Uralkali eyes new potash rally

29.03.2012
Dan Coatsworth / Shares (UK)

The megacap miner-to-trader is not worried about the first big drop in demand for several years

The potash industry is pausing to catch its breath after several years of fantastic growth as customers feel the pinch of high commodity prices. Farmers are now refusing to pay over-the-odds for the fertiliser raw material. I put it to Victor Belyakov, chief fi nancial offi cer (CFO) of Russian potash miner, processor and trader Uralkali (URKA) potash companies have lost their pricing power. ‘I don’t think so,’ he replies.

The £15 billion market cap is confi dent this is only a short-term demand blip and that potash will soon return to its upward trajectory. ‘Last year was a record year for demand and price increases,’ explains Belyakov.
‘Frankly, farmers can pay even higher prices now.’

The potash industry operated at full capacity in 2010 and 2011, which is unusual as the benchmark level is usually between 80% and 85%, I am told. Working at maximum output is unsustainable as equipment maintenance must be carried out at some point. This is why 2012’s weaker demand is proving a good excuse for potash companies to play catch up and fix their kit.

Top of the crops

Potash prices increased five-fold between 2007 and late 2008 to a peak of $1,000 per tonne for some Asian buyers. They then retreated to the $350 level by 2010 and edged back above $500 a year later.

Uralkali has two contractual markets and the rest is sold through its trading arm. Deliveries to China are priced twice a year and India is contracted annually. The company said in December 2011 that Brazilian customers had rejected a $580 per tonne price, instead waiting to buy more potash until early 2012 when the planting season got underway. Following my interview with Belyakov, reports emerge China and India continue to postpone purchases of potash. Uralkali acknowledges demand weakness but continues to forecast its production this year will be no less than 2011 and that prices will rise.

‘We believe that the second half of 2012 will be much more aggressive in terms of demand compared to the fi rst half,’ says the CFO. ‘It is important to understand what is behind the potash price — it is the price of soft commodities, soyabean, corn and palm Uralkali eyes new potash rally oil. Right now, these potash-intensive crops are on a very healthy level in terms of price.

‘Compared with 2008, there are no liquidity problems. Last year and 2010 were record years for farmers, so they earned very good profi t and they have lots of cash.

Thus it makes sense for them to purchase fertilisers in order to increase yields.’

Uralkali is standing fi rm with its pricing. It wants to charge more without being too greedy. ‘We are not going to repeat our mistake which we made in 2008 when we increased our prices very sharply. Now, we do it by smaller steps. We have to be sure that each level is sustainable and affordable for farmers.’ The Russian’s earnings should increase in 2012 even if production levels are fl at. This will be achieved through higher selling prices and cost savings from having more effi cient operations, together with the synergies from 2011’s merger with Silvinit.

Soft signals

There are strong market fundamentals in support of potash. There is a growing global population; people are living for longer; and there is increasing wealth in emerging markets. More and more people will need feeding and those with more money will want to buy better quality food. There is a constant decrease in arable land per capita so the only way to meet the rising demand for food is to use fertilisers to improve crop yields.

Potash refers to potassium compounds such as potassium chloride or polyhalite, explains investment bank Fairfax. It says the term ‘potash’ is derived from ‘pot ash’ referring to plant ashes leaching in a pot.

Potassium’s main use lies in fertilisers that strengthen plant cells and disease resistance, help photosynthesis and improve the absorption of two other primary nutrients, nitrogen and phosphorus. Uralkali says its potassium chloride can also be applied directly to the soil.

Belyakov says rising soft commodity prices like corn are a leading indicator for the potash price. ‘If the price for soft commodities goes up, we will obviously increase our prices as farmers will still earn a good margin.’

I have a theory about the potash market which I run past the CFO. If corn prices go up, farmers can afford to buy potash. This helps increase crop yields which will in turn push up global supplies of corn. More supplies would theoretically pull down the corn price and then the potash price will fall. Is this the typical price cycle? ‘You may be right,’ he replies. ‘But there are strong fundamentals behind the industry which will stimulate demand.’

Uralkali plans to increase its production capacity by 65% over the next 10 years. Its rivals are also investing heavily in new projects. Will we reach the stage in five to 10 years where there is too much supply?
‘The industry needs more capacity to satisfy growing demand,’ says Belyakov. ‘The first quarter of 2012 is not as strong as last year, but under normalised market conditions there is a lack of potash.’

Chemical attraction

Potash was historically the domain of the chemicals sector until a $40 billion takeover bid by BHP Billiton (BLT) for Potash Corp of Saskatchewan (POT:NYSE) in 2010 made the soft commodity a household name and raised its profile in the mining sector. The takeover may have failed yet BHP’s actions have since spurred several new potash miners and even saw Rio Tinto (RIO) last year return to potash after exiting the crop nutrient industry in January 2009.

One of the biggest industry deals in the past few years was the merger between Uralkali and Silvinit. The combined group is now the world’s biggest potash producer by output and employs 23,000 people.

Belyakov says he anticipates higher than the $100 million annual cost savings originally earmarked at the time of the merger. The two companies were previously a single entity until 1983. Why did they separate? ‘I don’t know for sure. In the Soviet era there was Beruskali and the combined Uralkali/Silvinit. I’ve heard some legend that in Russia there should be three controlled companies to create some department in a ministry. There is no logic behind Uralkali and Silvinit’s separation and it is obviously more efficient to have a single entity.’

Both companies have low-cost mining operations and assets in the same geographical location. Prior to the reunion, they even chased the same acquisitions with Silvinit outbidding its peer for the Polovodovsky mine with a $1.5 billion offer.

This asset is now one of two mining projects central to Uralkali’s growth. Does Belyakov believe Silvinit overpaid for the asset? ‘The price for the licence depends on the price for potash. The tender took place when the market anticipated a strong increase in the potash price.’

Uralkali hopes to start production at Polovodovsky in 2021. ‘We believe our greenfield developments will be the cheapest in the industry,’ says the CFO, referring to both Polovodovsky and a second mining project called Ust-Yayvinsky which will start production in 2020. The latter will benefit from existing infrastructure. Both are shallower deposits than competitors’ mines so it will be cheaper to access the potash-rich ore.

Cost advantage

Low-cost production is central to Uralkali’s success. It claims to have good quality deposits and cheaper input costs than its peers. ‘We have cheaper energy and labour costs are also cheaper compared to our foreign competitors. We also have some advantage in terms of logistics. We can deliver up to two million tonnes to the northern part of China by railway at a very competitive tariff. We also have our own port in St Petersburg. Freight from here to Brazil is cheaper than from Vancouver to Brazil.’

Although staff overheads are lower than other countries, Uralkali still has wage issues. ‘Growth rate in our salaries is higher than inflation in Russia,’ admits Belyakov. Staff numbers are being reduced to mitigate this inflation. Will this affect production levels? ‘We know that competitors produce similar volumes with much smaller amounts of people. Excessive staff is our heritage from the Soviet times,’ he reveals. ‘It is not easy to increase productivity but we have to do it. It is not only a question of cost cutting.

The demographic situation in our particular region is deteriorating. We know that Eurochem (a competitor) is going to bring on production in our region, which will add to the pressure on the labour market.’

Share price weakness associated with the pullback in the potash demand presents a buying opportunity for Uralkali. Shares rates the firm as an excellent play on long-term growth in food consumption. We like its assets and applaud moves to improve corporate governance within the firm.

Investors in the UK will have to put up with buying Uralkali through depositary receipts as plans to have a premium listing in London with ordinary shares looks unlikely in the near-term. Uralkali is a big proportion of the Russian Stock Exchange index and a London premium listing would decrease liquidity in its home territory.

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