Inventory figures often provide insights into supply and demand dynamics. When inventory levels rise, it often points to a reduction in demand more so than an increase in supply. On the contrary, falling levels of inventory are positive for fertilizer firms because they suggest more products are drawn out of the inventory than are replenished.
Inventory near 10 year highs
Potash inventory in North America stood at three million metric tons at the beginning of the year, according to the Fertilizer Institute. The figure is hovering near the higher range of the past 10 years, ranging from as low as 0.8 to as high as 3.6 million metric tons. Historically, inventory levels of ~3 million metric tons have preceded inventory level declines. This is because when inventory levels are high, producers such as Potash Corp. (POT), Mosaic, Inc. (MOS) and Agrium, Inc. (AGU) will react by cutting supply and raising prices, which reduces the replenishment rate of the inventory, lending to lower inventory levels.
Cyclical nature of inventory
Additionally, inventory levels tend to be cyclical. For the past 10 years, inventory levels tend to have risen sharply for a year, followed by a zigzag decline for the next two years. This is possibly because unlike nitrogenous fertilizers, farmers can forgo use of potash from time to time. During bad economic times, it makes more sense for them to cut potash than to cut nitrogenous fertilizer applications. This creates an alleviated inventory level. However, farmers will eventually have to buy potash or the soil will become less efficient. When demand returns, inventory levels tend to drop.
Inventory should fall over the next two years
If history holds, inventory levels should fall over the next two years. This is positive for companies like Potash Corp., Agrium, Inc. and Mosaic, Inc. that manufacture potash products because falling inventory levels often coincide with higher revenues and earnings through higher potash prices or demand. Potash Corp. will likely benefit the most as ~46% of its revenue comes from potash fertilizers whereas it is ~30% for Mosaic and ~25% for Agrium. This should also benefit the Global X Fertilizers / Potash ETF (SOIL), which invests in major fertilizer manufacturers worldwide.