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Uralkali heads for the classroom

Dan Coatsworth / Shares (UK)
Uralkali heads for the classroom

Crop nutrient potash theoretically has a bright future as the world’s population gets bigger and lives for longer. Food demand will steadily increase, forcing farmers to improve crop yields by using fertilisers. Yet a lack of demand in key markets of China and India has caused a correction in the commodity price.

The big industry players including Russia’s Uralkali (URKA) are trying their best to revive potash prices by curtailing supplies. Spot prices have this year started to edge ahead, giving the £14 billion cap the confi dence that it can strike more favourable sales contracts in Asia.

‘We believe 2013 will be the year of demand restoration which will give us solid ground to increase prices further,’ states the company’s chief fi nancial offi cer (CFO) Viktor Belyakov.

Planting seeds of growth

The chemicals-to-mining group is optimistic but the all-important new price agreement with China has yet to be struck. Market commentators suggest the fi rm will have to agree a lower price but Belyakov reckons this will not be the outcome.

The existing $400 per tonne Chinese contract expires at the end of June, at which point the CFO says Uralkali will start talking to Chinese buyers about new terms. ‘We believe farmers can pay a higher price. Farmers in India are paying $427 per tonne which is higher than the price in China, yet the Indian situation is much worse for farmers.’

A reluctance by Indian farmers to buy potash was central to last year’s commodity price correction. ‘The government signifi cantly decreased subsidies a year ago and the rupee depreciated a lot against the dollar,’ explains Belyakov. ‘Our selling price is denominated in dollars, so Indian farmers were eff ectively having to pay a higher price. India usually consumes 6.5 million tonnes per year; last year it consumed just 2.5 million tonnes.’

The second market to scale back purchases in 2012 was the United States, primarily because of unfavourable weather conditions. This year, Brazil is proving to be one of Uralkali’s bright spots. ‘Demand is very good and Brazilian farmers right now are very profi table. Back in 2008 when the price for potash in Brazil was $1,000 per tonne (more than twice the current level), prices for soft commodities were even lower than right now.’

Belyakov implies that farmers can aff ord to pay more for potash because their own operations are more profi table. I suggest that farmers would only buy potash when their crop yields are poor and income is reduced, acting as a catalyst to take decisive action. ‘It depends on the culture of farmers. In developed countries like the US, Europe and Brazil, farmers very well understand that potash is absolutely required to have good yields. In developing countries like India, China and even Russia, we have to educate farmers.’

Uralkali has a degree of fl exibility with its operations so it can increase or decrease potash production in line with demand. It forecasts the entire potash industry to sell between 53 million tonnes and 54 million tonnes this year. Uralkali itself is expected to produce around 9.5 million tonnes in 2013, depending on demand and pricing terms with China. That would put its capacity utilisation rate at 75%, lower than the historical market norm of 80% to 85% and certainly a diff erent story from 2010 and 2011 when the industry operated at full capacity because of record demand.

The CFO doesn’t see any point in building up stockpiles of potash to service any future increase in demand. One key reason is a lack of spare storage facilities. This is one area which could see investment in the near future, alongside infrastructure support – most likely a new port to complement an existing terminal in St Petersburg which doesn’t have the capacity to support Uralkali’s expansion plans.

The latter may depend on whether the company proceeds with building a large new mine called Polovodovsky. This is one of two projects that could dramatically increase the group’s production capacity by nearly 50% to 19 million tonnes. Work has already begun on the fi rst asset, Ust-Yayvinsky, ahead of an expected 2020 start-up date. Both assets are shallower deposits than competitors’ mines so it should be cheaper to access the potash material.

When I talk about start-up dates (2021 is on the schedule), Belyakov says the board hasn’t decided on exact timings, implying that the project could be delayed if market demand doesn’t dramatically improve. ‘Right now, we are working on a feasibility study for this greenfi eld project. We have to prove the investment case at board level in 2015.’

One infl uential factor will be BHP Billiton’s (BLT) plans for its $15 billion Jansen potash project in Canada. Reports suggest that Uralkali could delay Polovodovsky if BHP decides to develop Jansen as this would add eight million tonnes to global supply, a signifi cant fi gure. Although BHP is cutting back expenditure across its business, it is understood to still favour the fertiliser sector so the risks of Jansen getting the green light remain prevalent to Uralkali’s plans.

Producing for the world

The Russian group currently has 13 million tonnes production capacity, having just expanded operations at its Berezniki-4 project which added 1.5 million tonnes. It plans to add another one million tonnes of capacity through de-bottlenecking operations. Two years after merging with Silvinit, the enlarged group has delivered $300 million of cost synergies. The challenge is to now secure further cost efficiencies. Job cuts are certainly on the agenda.

‘We try to mitigate inflation by cost cutting, one way being headcount reduction,’ says Belyakov. ‘We know our productivity is far from optimal. Our competitors produce almost the same amount of potash with much fewer employees so we have huge improvements to do.’ Better workflow management is required, so too is increased automation.

Belyakov continues: ‘The most important job is to keep costs under control. It is not very easy when the company is really profitable to control costs.’ He says another cost-saving measure will be energy. Uralkali last year built its own power generation facility which will provide 20% of its energy requirements. ‘The cost is almost two times cheaper than purchasing energy on the market.’ The group is also looking at making repair and maintenance functions more efficient.

Most large cap diversified miners have maintained a strong balance sheet despite weaker commodity prices. Uralkali is also looking healthy, having earlier this month secured a $1 billion loan agreement to refinance existing debt and for general corporate purposes. In April, VTB Capital forecast that Uralkali’s net debt would move from $2.4 billion in 2012 to $991 million by 2014.

The company has a policy to pay out at least 50% of net profit in dividends. A forecast payment of $2.25 per share for 2013 puts Uralkali on a prospective 6.3% yield. Some analysts have suggested the company could soon pay a special dividend, given it generates large amounts of cash that isn’t needed in the immediate future. When I ask if the regular dividend might get a boost, I get the sense the answer to this question is no. Belyakov claims institutional investors say they are fine with the current payout level. Share buybacks are presently favoured by the Russian group. ‘We try to purchase our shares back when our performance is worse than the performance of our competitors or the index in which we are traded.’

The shares trade in London as global depositary receipts – essentially packets of shares. While these are aimed at institutional investors, the retail market can get exposure to Uralkali through spreadbetting where most of the big providers have the stock available for trading.

Belyakov isn’t tempted to switch the company’s main listing from Russia to London, even though there’s plenty of investor interest. Uralkali relishes the high liquidity in Russia so that will remain its primary trading location.

Its share price has held up quite well compared to diversified miners. Concerns about the ability to push up selling prices to China look fully priced into the stock. The one area of encouragement that we would highlight to any prospective investor is that Uralkali last year managed to maintain profitability despite lower selling prices, thanks to a weaker Russian rouble (its cost currency) and merger synergies from Silvinit. We believe further cost efficiency plans bode well for protecting profits ahead of a market recovery.

Preparing for tomorrow’s harvest

The attractive long-term market fundamentals underpin the Uralkali case. Therefore we see merit in buying into price dips. One reason for buying now, even though selling prices are fragile, is that Uralkali’s efforts to educate farmers on the merits for potash could result in a much bigger customer base in the future.In essence, it is planting the seeds for tomorrow’s harvest.

Analysts at HSBC made similar comments in April when they predicted that the potash industry would focus on volume more than price over the next few years, ‘attempting to reignite broader potash usage and deter new entrants such as BHP’. They added: ‘We think that producers may try to reignite the widespread use of potash in developing markets like China and India over the coming years, and once a healthy usage trend has been established, return to leveraging demand into higher prices.’

Education efforts are already underway. Belyakov says farmers need to understand that potash should be consumed in the right proportions with other nutrients: nitrogen and phosphate. ‘Potash is responsible for resistance against disease and wet weather. In India, the proportion between nutrients is very unhealthy; they apply nine pieces of nitrogen to just one piece of potash. The proportion should be two nitrogen, one potash.’

There is clearly a need for Uralkali’s expertise to encourage not only usage of potash but also proper application. But isn’t there a risk that educating farmers could be to its competitors’ advantage as they could then buy potash from anyone in the market? ‘You are partly right,’ admits the CFO. ‘But we don’t see that as a risk. Our programme is designed to promote potash consumption, not Uralkali. It is a good thing to educate people to promote potash.’

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