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«KENNETH WOODS PORTFOLIO MANAGEMENT PROGRAM Estevan Carvajal Potash Corp. Saskatchewan (POT) Fund Manager, Technology and Media Buy Report ...»

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Estevan Carvajal

Potash Corp. Saskatchewan (POT) Fund Manager, Technology and Media

Buy Report estevan_carvajal@hotmail.com Current Price: CAD $41.94 September 12, 2012 Highest Potash Leverage & diversified Portfolio: Potash Corp. NYSE: POT PotashCorp (Ticker: POT) is the largest fertilizer producer in the world by capacity Market Cap $37.09B giving investors exposure to all 3 fertilizer nutrients driven by top-tier assets, Shares Out. 859.27M greatest barriers to entry and pricing power. More importantly, POT is the largest low-cost producer of Potash with 50% of the worlds deposits located in its backyard Last Closing Price $41.94 which supplies 20% of global demand while sustaining an industry leading Potash 52 Week High $51.96 margin of 64%. POT also owns substantial investments in major global fertilizer 52 Week Low $36.73 companies (Sociedad Quimica y Minera de Chile, Israel Chemicals Ltd, Arab Potash Company Ltd, and Sinofert) which help participate in strategic global demand for Current P/E 13.01x fertilizer ($7.9B unrealized gain and $0.4B in dividends & equity income in 2011). EV/EBITDA 8.00x Source: Bloomberg High Walled Barriers to Entry with Potash Expansion Nearly Complete; Well Ahead of Peers POT controls 50% of potential industry Potash expansion at lowest capital cost as its $8.1B Brownfield expansion will be 95% spent by the end of 2012 which positions Pot well for future demand growth even if prices weaken. As a result, Pot has an advantage over its peers that

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Low Costs and Capex should help weather a downturn:

Pot’s operating costs are very low, especially for its potash mines with 65% variable costs and a sustaining Capex of $0.5B which provides POT with a healthy cushion as demonstrated in 2009 when POT suffered from depressed fertilizer prices and a significant reduction of its operating capacity at its potash mines. Despite these headwinds, POT managed to generate $925MM in cash flow from its operations vs.

losses sustained by POTs’ peers. Going forward, this strength coupled with a significantly lower capex post-2012, (accelerating FCF +2x) positions Pot as most Potash Gross Margin by Company, 2008-12f preferable vs. other industry peers in the event of a global downturn.

Theme of oversupply created by rapid potash expansions by 2015 One of the concerns of the market regarding potash is the line up of huge capacity expansion in next 5-7 years. This will pressurise utilisation rates and then pricing as the capacity build up in next 5-7 years will lead to a fall in utilisation rates to 70% on average from historical average of 80% (2005-2011 ex 2009). However given the low cost of these mines, the utilization rate is expected to not have a significant effect on the operating margins. It also important to note that this new capacity will be driven by an oligopoly market with few existing major players which would not materially impact the "supply flexibility" for POT. Thus, new players will act as marginal suppliers in the potash trade market and thus will be price takers rather than price makers.

Valuation Currently cheap:

POT is an attractive value play with a current P/E of 13.16 trading at the lower end of its 7 Yr. avg. and between 3x to 27x over the past 5 years with an average of 16x. As a result, by applying a discounted 15x PE multiple to our 2013EPS estimate of $3.50, we derive a target price of $52.5 warranted by Pots’ industry leading potash margins, low-cost potash business, oligopoly production capacity growth, and accelerated FCF (expected to double from 2012 to 2014) opening the window for a share Buyback program. Furthermore, the low valuation is not justified given strong growth outlook for the industry.

Table of Contents

Industry Thesis Approach

Industry Macro Graphs Overview

Nutrient Overview

Company Description

Corporate Overview & Management

PotashCorp Assets

Potash Segment

Phosphate Assets – Integrated Producer

Nitrogen Assets

Catalysts for the Stock

Risk Overview

Effect of Extra Potash Supply Online Post 2015


Investment Case


*Please See Appendix to Grasp Fertilizer Overview Prior to Reading Report Industry Thesis Approach Looking into structural growth — Fertilizer shares Global NPK Fertilizer Consumption (million metric tonnes) are usually traded on short-term demand and longterm supply estimates giving the opportunity to buy structural growth at an inexpensive valuation as 1) demand should rise progressively from 2013; 2) supply looks likely to remain rational in the mid term;

3) Imports in key markets have been deferred; and 4) valuations are very cheap.

Growing Appetite for Demand - Acreage expansion opportunities are limited so rising food demand has to be met by yield improvement. Increasing population and rising protein demand coupled with a grain stocks to use ratio well below needed minimum levels stress the need for optimal application of fertilizers, providing the bull case for K and P.

Supportive Fundamentals— Elevated grain prices have led to record profitability levels for farmers which provide strong incentive to increase productivity facilitating optimal use of all fertilizers.

The current drought has also decimated corn crops to record levels which means a robust planting season will make 2013 very strong in order for crop planters to satisfy unmet demand which will support corn prices at +$6.50 until at least midterm.

Supply is expected to remain rational — Attractive return in fertilizers business has led company’s to Indian Imports – heavy reliance on foreign production (000 t/y) think about capacity expansion. However, Greenfield expansion is extremely expensive and although majority of projects will go ahead, the market is controlled by few players who will balance the demand/supply equation in the medium term.

Imports are deferred not vanished: India and China have limited resource bases for K and P, while India is structurally short on N as well. Both countries are already facing significant food inflation; as such they can ill-afford to delay fertilizer demand for long unless it is at the expense of local agro economics. Brazil is a key agriculture powerhouse, which is on a rising import trend, especially for K and P, driven by its agriculture boom which is very positive for the fertilizer trade.

While the industry’s valuation multiples are off their recent lows…. They remain well below their peaks during times of expansion Industry Macro Graphs Overview (Sources: USDA, FAO, UN, Ferticon, CitiReasearch) Nutrient Overview Company Description A Diversified Giant with a Fortified Moat Canadian based (PotashCorp) is one of the world’s largest fertilizer manufacturing enterprises involved in the production of all 3 fertilizers nutrients with nitrogen, phosphate, and potash producing assets in Canada, the United States, and Trinidad. Out of the 12 largest producers, it is the world’s largest manufacturer of potash fertilizers with 20% global capacity, with 5 large, low-cost mines in Saskatchewan and one in New Brunswick. POT is also the world’s 3rd largest producer of both nitrogen and phosphate. The company sells its products in more than 50 countries, with half of its fertilizer sales volumes (predominantly potash and phosphate) sold internationally.

Over the past two decades, PotashCorp has undertaken a number of acquisitions, boosting its size and scale. These acquisitions have included purchases in Chile, Jordan, Israel and China in line with its projection that much of the anticipated potash growth will occur in emerging offshore markets. With regard to US manufacturing facilities, the company has plants in Florida, Georgia, Louisiana, North Carolina and Ohio. The company’s headquarters are in Saskatoon, Saskatchewan, and it has about 5,486 employees.

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Corporate Overview & Management Potash Strategy: Match production to market demand POT has a two part strategy in its potash business segment. The 1st is to match its potash production to market demand in order to minimize downside risk and conserve the long-term value of its resources. Approx.70% of the company’s potash operating costs are variable, which provides production flexibility during periods of lower demand.

The 2nd strategy is to build on its position as the world’s largest potash producer by completing Brownfield expansions and debottlenecking projects at its existing mines and investing in other global potash-related companies.

Source: PotashCorp Phosphate Strategy: Increase earnings stability PotashCorp’s phosphate strategy is to produce a diversified mix of phosphate products in order to maximize returns and increase earnings stability. The company has enhanced its position in the phosphate feed and industrial businesses, which have historically been more stable as there are fewer global producers vs. the fertilizer segment.

Source: PotashCorp

Nitrogen Strategy: Low cost producer PotashCorp’s nitrogen strategy is to maximize gross margins and earnings stability by being a low-cost nitrogen producer to the US nitrogen market. This is supplemented with an emphasis on sales to industrial customers who value long-term, secure supply.

Source: PotashCorp

PotashCorp Assets Potash Corp. Financial Summary POT produces 3 primary crop nutrients: potash, phosphate, and nitrogen. The company’s focus is on its potash assets located in Saskatchewan and New Brunswick, as well as strategic offshore investments in potash-producing companies in Chile, Israel, Jordan, and China. POT is the world’s largest potash producer with almost 20% of global capacity. In 2011, potash accounted for approx. 64% of the company’s gross margin, compared to 15% for phosphate and 21% for nitrogen. As seen below, the time period of 2008-09 showed a very quick reversal for Potash Corp where revenues fell by nearly 60% y/y, gross margin by nearly 80%, and EBITDA by nearly 70%. Yet in contrast to so many other companies in the commodities/materials sector during that time, POT remained profitable – the company earned $1.08 per diluted share for 2009.

As a result, Potash has been the primary contributor to the company’s financial results with leading gross margins over the other 3 nutrient as illustrated in the graphs below.

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Source: Company Filings, Barclays Potash Segment Lion’s Share of World Potash Reserves in POT’S Backyard Potash is a strategic asset with highly concentrated production. Commercial operations are currently located in 12 countries with approximately 90% of the global potash reserves located in Canada, Russia, and Belarus. The Canadian province of Saskatchewan has almost half of world reserves and 35% of global capacity.

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Worlds Largest Producer in an Oligopoly Market As a result of Potash reserves being highly concentrated among few nations, POT is the worlds largest producer with capacity highly consolidated among six big market players: PotashCorp (18%), Uralkali (18%), Mosaic (13%), Belaruskali (12%), ICL (9%) and K+S (8%), together holding around 78% of world capacity.

World Potash Producer Profile Few Players: 2012 Plant Capacity In addition, exports are even more consolidated with BPC (owned by two of the main players in the FSU, Belaruskali and Uralkali) and Canpotex (Canadian marketing firm owned by three main producers of Canada – PotashCorp, Mosaic and Agrium) controlling around 70% world’s traded potash. On the other hand, consumers (farmers) are highly fragmented, so pricing power lies with the suppliers.

As such, these major players are able to keep prices artificially high and demand plays a more important role than supply conditions. These characteristics define 2008 price run despite abundant supply at that time. Supply is responsive to demand and while capacity expansions are underway market supply will still be driven by major players.

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In 2011, Canpotex’s annual potash sales were 8.2 million tonnes, sold mainly to the company’s top five markets: China, India, Brazil, Indonesia, and Malaysia. In 2011, China began purchasing potash under six-month pricing contracts with minimum annual volume commitments, a change from its historical annual pricing contracts. In India, potash is typically purchased through annual volume and price contracts. Latin American customers tend to purchase potash on the spot market.

Canpotex Sales (2005 to 2011E)

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Enormous Potash Mines & Still Growing POT operates 6 potash mines in Canada: four conventional underground mines and one solution mine (Patience Lake) in Saskatchewan and one underground mine in New Brunswick. Total “nameplate” or peak capacity was 13.3 MM tonnes as of the end of 2011, with estimated actual operational capacity of 11.3MM tonnes representing ~20% of total global potash capacity.

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Source: Company Reports The company’s potash reserves at the mines are vast, totalling 1.69 billion tons of recoverable ore as of the end of 2011 – enough for 75 years of remaining operational life at its shortest-lived mine, Lanigan. Cory and New Brunswick are both estimated to have over 100 years of mine life remaining.

Well Positioned to Significantly Grow Sales Volumes with Majority of Capex Behind New potash supply will be required in coming years to keep pace with rising demand. In 2003, POT began a CDN $8.2 billion Brownfield Potash expansion program designed to raise annual operational capability at existing mines to 17.1 million tonnes by 2015. By mid 2011, 2/3 of the capex was already spent and five parts of a nine-project program were completed, which significantly reduces capex risk for the company and leaves PotashCorp well positioned compared to its competitors that have significant expenditures ahead and face the risk of cost increases and timeline. In addition, capex will be winding down from 2012-2014 as the project nears completion allowing FCF to double.

Source: Company Reports

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