I previously wrote up high-cost potash producer, K+S (SDF, listed on the DAX in Germany) last November, contending that the combination of a turn in the potash market; a structurally high-cost set of assets; and a terribly-levered balance sheet with near-term maturities all made for a potent short cocktail. The stock has since fallen ~55% in about 4 months, and – while I initially covered my short a couple of weeks ago, a little too early but close to my conservative base-case price target – the complete obliteration of the oil price breathes new life into the short. This time, I’m going after not just the stock but also the bonds.
Let me explain. You may recall that a large portion of global Potash supply comes from the ‘Russian’ portion of the cartel (‘BPC’, comprised of Eurochem, Belaruskali and Uralkali) – in total they supply about half the global market and enjoy 1st quartile cash costs (around $100-130/t FOB, and definitely below $100/t at the mine). Much like other global commodity markets, Potash is priced in USD but clearly with mines in Russia/Belarus, many of BPC’s costs are locally denominated – that is, Ruble linked. When local costs go down, despite the fact that Potash remains a cartel, the temptation for RUB-based producers to ‘cheat’ is immense – this is why historically in times of a weaker Ruble, Potash has fallen, often aggressively. See this chart from the 2014-16 period (from US producer, Mosaic):
You can see that when the Ruble is in the 65-80 range versus the USD, Potash prices have generally been below $250/t and basically parked at multi-year lows around $225/t (for reference: the current price of MOP in Brazil – the standard benchmark – is around $245-250/t).
Now here is what the RUB has done over the last month. Note the spike weaker post the OPEC debacle – RUB is currently trading in the 72/73 range:
All else equal, it seems to suggest Potash will do very well to stay above $225/t – that is multi-year lows. Actually, I think the damage this time around could be far worse, for a few reasons:
- every single producer has already shut in low-cost production to support prices and is sitting on inventories and excess capacity – but even at $200/t BPC RUB-based capacity now probably makes 60% gross margins;
- in particular the Russians (Eurochem) as well as the Belarussians (Belaruskali) have been trying to ramp new capacity for the last couple of years – the collapse in their production costs gives them an additional spur to push tons into the market at the expense of high-cost players;
- the cartel broke once before – spectacularly – in 2013/14, and at that time the proximate cause was Belaruskali wanting to expand market share to take advantage of low cost production;
- Because of Coronavirus the Chinese annual contract never got signed and inventories in Brazil and China still look quite high so there is no knowing if the market doesn’t crater anyway later in the year because of a demand issue.
This last issue is particularly worrying for producers since many were counting on a return to demand from Asian palm-oil producers – big consumers of potash, and where prices had been very firm until quite recently – but, with the linkage to oil prices, palm oil prices are now collapsing.
Consequences for K+S are…dire
So at this point, I don’t think it is unreasonable to expect an OPEC-like breaking in the Potash cartel, just like we saw in 2013. The Canadians and the Russians/Belarussians must all be silently sitting at the poker table, side-eyeing each other, wondering who is going to blink first – whilst poor old K+S is left holding the bag whatever happens. And while this time we may not see as much absolute downside in prices – perhaps we just remark $75/t lower to say $175/t – it should be noted this outcome would still be a DISASTER for K+S and likely wipe out remaining equity value. At just $200/t, I believe K+S burns >$600mm in FCF; will end 2020 close to 8x net levered; and – most importantly – will probably be unable to sell a minority stake in Bethune because extant prices may well be loss-making even for the new Canadian assets (still sub-scale). The scale of burn would further complicate the attempted sale of the Salt business, since doing so would leave the remaining company (Potash only) burning a hideous amount of cash and still incredibly levered.
Frankly, I think with this new wrinkle from cratering oil prices, along with the ongoing torching of the high yield market, I think refinancing the 2021 bonds will now present a meaningful challenge. That’s why I’m adding not just to my equity short – where I have a hard time seeing any residual value – but also supplement the position with a highly asymmetric wager against the ’23 unsecured bonds at 94 – still a 2.5% yield – for paper that may well end up needing to be restructured or highly subordinated in some form.
Disclosure: short SDF.GY stock and bonds