Monday, December 07, 2009

Potash (NYSE:POT): Upgraded to Buy from Neutral at Goldman Sachs

Goldman Sachs is upgrading Potash (NYSE:POT) to Buy from Neutral with a $140 price target.

According to the firm the upgrade is based on an improved demand outlook for potash in 2010 both in the US and globally. Over the past few weeks, datapoints have confirmed returning demand and they believe POT offers the most attractive way to play a potash recovery. Goldman believes US farmers will significantly increase applications vs. significantly weak 2009 rates, and worldwide demand should pick up following the long-awaited China contract settlement. Finally, investor sentiment on fertilizers has improved meaningfully, yet they believe we are still in the early phase of this upcycle. Firm sees 20% potential upside to their $140 price target.

Goldman notes they want to own POT shares today for two primary reasons:

1. The impending China contract settlement should serve as a major catalyst for the global potash markets and fertilizer stocks. This could come as soon as this month, but we more conservatively expect a settlement by mid-February. Settlement of the China contract will give retailers and dealers’ confidence in restocking inventories throughout the supply chain.

Given recent improved demand trends, including higher prices in the Chinese domestic markets, they believe the risk of a damaging contract settlement is diminishing. When the contract settlement finally occurs, they expect it to set off a global demand spurt as buyers will come out of the woodwork to secure potash for 2010. Buyer confidence is key to the market right now, and until the China contract settles, uncertainty remains. That said, similar to the US, Goldman believes farmers across the globe are likely to return to the market and buy potash for 2010 application.

Recent anecdotes from their China analyst suggest that the domestic potash market in China has thawed in recent weeks and demand is pulling inventory through the supply chain. Producer inventories have fallen meaningfully, according to Goldman China analyst, and are now about 3 million mt vs. the prior estimate of an excess of 4 million mt due to inventory draw downs during the recent weeks. Accordingly, prices have recently strengthened within China—from $350/mt up to $425/mt (at the retail level) depending on quality (with Canadian potash receiving a premium).

2. Investors are likely underestimating the 2010 US demand recovery that could see staggering yoy percent increases in volume given the depth of the 2009 reduction and the atypically weak fall consumption levels.

Over the past 4-5 weeks, they have spoken to many industry contacts—from farmers to producers—and sensed a critically important sentiment change within the fertilizer industry that potash demand is returning, and that fears of another decline in application rates are overblown. After spending time in the field over the last few weeks and discussions with various industry contacts, the firm ise now highly confident that farmers do not doubt the need to replenish their soil, and will do so at rational prices.

POT is the best way to gain from the 2010 potash rebound
Goldman views Potash Corp. as the best way to play a rebound in the global potash markets given its high earnings leverage to potash prices and volumes as well as being the natural large market cap choice for investors looking to gain exposure given its size and trading characteristics. Compared to Mosaic, POT has higher potash exposure; compared to Intrepid Potash, POT has a significant market cap advantage ($37bn vs. $2.5bn) as well as much lower unit production costs. They believe that POT is portfolio managers’ ideal choice for potash exposure.

Valuation, reflecting abrupt sentiment changes, can be volatile
After the recent run, which was NOT accompanied by a rise in estimates, fertilizer stocks look significantly more expensive than just a couple of months ago. Of course, the same can be said across the market if looking back to the March 2009 lows. Goldman notes they are conscious, however, of the role sentiment plays in these names, which can lead to seemingly stretched valuations relative to historical standards based on investor expectations for upward earnings revisions. In POT, for example, downward earnings revisions over the past three months have come hand-in-hand with higher multiples and significant stock appreciation as investors willingly look past any near-term earnings weakness and toward the rebound potential for 2010 and beyond.

Moves like these where share prices are moving in contrast to earnings revisions, indicates that market (buy-side) expectations had adjusted lower more quickly than sell-side. Indeed, they find the sell-side applied its highest rating on the shares as earnings were peaking essentially exhausting the chance for additional upgrades and creating asymmetric risk to the downside. However, now that we are closer to an earnings bottoming the firm sees a much more balanced spread of analyst ratings. This is a bullish signal suggesting that as industry fundamentals improve we could see analysts upgrade the stock.

Notablecalls: Well, Goldman is surely playing ketchup here with POT. Several other firms upgraded POT 20pts lower and I suspect Goldman's Agriculture team was praying for a sizable pullback to upgrade the name. They got one on Friday and voila..we have an upgrade.

While it's tough to love POT here Goldman does highlight the China contract catalyst hinting it may come earlier than most expect. I think most of you have seen the moves in some of the Chinese Agri names which seems to indicate there is something going on in the sector. If they can strike a deal here I suspect pricing would likely be on the more positive (closer to $400) side.

Note we have UBS out somewhat positive on the Fertilizer space, upgrading Agrium (NYSE:AGU) to Buy saying things should return to normal by 2011. This should add some fuel the the fire.

POT is trading close to its 52-week highs & we may see a breakout today. Note that Goldman's $140 target is the new Street high target for POT.


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