Is Worst Over for Mosaic or Do Challenges Persist?

Mosaic Company (NYSE:MOS), the largest U.S. based potash producer, reported adjusted 4Q13 EPS of $0.36, missing consensus estimates of $0.44 by 8 cents. The headline EPS was adjusted for non-operating charges and discrete tax items. Earnings miss was largely driven by lower potash prices and higher costs, which were partially offset by higher phosphate volumes. Higher-than-expected shipments for phosphates and potash were offset by higher operating costs that weighed on gross margins.

Despite an earnings miss, the company’s shares responded positively to both an incremental $1.0 billion buyback program, which is in addition to the ongoing agreement to purchase 43.3 million shares through July, and management’s view that phosphate has clearly turned the corner and that potash is likely to follow. Going forward, the company is highly optimistic about the potash market, believing that, “The stage is set for improving potash prices later this year [with] record global shipments and improving producer operating rates.”

In a challenging backdrop, the company continues to optimize what’s in its control. The steps, both small and big, that the company has taken to optimize its asset base and performance include the recent purchase of CF Industries’ (NYSE:CF) phosphate assets and the ammonia off-take agreement, which will increase revenue and lower COGS. The Ma’aden JV should also provide growth at an attractive ROIC due to a favorable JV split and logistics arbitrage. MOS has also reduced brine costs as it enjoys some mitigation success.

More Optimistic on Potash Recovery Than POT

MOS seems more optimistic on potash demand recovery in 2014 than Potash Corporation of Saskatchewan (NYSE:POT). The Plymouth, Minnesota-based company expects 57-59 million tons of potash shipments in 2014, up from 54 million tons in 2013. Although we think this is a very optimistic view, if these figures are achieved, this would represent a strong rebound in demand than POT is forecasting. MOS is more optimistic on Asia (including India and China), and Europe and FSU, where the company sees 1 million ton more shipments in 2014.

MOS Sees India Contract By End of April

Jim Prokopanko, Mosaic’s CEO, recently said in an interview that he expects Canpotex — the offshore sales arm of Mosaic, Potash Corp. of Saskatchewan and Agrium (NYSE:AGU) — to set a potash supply contract with Indian buyers by the end of April. MOS thinks that the South Asian country will announce new fertilizer subsidies within the next 60 days. Although adjustments which make potash and phosphate more affordable for farmers would be positive, it’s unlikely to result in any major changes.

MOS expects India phosphate demand to surge from 3.5 million tons of imports in 2013 to 5.0-5.5 million tons in 2014, reflecting the need to restock the supply chain. In addition, the company also sees the potential for India to boost 2H14 potash volumes.

Additional Share Repurchase Program

On top of the ongoing buyback of 43.3 million Class A shares occurring through July, Mosaic announced that its Board of Directors has authorized an additional $1.0 billion of share repurchases that could be completed through direct or open market repurchases. While the additional share repurchase program is constructive, it was largely expected by the market and is consistent with the company’s ongoing goals of right-sizing its balance sheet and returning capital to shareholders.

Conclusion

MOS shares responded positively to earnings report. The improved mood in the potash market, boosted by contracts signed in China and recent price increases announced by Uralkali and Canpotex, has led investors to focus on the positives. However, we are of the opinion that MOS’s shares are fairly valued given the balance of what we know and what’s still uncertain including Indian import’s levels and the production discipline following the break-up of BPC.

In the meantime, Mosaic continues to optimize what’s in its control, with the latest action coming in the form of an open market share repurchases authorization. While the company’s phosphate business is looking promising, we believe the potash fundamentals remain challenged. We believe the expectations for the potash market improvements are too high and we prefer to remain on the sidelines until there is more certainty. The near-term potash market trends are likely to appear positive given 1H14 China import contract and normal seasonal demand in the Northern Hemisphere; however, a sharp recovery in global potash demand in 2014 as predicted by MOS is highly unlikely given ongoing subsidy/FX challenges in India and prospects for a significant degradation in farmer economics in 2H14.