Monday, October 19, 2009

Potash (NYSE:POT): BHP could pay USD 125-130 for Potash Corp. (POT), bid would be 13% EPS accretive - Merrill Lynch

Merrill Lynch/BAM is out with a major call on Potash (NYSE:POT) saying BHP Billiton should buy the potash producer.

Firm estimates that an all-cash bid for POT at a 30% premium could be 13% EPS accretive in years 1 and 2. From discussions with clients during recent marketing, they believe the market is receptive to BHP acquiring potash assets.

Why is POT the right deal for BHP?
1) BHP has an interest in being a world-scale producer of Potash. This deal provides instant scale. 2) BHP wants to own world class long life, large scale, low cost assets. We think POT ticks all these boxes. 3) POT dovetails nicely with BHP’s existing land position and Greenfield project in Canada. 4) BHP’s balance sheet is ungeared and the company generates huge cashflows. An all cash acquisition regears the company and adds an appropriate, complementary asset. Merrill believes that Potash as an industry matches BHP’s core competencies i.e. 1) Project development 2) Resource operation management 3) Resource marketing.

Kudos for being ungeared into downturn but missed bottom
BHP Billiton was widely admired by investors for entering into the downturn with little/no debt having walked away from its bid for Rio Tinto. However, whether because it couldn’t move quickly enough or because its bids for available assets were too low, in firm's view BHP did not use its balance sheet to its advantage during the downturn. To be fair, the high quality assets that BHP wants to acquire are rarely going to be distressed and the downturn was relatively short lived.

Why now? Sentiment regarding potash nearing a low
Merrill believes that negative sentiment regarding Potash gives BHP a second chance at acquiring assets at a cycle low. Consider the following:

- Ag chemical companies have issued profit warnings.

- Price dropped below Merrill's estimate of long term price for the first time in years.

They think that bearishness is likely to persist up until China settles which could be 2-3 months out and could be a powerful catalyst. Distributor inventory levels in the Americas are low and will need to be restocked.

In Merrill's view if there ever was a time to buy a big potash producer, this is it.

BHP already owns Potash assets
Potash assets would not be a new M&A target for BHP, with the company having previously commented that potash is a good industry that suits its skill set i.e. mining, project development and product marketing and trading. In mid-2008, BHP acquired Anglo Potash for C$263 million. It has also secured numerous attractive mining permits in Saskatchewan.

Earnings accretion analysis
Merrill's simple earnings accretion analysis assumes an after tax cost of debt of 4% and a 30% acquisition premium. They also assume a simple 1% of sales as synergies although, from previous discussions with BHP, they believe that they think there is potential for material improvements by bringing “best practice” from their other mining operations. Is it surprising that an all cash transaction is so accretive? Not really, in our opinion, given that they are comparing after tax cost of debt to a return on equity. Still, given that BHP is perceived as undergeared, a transformative transaction of this size provides the releveraging that many in the market perceive as necessary.

Notablecalls: WOW - I sure didn't expect a call like this one from a firm the size of reputation (no pun) of Merrill/BAM. Surely, there have been hints from other firms and even speculation that a deal may be in works but nothing on the scale we are seeing this morning.

There were some positive rumbling regarding the coming Chinese potash price settlement on Friday, so I think the stage may be set for a large upside move in Potash shares.

Note the co reports this week but given they have already pre-announced there isn't much headline risk.

I think POT will trade up today to the tune of 5%+ meaning anything below the $100 level is a buy.

PS: This is what RBC Capital's Technical Analysis team has to say about Potash (NYSE:POT) today:

POT is of interest as it appears to be on the verge on reverson 4+ month downtrend. Similar to MOS, MON, IPI, POT will need to break its 4+ month relative performance downtrend to confirm technical relative reversal developing:

Notablecalls: This is exactly what it feels like - STAGE IS SET FOR A MAJOR UPSIDE MOVE.

Make sure you keep it on your radar.


Fanatic said...

Only sellers at 100 range in the stock premarket for such a "great" call.

notablecalls said...

should the day high break...its gonna ramp.

notablecalls said...

there ya go.

bl said...

MTW JOYG BUCY DE CAT same industry nice early move! My old POT 100jan call might come to life.

Shekhar said...

Postash at 125 will be cheap for BHP. The inherent value of POT is much higher. Goldman has a target north of $140 and several other analyst have a 170 target on Potash.