The seeds of economic recovery have been planted. Over the last 9 months, governments across the globe have poured more stimulus packages into the economy than any of us could have imagined just a year ago. But like the biblical parable of the sower and the seeds, new growth is anything but guaranteed.
Monday the markets were down sharply as investors worried about rhetoric from the G-8 meeting. Specifically, comments about cutting back on stimulus programs weighed on the markets. One prominent report likened this potential decline in stimulus measures to planting seeds and then deciding not to fertilize. While we have been skeptical about the long-term benefits of excessive spending, it seems illogical to generate a market recovery based on the expectation of spending, only to back off this plan before the fundamental picture gives significant evidence of a rebound.
Commodities were especially hard hit due primarily to strength in the dollar (which makes everything else less expensive on dollar terms). These comments should be taken with a grain of salt, especially when considering the motives behind the speakers. It is in the best interest of nations who have significant dollar reserves, to see the dollar stronger. So as nations that the US relies on to purchase debt state their confidence in treasuries and in the dollar, it is similar to a trader “talking up his book” or boosting confidence in positions he has already taken.
While the decline in commodities was disconcerting, it does not appear to be a fundamentally justified move. I believe over the coming months we will see a robust trend towards higher prices of hard and real assets. While the dollar may not fall in comparison to other currencies (remember other governments can print currency too), the purchasing power of the dollar will likely fall sharply. This could correspond with a sharp rally in the dollar price of commodities.
One company that could benefit greatly from this trend is Potash Corp. (POT). The company makes fertilizer and feed products for use in the US and Canada. These products are obviously in strong demand regardless of the economic cycle as few would consider basic food to be a discretionary item. There is a relatively finite supply of potash available for fertilizer and since POT owns rights to a significant amount of this resource, it should benefit from strong pricing power in the coming months.
The stock traded lower well ahead of the financial slump for much different reasons. Potash had been trading at an unsustainable level when biofuel was considered to be a viable alternative for our energy issues. Investors bid POT higher in expectation that the company would enjoy high prices due to the inordinate amount of corn being produced for ethanol. As this alternative became less popular, and traditional energy prices dropped, Potash pricing dropped as well.
Today the dynamics are much different with a lower stock price, significant expected growth, and the demand being driven by true agricultural consumption and not as much by biofuel speculation. When added to the inflation scenario we spoke about earlier, Potash Corp begins to look like a very appealing investment.
From a valuation standpoint, POT currently holds a PE of roughly 11 times earnings. That number is less helpful when you look at the volatility in earnings over the past two years. In 2008, the company made $10.95 per share as commodity prices spiked higher. In 2009, the company is expected to earn only $6.89 due to lower pricing power and the biofuel headwinds. But looking to 2010, analysts expect the company to make $11.29 and I expect that estimate to be relatively conservative as most analysts still have some deflationary biases.
Potash Corp has a relatively stable balance sheet with debt adequately covered by cash flow. The company pays a small dividend which is not really that important as an investor, but it appears that management has confidence in its ability to generate free cash flow enough to pay investors on a quarterly basis.
The stock should likely be priced more in line with the assets underground than with the earnings on any given year. As potash pricing picks up over the coming quarters, those reserves will become more valuable and the true net equity of this firm will be supported. Over time, this will likely be reflected in the stock and could push prices past $200 in the next 6 to 9 months.
FD: Author does not have a position in POT
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