MOS Trims Expectations as Near Term Weakness Abounds
This morning, in conjunction with a sell-side conference, MOS updated its outlook for the balance of ’13, taking the opportunity to overlay what are clearly very weak industry fundamentals (both potash and phosphates) near-term with a re-affirmation of the company’s positive long-term outlook. We are in fierce agreement on both counts, but would suggest that the recent stock price movements in the fertilizer sector ignore what we continue to see as potential, material, near-term weakness.
The company lowered volume expectations for both business segments (potash and phosphates) as well as trimming pricing expectations (essentially eliminating the top end of both ranges). The current expectations for potash are $330 to $340 per ton, from $330 to $360 per ton.
MOS also took the opportunity to defend “legal export associations” (Canpotex), suggesting that the existence of global potash cartels was a matter of cost savings rather than pricing, and that price was determined by supply and demand. We suppose that is technically correct, as once demand became clear, supply was managed to yield a price, but that isn’t exactly “supply and demand”, rather “supply based on demand”.
Regardless, while we embrace the long-term demand profile for grain and oilseed consumption and the associated need for crop nutrients to meet that demand, we see 2014 as a transition year for nutrient pricing in the wake of the break-up of BPC. Additionally, a key driver of demand, India, remains weak, suggesting that a volume rebound, despite likely lower prices in ’14, is less than certain.
Over shorter to medium term durations, we believe that it is highly unlikely (even with one jailed Russian executive and heightened political tensions between Russia and Belarus) that the cartel will be restored. In that world, investors have to consider the possibility that instead of an industry profit structure that reflects export cartels managing volume to meet the downstream production demands of the global agricultural industry, the industry may revert to pricing that more accurately reflects the marginal cost of production. While the current thinking by Uralkali is that prices will settle in around $300 per ton, ultimately the price will be a market-clearing price, so we think it is unwise for investors to value these names using that pricing assumption.
We believe that a low probability event such as the re-formation of the cartel is best expressed through options and that long-dated options may be a way to express a long-term view that the cartel or some reasonable facsimile thereof is resurrected, perhaps on the heels of Putin sweeping in riding a pterodactyl to save the day (or some such similar photo opp, see below), but that near-term this is a sector best avoided.