In addition to a spectacularly bad earnings miss (40 cents below estimates) on July 25, POT dropped over 20% this week following some unexpected news from Russia’s Uralkali. The Russians ended a cartel with Belarus that controlled 43% of total global exports in an effort to capture more market-share. The move is likely to drive potash (the commodity, not the company) prices down 25% to 2010 levels.
In this environment, Potash Corp. (POT) is likely to rally based on very low investor expectations, a beaten-down share price finding solid support, commodity market fluctuations, and share float dynamics.
Corn Prices Weigh on Potash, but Commercial Hedgers Are Optimistic
The precipitous drop in corn futures prices since August 2012 is likely a factor in the uncertainty around potash. Corn prices have been dropping because of expectations for record yields from the wet weather that Iowa and Illinois have experienced recently. Those two states account for the majority of corn produced in the U.S.
Click to Enlarge Potash fertilizer is primarily used to yield corn, so as corn supply has increased, there has been less need for fertilizer. From this first chart plotting corn prices against Potash shares, you can see the persistent downtrend in corn loosely matching the bear market in Potash shares since August.
Corn prices are low, and may continue lower, but they will reach a point when prices are low enough to stimulate new demand. Typically dramatic drops in prices such as the one corn and POT are experiencing now bring about speculators who bet that prices can’t drop much further in the short term.
Click to Enlarge One way to gauge speculators is to take a slightly contrarian view of the Commitment of Traders chart at right. We watch the action of commercial hedgers who primarily have an interest in being short corn futures to protect profits when corn prices are high. The majority of the time they will be net short because of their need to hedge. Usually they increase their shorts as the price of corn goes up, and decrease their shorts as the price goes down. When corn prices drop to extreme levels, on rare occasions they go net long corn futures. Now is one of those times. It’s happened on only three other occasions since 2009. On these occasions, hedgers have actually been surprisingly good at identifying when corn is due for a sharp reversal to the upside. See the chart at right:
Click to Enlarge This is not the lowest point POT has reached in the last 5 years and represents a very important long-term support level. As you can see in the weekly chart, $29-$30 was support for most of 2009 and 2010. Looking for a bounce here is definitely contrarian, but not unreasonable, considering the upside potential. If support holds like we expect, resistance is at $38 per share.
Why Potash vs. Peers?
POT wasn’t the only stock to get beat down on the news from Russia. However, if you take a look at Potash’s fundamentals compared to its main competitors, Mosaic (MOS) and Agrium (AGU), you’ll see that Potash is #1 in all categories.
A higher dividend yield supports the stock price in the short-term as dividend-thirsty investors could seek Potash for income investing. Recall from above that the BMO analyst does expect Potash to further increase the dividend. A dividend of 4-5% would rival that of some of the most stable and stodgy utility companies.
Potash also offers investors tremendous growth potential. Gross margins are at 43%, operating margins at 37% and profit margins at 26%. Those margins are as high as some of the best technology companies.
Recommendation: The stock has taken a big hit; however, we are very encouraged by the early buyers at long term support near $30 per share. Our near term upside target is at $38 and we recommend stop losses below $29.
Options Alternative: Like all counter-trend trades, risk is fairly elevated and there is the potential for a whipsaw. That may make POT a more attractive opportunity for option traders with a long call position. We recommend the POT December 32 calls for $2.50 per share or less.
InvestorPlace advisors John Jagerson and S. Wade Hansen are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news. Get in on the next trade and get 1 free month today by clicking here.