Buy, Sell or Hold: Potash Corp.

As the old Wall Street adage says, nobody ever got poor by taking profits.

And Potash Corp. (NYSE: POT), the world’s largest fertilizer company, is a living case study as to why that’s true.

The Saskatoon, Canada-based Potash posted stellar results for the second quarter.  Gross margins and earnings tripled to 68% and $905 million, respectively, from the same quarter last year on the back of huge gains in the prices of potash, phosphate and nitrogen, which in the past 12 months increased more than 160%, 130% and 55%, respectively. And the company raised its earnings outlook by about 30% for the year.

This stellar financial performance came on the back of increased global demand for grains, which drove grain prices to record highs and caused the head of the United Nation’s World Food Programme to warn that soaring food prices are causing a “silent tsunami” of hunger to sweep the globe.

But despite posting superb profits that handily beat earnings estimates and raising outlook, the stock sold off, together with the rest of the sector.  That’s partly because commodity prices have dropped back, causing related stocks to do the same. The stock-price decline, in the case of Potash, also has a company-specific negative component: Workers are threatening to strike at three mines that account for roughly 30% of Potash’s output. Without question, a strike could negatively affect Potash’s output – even as it raises the price of potash globally, helping the company’s rivals in the near-term.

However, the afore-mentioned sell-off in commodities has been driven by several important factors:

  • Short-term momentum players and some institutional investors have moved away from the so-called “ethanol trade,” since electoral uncertainties raise probability that next year’s ethanol subsidies might be reduced or scrapped altogether.  This worry also has affected Archer Daniels Midland Co. (ADM), a prime beneficiary.
  • The U.S. dollar has been climbing against both the Japanese yen and the European euro, especially now that Europe has started to slow, a victim of its appreciated currency tight monetary policy. Some emerging economies also tightened their monetary policies to curb inflation. In this environment, commodities as hedge for inflation have lost some appeal, at least for the moment.
  • This slowdown and demand destruction, in part because of higher prices, have also induced oil prices to decline, and that, in turn, has helped reduce overall inflationary pressures – reducing the need for investors to hedge energy with grains and other agricultural commodities.
  • Summer in the United States has not seen extreme temperatures nor hurricanes, so this year’s crop has only been mildly affected by floods, unlike last year’s weather-induced crop losses. Benevolent weather has also helped lower the price of oil.

On the positive side, emerging-market urbanization, and the accompanying consumer boom (all driven by strong growth in real incomes) is alive and well and will continue unabated for the long-term.  So, at some point, Potash and its competitors will become a compelling long-term “Buy.” But the uncertainty regarding the U.S. ethanol subsidies, which originally helped fuel the demand for fertilizer, is too difficult to call at this point.

With most investors having captured massive profits in these stocks and with a high probability of seeing next years’ capital gains taxes increased, there is a strong incentive to take profits now.

Therefore, I would lock in profits and wait for an opportunity to get back into this stock closer to the year-end. You’ll want a bit more clarity about the prospects for continued ethanol subsidies and lower prices to get back into this stellar company and its main peers in the sector.  And stay tuned for news on the Potash strike.

Action to Take: SELL Potash shares right now, and look to buy back in later this year when the outlook is clearer.

[Editor’s Note: Horacio Marquez was working as a vice president of the Merrill Lynch Emerging Markets Fixed Income Group in 1994 when he correctly predicted that both Argentina and Mexico were headed for currency crises - cementing his reputation as an expert on both the emerging markets and on the nuances of global finance. Now Marquez brings that expertise to you with his newly created "Shadow Stock Trader" service. To find out how to subscribe, please click here. "Buy, Sell or Hold" is a brand-new Money Morning feature that so far has covered Cisco Systems Inc. (CS), ABB Ltd (ADR: ABB), Cummins Inc. (CMI), and Chevron Corp. (CVX). We continue to appreciate all the readers who are writing to us, suggesting stocks they’d like to see analyzed.]

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