It looks like North America’s potash cartel may have finally lost its pricing power. Uralkali, a large Russian potash producer, decided to break rank and switch its business strategy, opting for volume over price. As a consequence, it’s likely potash prices will take a 25% hit from current levels (from $400/tonne to an estimated $300/tonne). And obviously that can’t be good for companies like Potash and Mosiac, which just finished cutting their outlooks. But was the plunge in agricultural stocks really just inevitable in the long run? Potash and Mosaic’s future already looked bleak. But the breakup of the oligopoly just adds another major headache to their story. Let’s investigate:
Ever since emerging markets topped in 2011, not only has Potash’s stock followed their markets lower, but their sales have also suffered. Why? Because nearly 70% of Potash’s sales come from outside North America. And that information is extremely important when considering a long term investment, especially around current levels.
Another example of how fertilizer stocks follow emerging markets, this time using the Global X Fertilizers/Potash ETF (you can find the top ten holdings here).
As it stands, 2013 doesn’t look so bad when you look at forecasts. But the question you have to ask yourself is: how much do you trust a model generated by a computer (if you haven’t read Analyzing the Analysts, I urge you to give it a read before continuing)? Forecasting for corporate earnings is extremely difficult, why should this be any different? The risk at the moment is that forecasts are too optimistic, and thus may need to be revised lower. And if that happens, I guarantee you fertilizers/potash stocks will follow those revisions lower.
Investing in highly exposed international companies is very risky at the moment. Emerging markets should specifically be avoided. As the Federal Reserve tries to wean the US economy off of quantitative easing (consequently causing the US Dollar and Treasury yields to rally), it’s capital flows in emerging markets that get hit the hardest. As money flows out of emerging economies, it destabilizes their currencies, hurting equity markets and growth. Imagine the wealth effect in reverse, coupled with rising inflation and falling exports. It’s a disaster. It throws the country and its economy into turmoil, increasing the unemployment rate and the likelihood of unrest. Imagine what would happen if an ‘Arab Spring’ sprung up in China? It could destabilize the entire region.
The venture that Russia’s Uralkali is abandoning is extremely important for the entire agricultural sector. Not only does it drive prices lower (which eventually could lead to lower food prices for consumers as farmers pass on their savings), it introduces a foreign concept to potash producers, competition. Because producers would negotiate long-term fixed supply contracts with their buyers, competition wasn’t very common (after all, the industry was an oligopoly). With the game changing, companies are going to have to work a lot harder to achieve the same profitability they enjoyed in the past. Uralkali’s move will effectively transform the entire industry, and as an investor you have to seriously take these problems into consideration when going long this sector.