Wednesday, August 18, 2010

BHP and me...

Does the stunning all-cash offer for Potash Corp. by mining giant mean anything to Midwest farmers?  I'm positive it does, but exactly what?
BHP Billiton’s unsolicited US$39-billion takeover offer for Potash Corp. of Saskatchewan supports the underlying strength within the fertilizer sector. It also provides support for key mine site resources as major miners seek to diversify further into the fertilizer sector, according to Clarus Securities analyst Steven Gold.
He believes this bodes well for the entire fertilizer group, primarily Potash One Inc., since its Legacy Project is in the same region as many of Potash Corp.’s assets.
He also thinks specialty fertilizers will benefit from this news as consolidation within the conventional fertilizers continues.
“Increased focus will be on specialty fertilizers that in many cases offer farmers higher yields,” Mr. Gold said in a note to clients. [More]
Reading between the lines, it looks to me like mining companies see farmers as one of the brighter sources for attractive margins.  Just like Monsanto indicated to Wall Street just a few months ago, our input suppliers intend to get their share of the prosperity on the farm, and one way is to dominate market share. Bottom line: higher fertilizer prices unless more competition shows up.
Of all the nutrients, potash has the greatest potential for growth — a potential 298% increase to match that recommended rate of 66 pounds per acre.
One interesting piece of news from China in February was the government initiative to boost crop yields by sending out 100,000 agronomists to educate 160 million farmers about modern farming techniques. The goal is to boost fertilizer use and demonstrate the benefits by way of soil samples. China is the biggest fertilizer market in the world, but crucially, it lacks much in the way of potash. China must import most of its growing needs.
That’s because potash is a rock and quality mines are scarce. It costs a lot of money and time to bring one online. A brand-new (or greenfield) 2 million-tonne potash mine will cost you a minimum of $2.2 billion — not including what it would cost for infrastructure such as rail, power, etc. It would also take seven years.
So the bigger-picture reasons for owning potash still make sense. More importantly, for our purposes, is the value of the stocks.
The April 20 edition of Foreign Policy included a story titled “Peak Phosphorous,” with the subhead: “It’s an essential, if underappreciated component of our daily lives, and a key link in the global food chain. And it’s running out.”
The story begins:
“From Kansas to China’s Sichuan province, farmers treat their fields with phosphorus-rich fertilizer to increase the yield of their crops… Our dwindling supply of phosphorus, a primary component underlying the growth of global agricultural production, threatens to disrupt food security across the planet during the coming century. This is the gravest natural resource shortage you’ve never heard of.”
You think OPEC is a force with 75% of the world’s oil reserves? Well, just five countries control 90% of the world’s phosphate reserves: Morocco, China, South Africa, Jordan and the United States.
The U.S. has only 12 phosphate mines. When food supply issues get hairy, countries essentially stop exporting phosphate. China did this in 2008. (China has the second largest reserves of phosphate, after Morocco.) I don’t see a phosphate shortage as imminent, but it’s a potential flash point that would surely light a fire under a couple of the stocks in the Capital & Crisis portfolio.
These stocks are potential monsters. They could double their output by 2015 and 2020. About 75% of new supply coming online till 2020 is from these two titans. This provides a powerful way to increase earnings even if potash prices go nowhere. If prices do climb, then earnings will jump sharply.
The value in these stocks, though, really comes from their huge net asset values (NAVs), as seen by looking at replacement values. In other words, let’s answer the question what would it cost us to build these assets from scratch?
If it is cheaper to buy the stocks than to build the assets, we have a promising situation. Think about that as if you were potash producer. If it cost you $1 billion to build a 1-million-tonne facility or $500 million to buy a ready-made potash mine in the stock market, what would you do?
All things being equal, you buy the stocks. In today’s market, the stocks are cheaper than building new mines. A number of global mining giants get the attractive investment profile I’ve laid out for you. Vale and BHP have already made small purchases. Vale bought Bunge’s phosphate mines and took a majority stake in Fosfertil, a Brazilian fertilizer company. In 2009, Vale also bought potashBHP already owns reserves for a possible mine in Saskatchewan. All of these would be greenfield projects. reserves in Argentina and Saskatchewan.
So given all the risks, expense and time… why not just buy the two big players in the Capital & Crisis portfolio if they are cheaper? (Not only are they cheaper, but the assets are of a much-higher quality).
I have my own conservative estimates of their NAVs based on replacement value. However, I could be way conservative. Morgan Stanley’s estimates are much higher, to give one other estimate. They include an estimate for infrastructure. They also use average costs based on existing publicly disclosed greenfield projects.
The high cost of new assets also provides price support for fertilizer prices. To lay out all of that cash for a new potash mine and get just a 10% return on your investment, you’d need potash prices of $500 per ton to make it work. Currently, prices are around $350 per ton. Brownfield expansions — or additions to existing mines — are cheaper. Some can work at prices as low as $250 per ton. These brownfield expansions are what the Capital & Crisis investments are doing. But they’ve got the best assets. [More - although I was a little generous excerpting]
Meanwhile at the same time, the USDA is fussing about consolidation within our borders.  This discussion may be needed but will it really matter much if our adjacent links on the value chain (suppliers and buyers) are all global-sized. Tinkering with our ag market structure here won't touch multinational concentration, it seems to me.


Anonymous said...

The federal government abandoned a sustainable rural economy in the 1980s when the justice department and the judiciary supported agribusiness consolidation, believing that consolidation was necessary to complete the globalization process. Ever since, the competition in all of the major agricultural industries has gotten very narrow. Deere, Monsanto, Tyson, Cargill and now JBS etc. We are already paying for economic consolidation through the lack of job creation in the US. But a funny thing about economics, workers without paychecks can't spend and consolidation always puts people out of work. We have forgotten what Simplot said years ago; "The great thing about the US is consumer buying power." Some day soon ag will pay more for this consolidation frenzy, farmers will be serfs, employees, tractor drivers and those who clean up behind the livestock. We only have to look at 18th century European agriculture and the enclosure movement to see what is coming.

Anonymous said...

I tend to agree with Anon 1.
Just 10 years ago 99% of the farmland that sold at auction went to farmers. Investors bid but farmer-operators got the land. Within the last 8 months however the auction land has gone to outside investors who are then renting the land to large farmers. One step (generation) away from serfdom.