On the surface, Agrium Inc. (TSX:AGU)(NYSE:AGU) and Potash Corporation of Saskatchewan Inc. (TSX:POT)(NYSE:POT) seem similar—both produce potash, nitrogen, and phosphate fertilizer, and both market their products in North America, Latin America, and Asia.
Despite this, Agrium has managed to outperform Potash Corp. by 40% this year and by 80% over the past five years. The important question for investors is, will this continue? The answer requires an understanding of the factors that have produced, and will continue to produce, the performance of each business.
Potash Corp.’s returns will be driven by global potash pricing and demand
Potash Corp. is just as its name suggests—primarily potash oriented. Fifty-seven per cent of gross profit comes from potash, most specifically, potash sold to international markets like Brazil, China, and India. In Q2 2015, 66% of revenues came from these markets with the remainder from North America.
Therefore, Potash Corp.’s performance is mainly determined by the prices and demand from these markets. Unfortunately, there have been numerous challenges for Potash Corp. on both of these fronts, and many analysts expect the next few years to be challenging
Firstly, there is ample global supply of potash. In 2013 the world’s number two and four producers of potash (in eastern Europe) broke up their joint venture, which resulted in both producers producing potash at near-full capacity to gain market share, rather than being disciplined on production to maintain prices.
As a result, Potash prices plunged as the market was flooded with supply. One of those companies—Belaruskali—boosted its exports to China by 2.7 times since 2013, and to Brazil by 85%. It recently undercut Potash Corp. on recent supply negotiations with the Chinese, which reduced prices.
Things are also challenging on the demand front. Excellent growing conditions have led to record crop yields, which in turn have put pressure on crop prices. Low crop prices mean farmers have less to spend on potash, and potash is often the nutrient that farmers choose to cut.
In addition, weak currencies in Brazil, China, and India mean that potash is more expensive for farmers in these countries, which reduces imports. The relatively strong U.S. dollar also has the effect of maintaining high production levels for low-cost Russian and eastern European potash producers.
The end result is that analysts at Macquarie expect both potash demand and prices to slide 8% next year. These challenges explain Potash Corp.’s poor performance so far, and also indicate that 2016 could be another challenging year.
Agrium’s returns are determined by its retail segment and nitrogen
Agrium does have exposure to potash, but it is very small. In fact, over the last four quarters, only 2% of Agrium’s sales have been from potash. The majority of sales came from Agrium’s retail segment (82%) and nitrogen fertilizer segment (10%).
Agrium’s retail business results are primarily driven by farmer spending in the U.S., which has been under pressure due to low crop prices. Despite this, the business has performed well because many of their products have fairly stable demand. For example, a large portion of Agrium’s retail sales are from crop protection products, which are up 1% in North America and only down 1% overall.
Agrium has been growing its retail segment by acquiring smaller retailers (with 16 acquired this year so far), and plenty more to go in the U.S., as about 30% of the market is comprised of small independent retailers. Weak crop prices actually assist this growth strategy by allowing Agrium to acquire at low prices.
Outside of retail, Agrium is primarily focused on nitrogen fertilizer, which, unlike potash, has highly stable demand because farmers need to apply it each year. In Q2 2015 Agrium managed to increase nitrogen sales by 35% and profits by 167%, which contributed strongly to the bottom line.
While nitrogen is a highly competitive industry, especially in North America where Agrium sells, it does have a stable growth outlook. Currently, about 25% of North American nitrogen is imported, and about $15 billion of domestic investments will be required to close the import gap, which presents a growth opportunity for producers like Agrium.
The verdict
Agrium’s lack of exposure to potash means it is likely to continue to outperform Potash Corp. unless potash prices rise significantly, which is not expected in the near term.
