlier this year when shareholders voted in favor of a merger with Jefferies, a leading mid-sized investment bank.  Alas, the long-time duo at Leucadia's helm recently penned their final letter to shareholders.  Warren Buffett's annual letter is the gold standard in the corporate world, but Ian Cumming and Joseph Steinberg's co-written communication is not far behind.
This year's piece strives to do two things: make the case that the new incarnation of the company will be a success, and recap what's happened over the past three and a half decades.  Cumming and Steinberg met Rich Handler, Jefferies' CEO and the incoming chief executive of Leucadia, more than 25 years ago, and have been doing business with him ever since.  Jefferies returned an exemplary 22% per year for the 23 years ending in 2012.  Importantly, not only did Jefferies survive the recent financial crisis, it flourished, using the upheaval as an opportunity to almost triple revenues between 2008 and 2011.  Put simply, Jefferies is in sure hands, and it’s likely that Leucadia is too.
Rather than merely discussing the year that was, though, the CEO and President recap their 35-year run, which investors would be wise to read.  Starting at a small firm, ironically named Carl Marks, they navigated booms and busts, invested in a wide range of businesses, suffered some failures and hard luck, enjoyed some great good fortune and came through it all far ahead of where they were at the beginning.
Leucadia's future will almost certainly not be as dazzling as its past.  There's an unfortunate Catch-22 in investing: every year of above average gains makes it more difficult to outperform the market in the future, because increased size shrinks the number of potential investments.  In 1979, Leucadia's book value was $22 million; by the end of 2012, it had grown to $6.8 billion (and now stands at $9.8 billion).  Cumming and Steinberg note that good investments have become harder to find these past few years, but blame increased competition from hedge funds and private equity, rather than the constraints of being an elephant.
Still, there's a good chance that Leucadia 2.0 will be able to outperform the market for years to come, though by a narrower margin.  Handler and number-two Brian Friedman will likely continue their very fine work at Jefferies, and Leucadia's handful of long-serving senior executives, minus only the retired Ian Cumming, remain on board.  It's worth noting that Leucadia has successfully navigated the pitfalls of global investing, rather than focusing only on the US.  This brings many risks, but also greatly increases the pool of possible investments, which should somewhat counteract the "Elephants-can't-dance" problem.  Now may not be a bad time to buy, either, since Leucadia's share price is trading at less than book value.
Disclaimer: The host of this blog shall not be held responsible or liable for, and indeed expressly disclaims any responsibility or liability for any losses, financial or otherwise, or damages of any nature whatsoever, that may result from or relate to the use of this blog. This disclaimer applies to all material that is posted or published anywhere on this blog.