Potash Corporation of Saskatchewan a Long-Term Macro Value Play on Population Growth, Agriculture, and Inflation
by Bryce
Executive Summary
Potash Corporation of Saskatchewan (POT) represents a considerable opportunity at current levels for a long-term investment. Population growth combined with increased protein-rich diets overseas will necessitate higher agricultural yield. Potash has many benefits to agriculture but some of the most prominent are increases in yield and disease resistance. Unlike other companies in this sector which provide products that increase agricultural yield such as MON, POT produces a natural product that does not involve bio-engineering thereby reducing any social and political fallout.
Potash Corporation of Saskatchewan is number one in global production of potash. Based on a DCF, shares of POT are fairly valued at $95 – a 10% discount. Over the past ten years, POT’s P/E has averaged 20. It currently is at 8. EPS estimates for 2010 are near $10. At a P/E of 15, shares of POT could nearly double. For those concerned with inflation, POT provides added benefit in that it is a commodity.
The risks associated with this investment largely lie in economic growth which impacts the spot price of potash. While I will not postulate on our economic position in 6 months, I would argue that 1-2 yrs. down the road, global economies (especially those overseas) will rebound. I feel that any weakness in POT is a buying opportunity as the macro outlook appears favorable.
Macro
While people around the world seem caught up in the current crisis (for justifiable reasons), the long-term ramifications of a growing and ever “flattening” world remain.
The U.S. Census Bureau predicts that the world population will increase by 2 billion by 2025 and 3 billion by 2050.
While agricultural demand is a function of population, it is not the absolute number of people that makes the biggest difference but changing habits and diet. The following is an excerpt from The Economist published March 19, 2009.
China’s role has been profound, reflecting its enormous economic progress and huge population. In the past decade, says Carlo Caiani of Caiani & Company, an investment-advisory firm based in Melbourne, the consumption of milk has grown seven-fold, and that of olive oil six-fold. China is consuming twice as much vegetable oil (instead of less healthy pork fat), 60% more poultry, 30% more beef and 25% more wheat, and these are merely the obvious foods. Scores of niches have expanded dramatically: people are drinking four times as much wine, for example.
And yet even with all this growth, people in China still, on average, consume only one-third as much milk and meat as people in wealthy countries such as Australia, America and Britain. The gap is even larger with India, which is also growing fast. Overall, protein intake in Europe and America is unlikely to expand much, but a combination of rising incomes and population in developing countries could increase demand by more than 5% annually for years to come. “Once people are accustomed to eating more protein, they won’t take it out of their diet,” says Mr Caiani.
The following is an excerpt from The Economist April 8, 2009, which focused on water however; the growth in water demand is a function of increased agricultural yield as a result of protein-rich diet.
Different foods require different amounts of water. To grow a kilogram of wheat requires around 1,000 litres. But it takes as much as 15,000 litres of water to produce a kilo of beef. The meaty diet of Americans and Europeans requires around 5,000 litres of water a day to produce. The vegetarian diets of Africa and Asia use about 2,000 litres a day (for comparison, Westerners use just 100-250 litres a day in drinking and washing). In 1985 Chinese people ate, on average, 20kg of meat; this year, they will eat around 50kg. This difference translates into 390km3 (1km3 is 1 trillion liters) of water—almost as much as total water use in Europe. The shift of diet will be impossible to reverse since it is a product of rising wealth and urbanisation.
In order to meet future demand, many countries with excess liquidity have been making investments in arable land. While land grabs aren’t a new phenomenon, the increasing size is. A big deal used to be around 100,000 hectares (240,000 acres) whereas recent purchases by South Korea and the U.A.E. top 400,000 hectares. Among other acquisitions, China has procured the use of 2.8m hectares in Africa. The following excerpt from The Economist published May 21, 2009 emphasizes the significance of these transactions and transitively their importance to the acquirer.
In total, says the International Food Policy Research Institute (IFPRI), a think-tank in Washington, DC, between 15m and 20m hectares of farmland in poor countries have been subject to transactions or talks involving foreigners since 2006. That is the size of France’s agricultural land and a fifth of all the farmland of the European Union. Putting a conservative figure on the land’s value, IFPRI calculates that these deals are worth $20 billion-30 billion—at least ten times as much as an emergency package for agriculture recently announced by the World Bank and 15 times more than the American administration’s new fund for food security.
Potash is important for agriculture because it improves water retention, yield, nutrient value, taste, color, texture and disease resistance of food crops. It has wide application to fruit and vegetables, rice, wheat and other grains, sugar, corn, soybeans, palm oil and cotton, all of which benefit from the nutrient’s quality enhancing properties. Potash also aids in animal growth and milk production.
Potash Corporation of Saskatchewan (POT)
The stock is fairly valued and attractive in my eyes over the long-term. In my opinion the maximum downside is to ~$47 which was reached at the peak of the economic crisis. This seems unlikely to me as both U.S. and emerging economies seem to be rebounding. Stockpiles of potash have been utilized over the last few months while the global economic situation looked dire and farmers will need to procure more to meet yield requirements.
If you are in any way concerned that the increased monetary supply and deficit will lead to a weaker dollar, POT will provide protection because (1) it is a commodity, (2) it generates a large portion of revenue from overseas.
Based on current valuations and macro expectations discussed above I have initiated a position (@$86) and intend to increase that position on any weakness. I would have preferred picking up this equity at a slightly lower price however a bird in the hand is worth two in the bush and I have missed a few very good calls looking for too much value (just look at my call on TC-it has gone up 4x in 4 months!).
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