While 
Potash Corporation of Saskatchewan's POT fourth-quarter results generally met our expectations, the company's guidance for 2014 fell below our forecast.
Potash volume is the primary driver of the discrepancy. We were expecting a sharper bounce-back in potash volume, as uncertainty in the potash markets seems to be abating and buyers are returning to more normal purchasing patterns. While the market has settled down somewhat with new China contracts from Canpotex and Uralkali, PotashCorp is predicting its potash volume will grow only 1% to 6% in 2014. We were expecting a growth rate in the double digits, even given the company's December announcement that it would temporarily cut operating capacity to reduce costs.
Despite a potash market that remains in flux in the near term, we still think PotashCorp's volume is set to expand significantly over the long run as potash demand in emerging markets grows and the company fills newly installed brownfield capacity. We forecast long-term sales volume of more than 14 million metric tons per year, compared with our revised 2014 forecast of about 8.4 million metric tons.
Potash takes the starring role
While PotashCorp has its hands in the production of all three primary crop nutrients, potash remains the jewel of the firm's operations. With a 20% share, PotashCorp is the world's largest producer of potash fertilizer by production capacity. The firm's Canadian mines sit at the low end of the cost curve and should generate profits even if prices drop to marginal costs of production. PotashCorp is in the midst of spending about $8 billion to expand its potash production capacity, with operational capacity expected to reach roughly 17 million metric tons by 2015.
With a handful of players controlling a large portion of global potash assets, the industry has recently functioned as an oligopoly, with big producers shuttering production temporarily in periods of low demand. However, the sustainability of pricing power in this oligopoly is in doubt following the announcement that Uralkali plans to produce at full capacity in 2014 and accept lower potash prices. That said, lower near-term prices are likely to lead to indefinite delays for large greenfield potash projects, which should eventually produce a tighter market.
In addition to potash, which accounted for nearly 60% of gross profit in 2012, the company produces nitrogen and phosphate fertilizers. These industries have lower barriers to entry than potash.
From a competitive standpoint, we rate the firm's phosphate operations as more attractive than its nitrogen business. PotashCorp owns phosphate rock mines in the U.S. and benefits from not having to purchase expensive rock from third parties. Nonintegrated producers, which typically buy rock from Morocco, are commonly the marginal producers, and PotashCorp's access to cheaper rock currently places it below the marginal producer on the phosphate cost curve.
Nitrogen fertilizer production is essentially natural gas upgrading, so the ability to produce is dictated by access to natural gas. PotashCorp uses long-term contracts to purchase the majority of its gas from Trinidad. With gas prices in North America subdued from the explosion in unconventional extraction techniques, PotashCorp's gas currently sits at a cost disadvantage to North American competitors.
Low-cost assets and high barriers to entry dig a wide moat
PotashCorp has a Wide Economic Moat Rating thanks to its low-cost potash assets and high barriers to entry created by staggering greenfield capital costs. PotashCorp is on the low end of the potash cost curve, allowing it to pump out profits even if potash prices should approach marginal costs of production in the future. Lower costs stem from the geology of the company's Canadian deposits and the scale of its mines. Further, barriers to entry in the potash market are high, in our opinion. Economically viable deposits are found in only a handful of locations around the globe, with Canada, Russia and Belarus as the main producing regions.
PotashCorp's brownfield expansions come at lower capital costs per ton than proposed greenfield projects, most notably BHP Billiton's Jansen project. Additionally, greenfield projects can take more than seven years to complete and fully ramp, creating a barrier to entry for new participants. Further, PotashCorp will be able to produce potash for many years, with reserve lives for its mines ranging from 65 to 85 years at current production levels. We expect returns on invested of roughly 17% in year five of our forecast, despite pressure on potash prices from growing supply and a potential end to high prices previously supported by a rational oligopoly.
If we become more confident that the cartel-like nature of the potash oligopoly is truly dead and all competitors in the industry begin to produce at capacity without regard to price, we may reduce our wide moat rating for PotashCorp, as this could mean high-cost producers could be kicked off the cost curve, leading to lower marginal producers setting market-clearing prices. However, we view this scenario as very unlikely.
Prices for crops and fertilizer can fluctuate
Crop prices, which take their cues from demand and weather, can drive fluctuations in fertilizer pricing. Fertilizer prices have fluctuated wildly in the past, and uncertainty of future supply makes it difficult to predict long-term prices. For example, BHP could theoretically break up the potash oligopoly by successfully developing the Jansen project. PotashCorp is exposed to underground mining risks associated with its potash assets in Canada. In addition to mining safety, underground water issues could drive up potash costs. The firm may be subject to lawsuits and regulations related to its phosphate mines. Further, the company has run into antitrust issues in the past, given its strong position in the potash industry, and these concerns could resurface.
Our uncertainty rating for PotashCorp is high. Our forecast for fertilizer prices depends on a few hard-to-predict factors, including demand and the scale of greenfield capacity that enters the market. Further, Uralkali's new volume-before-price strategy heightens long-term price uncertainty for potash. Newly announced nitrogen projects in North America could lead to oversupply, and Morocco has the reserves to swamp the phosphate market if it chooses. On the upside, potash prices could skyrocket if demand accelerates in China and India and supply is constrained. A wide potential sales range and high operating leverage lead to a high fair value uncertainty rating for PotashCorp.
