Hansen of Raymond James sees the potash market as a barbell, with a handful
of large incumbent producers on one end and dozens of junior miners clustered
at the other. In this exclusive interview with The
Energy Report, Hansen discusses which juniors
may migrate to the mid-cap arena and why current share price weakness does
not dampen Raymond James' bullish sentiment on the sector, from Canada to
Report: Potash prices and production collapsed in 2008. Why
is Raymond James still bullish on potash?
Steve Hansen: It
is a relatively simple supply-demand thesis. On the demand front, global food
consumption is growing steadily alongside population growth, urbanization, rising
disposable income and shifting dietary patterns—particularly in
emerging markets. According to the FAO, global food production needs to
increase by 70% by 2050 just to keep the world adequately fed. That's an
enormous uplift compared to current levels. We view higher rates of
fertilizer application, especially potash, as one of the key factors in
achieving these necessary production gains.
On the supply
side, global potash reserves and production capacity are concentrated in the
hands of just a few key players. The world's top-five producers account for
two-thirds of global potash capacity. The immense capital requirements needed
to develop new mines present significant barriers to entry. This combination
of concentration and capital creates an attractive supply-controlled
environment; it allows the incumbent producers to extract favorable pricing.
What countries are the major users and/or exporters of potash products? Which
countries produce enough for their own consumption, and which are import
"There are three buckets of potash players in
Saskatchewan: the incumbent producers, the 'super-major' developers, and a
handful of junior developers." –Steve Hansen
largest exporters are Canada and Russia, where more than 70% of global potash
reserves are concentrated and the largest incumbent producers are also based.
The largest consuming nations are China, the U.S., Brazil and India, all of
which have large, agriculturally influenced economies. The largest consumers
are also the largest importers, although, in some instances, importers do
have material amounts of domestic production. The obvious cases are the U.S.
and China, both of which have fairly sizeable domestic potash industries that
help reduce the amount of required imports. On the other end of the spectrum
are Brazil and India. Because both have very little domestic production, they
must rely almost entirely upon international imports.
Saskatchewan holds 40% of the world's potash reserves. Who are the major
potash players in Saskatchewan? How have those firms been affected by the
recessionary economic situation since 2008?
From our perspective, there are three buckets of potash players in
Saskatchewan. First are the incumbent producers, including the large-cap
bellwether names, such as Potash Corp. (POT:TSX; POT:NYSE), The Mosaic Co. (MOS:NYSE) and
Agrium Inc. (AGU:NYSE; AGU:TSX).
bucket is filled with what we call the "super-major" developers.
These companies are relatively new players to the Saskatchewan basin, but
they have very deep pockets and plentiful access to capital. These firms
include BHP Billiton Ltd. (BHP:NYSE; BHPLF:OTCPK), Rio Tinto (RIO:NYSE; RIO:ASX) and
Vale S.A. (VALE:NYSE).
European producer K+S Aktiengesellschaft
(SDFG:FSE), also entered
Saskatchewan recently, as did a large Russian-backed player, ACRON Group (AKRN:LSE; AKRN:RTS).
bucket contains a handful of junior developers. These players are small-cap
companies looking to advance their flagship greenfield projects through the
traditional development milestones, typically with the goal of selling the
asset and/or luring in a strategic partner. These juniors do not have the
financial capability to advance a project beyond its initial development
stages. A couple of the key players are Western Potash Corp. (WPX:TSX.V) and Encanto Potash Corp. (EPO:TSX.V).
did falling potash prices affect the industry during the past recession?
"There is an increasing risk that small firms
working on good projects could be 'left at the altar,' with no partner to
consummate the marriage. This is likely to trigger a wave of junior
consolidation." –Steve Hansen
effects have varied. The large incumbents were not impacted much. Their
financial performance clearly suffered temporarily, as demand and pricing
both fell precipitously during the downturn, but both have recovered
handsomely since then, and these producers are now doing very well. There was
also some industry consolidation in the east. Developers also fared
reasonably well, buoyed by a few large takeouts in
the space. Most have also made solid strides in advancing their flagship
Given that demand for potash is subject to large demand volume and market
price fluctuations, what are the opportunities for potash juniors in Canada?
What about juniors in other regions of the globe?
Prior to 2007, the concept of a junior potash developer was pretty much
nonexistent. Prices had dwindled below $200 per ton for the better part of
three decades, and the major incumbent producers around the world had
multiple decades of low-cost reserves. So there really was no economic
incentive for junior developers to seek out new potash projects.
But as potash
prices began to surge, post-2007, junior developers sprouted up all over the
world, all racing to develop the next wave of greenfield potash mines, the
likes of which had not been built since the 1970s.
movers in the space have already played a major role in shaping the
industry's future. BHP acquired Anglo Potash Ltd. in May 2008, as well as
Athabasca Potash Inc. in January 2010. K+S later acquired Potash One Inc. in
November 2010. Most of these projects are now being advanced by their
respective new owners with first production being discussed in the latter
half of the decade.
this trend continue?
Looking forward, we believe it's going to be more challenging. The new
"super-majors," which are the most likely players to construct new
mines—BHP, Rio Tinto, Vale, ACRON, K+S—all appear to have made
their beds at this point, each with substantial land positions and/or
mega-scale projects already secured, thereby limiting the number of natural
To be fair, we
still believe there are reasonable prospects for large downstream players,
the big consumers of potash, to step in and provide critical financing and/or
offtake arrangements for junior developers. But
there is an increasing risk that many small firms working on good projects
could be "left at the altar," with no partner to consummate the
marriage. And as in most cycles of the commodities trade, this is likely to
trigger a wave of junior consolidation over time.
is the potential for offtake contracts for junior
That is the million-dollar question for the developers. The capital
requirements are enormous for greenfield potash projects. A smaller niche
project can require $750 million ($750M) in capital expenditures and a larger
one can require $3–4 billion. Juniors just don't have the financial
resources to capitalize these large-scale projects.
however, anecdotal stories of downstream Chinese and Indian parties preparing
to step up. They're doing a lot of due diligence. We know that. We just
haven't seen anything significant
exception is the recent offtake arrangement that IC Potash (ICP:TSX.V;
ICPTF:OTCQX) struck with Yara International (YARIY:OTCPK). Yara is one of the world's largest suppliers of
fertilizers, and this specific deal entailed Yara
taking roughly a 20% stake in IC Potash for $40M at a very nice 41% premium. Yara also entered into a 15-year offtake
arrangement for 30% of all production out of IC Potash's flagship Ochoa
opportunities for more offtakes, and I suspect we
shall see more of them. But I do not expect a wave of them in the near-term
Ethiopia has been a source of potash since the 14th century. In late 1960s,
floods shut down potash production, and then war and internal strife kept the
mines closed. How has this situation changed? Is the Ethiopian government
friendly to foreign mining investment? Is it stable?
"Developers in [Ethiopia and Brazil] are likely
to have access to capital from nontraditional sources, such as the
International Finance Corporation and World Bank." –Steve Hansen
Ethiopia is blessed with a high-grade, relatively shallow, world-class potash
deposit in the Danakil basin, which is located in the northeast near the
Eritrean border. It's very well positioned geographically to service some of
the world's highest-growth markets for potash, with relatively short shipping
distances from Africa's eastern coast. However, from our perspective, the
principal challenge for the basin pertains to the country's relatively
undeveloped infrastructure. It's still lacking in a lot of key roadways,
rail, and power infrastructure. There are also key technical issues around
water availability that still need to be addressed. The Ethiopian government
has made significant progress on road development, however, having paved a
large roadway into the southern side of the Danakil basin. The government has
also contracted a Chinese state-owned railway group to build out the rail
infrastructure. The early stages of this rail infrastructure are not headed
into the Danakil, but there is the potential to extend rail there, which
would be a huge win for the basin. Other large parties—Yara being a key example—are also making additional
investments in the basin.
So the short
answer is that Ethiopia still has clear challenges to overcome. But the
quality and size of the resource is not to be ignored. Over time, the Danakil
will certainly be developed, but a few more things need to fall into place
before large-scale development can take off.
counterintuitive advantage Ethiopia has going for it is that developers in
the country likely have access to capital from nontraditional sources, such
as the International Finance Corporation and World Bank. Developers with
projects in advanced countries, such as Canada, cannot access this type of
capital. There are good examples of infrastructure-related
projects—wind in particular—where the IFC and World Bank are
already providing attractive financing terms to advance the economic
development of Ethiopia. And we expect that potash developers in the Danakil
basin likely have access to similar sources of capital. For example, Allana Potash Corp. (AAA:TSX; ALLRF:OTCQX) has already
struck very good financing arrangements on both the commercial and
international banking fronts.
has Allana partnered with?
the equity side, Allana has received equity
financing from Liberty Metals & Mining Holdings LLC. (a
subsidiary of Liberty Mutual Insurance). Liberty is a large, sophisticated
group with a great deal of mining interests around the world. The World
Bank-affiliated International Finance Corp. has also taken an equity stake in
Allana. This was a critical accomplishment for the
company's credibility. Thanks to a recent equity raise, it is now fully
funded through its definitive feasibility study (DFS). The one key piece of
the financing puzzle still to be completed is on the debt side, but this
likely won't occur until the project's DFS is completed later this year. At
that point, presuming everything goes to plan, the company will need to raise
one last tranche of equity to finance construction. The big question for Allana is what percentage will go into debt versus
equity? Typically, it's a 60/40 or 70/30 split. But Allana
may be able to raise the ratio even higher, perhaps even 80% debt, given its
access to development agency financing. It just needs to address key
technical issues that are still outstanding.
there other players operating in the Danakil basin?
a partnership in the basin. South Boulder Mines Ltd. (STB:ASX) is on the Eritrean side of the
border. And Ethiopian Potash Corp. (FED:TSX.V; FED.WT:TSX.V) has a deposit.
BHP also has a large concession in the basin, although it hasn't been too active there of late.
footprint is well mapped out. It is a world-class deposit, with attractive
attributes. Multiple parties are expressing interest in it. The big question
remains: Is it the easiest deposit to develop in the current context, versus
What other regions are you looking at for potash?
the incumbent producers' side, we favor Canada. But in terms of the
developing opportunities, we really like Brazil for junior developers. There
are some very large potash deposits in the Amazon basin, but they're not easy
to get at. There are complexities around climate, humidity, access and
infrastructure. A benefit is that Brazilian firms do have access to some of
the same nontraditional funding I mentioned earlier, including the
International Finance Corporation. Furthermore, the Brazilian Development
Bank has already expressed definitive support toward other fertilizer
projects, including one controlled by MBAC Fertilizer Corp. (MBC:TSX).
become an agricultural powerhouse in recent decades. But the challenge is
that it needs to import up to 90% of its potash. The government views this as
a strategic issue, and it is working toward self-sufficiency in potash by
2020. That timeframe may be a bit ambitious, but at least it has outlined a
What are investors looking for in a potash company?
Overall, from a financial constraints perspective, potash investors looking
at junior developer opportunities seem to prefer smaller, bite-size capital
projects, given the significant challenges around raising capital. Investors
also prefer that production come online sooner rather than later, which is
one of the reasons we suspect many projects are steering toward solution
mining, versus traditional underground mining techniques.
do you determine a target price for your stock picks?
the large incumbents, we apply a target multiple to the company's forward
projected earnings. Flexibility in this target multiple, at least compared to
its historical range, allows us to capture a wide
array of potential factors that may also influence the share price and
outlook. For the developers, our target prices are generally derived using a
risk-adjusted, net asset-value (NAV) approach. Most of the junior potash
developers do not have cash flows today. So, in simplistic terms, we forecast
a company's future cash flows based upon its development project attributes,
and then discount it back to present day to derive a NAV. Finally, once we've
got the aggregate NAV figure, we risk-adjust it for various factors, such as
stage of development and geopolitical and technical risk. Handicapping is
more of an art than a science, particularly for the earlier-stage developers
when the cash flows are years away.
you prefer any particular potash players?
two favorite names are Potash Corp., which we rate as an Outperform with a $60/share
target price, and MBAC, which is Outperform
with a $4.50 target price. In the current environment, we
generally prefer the larger companies with current cash flow. Potash Corp is
the bellwether in this space. It is the world's largest fertilizer enterprise
with the number-one ranking in potash capacity. It is number three in
phosphate and nitrogen. Potash Corp is in the final stages of a decade-long capacity
expansion program, whereas many of its large competitors are just getting
started with expansion programs. And at the same time, as its capital
expenditure winds down, its free cash flow is set to balloon. That should
facilitate stock buybacks, dividend increases and further strategic
investments. Given its share price retreat in recent months, it's now trading
at ultra-low levels.
MBAC is a
unique story. It is phosphate focused and it is Brazilian. Its flagship Itafós Arraias SSP
project is fully funded and poised to go into production later this year. The
potash industry today is a barbell. On one end are the big, incumbent
producers and clustered at the other end are the small developers. MBAC is a
junior developer that is going to migrate into the big production bell. We
see that as a rerating opportunity for the company. We also see it as an
opportunity for MBAC to develop as a large fertilizer enterprise, because it
has a number of very attractive assets in its pipeline. MBAC is our second
favorite name. The other developer that we are positive on is Western Potash.
It has a very attractive property in the Milestone project in southeast
Thanks for talking to us today, Steve.
was a pleasure.
joined the Raymond James investment firm in October 2005 as an associate
equity analyst covering the industrial sector. He was promoted to equity
analyst in April 2007. Prior to joining the firm, Hansen worked as a stock
analyst with Morningstar, covering the forest products sector. Hansen holds a
Master of Business Administration from the Ivey School of Business at the
University of Western Ontario and a Bachelor of Science in forestry from the
University of British Columbia. Steve also holds a CMA designation and is a
CFA Charter holder.
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1) Peter Byrne of The Energy
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stock in exchange for services. Interviews are edited for clarity.
3) Steve Hansen: I personally and/or my family own shares of the following
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