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Continued from Part 1: Why are potash producers increasing capacity?
Delaying capacity addition
The same can be said for capacity additions. Mosaic recently announced that it will delay its expansion by one or two years. Uralkali, which intends to leapfrog Potash Corp. (POT) by 2021 in total output, also said it will delay its expansion plan for as much as a decade if BHP plans to build the world’s biggest potash mine.
Delay possible in 2014 if market’s weak
Potash Corp. (POT), on the other hand, hasn’t said anything. But this isn’t worrisome because the majority of Potash Corp.’s (POT) new capacity is expected to come online in 2015. If the company wants to show better earnings to investors and expects that additional capacity in 2015 will be too much for the industry, it may delay the expansion in 2014, next year. This will reduce the possibility of lower returns.
Depreciation doesn’t start ticking
Because depreciation doesn’t begin until the expansion is complete, as Potash Corp. (POT) said in its annual report that “depreciation of assets under construction commences when the assets are ready for their intended use and is subject to management judgment,” the company won’t see the impact of increased depreciation expense in 2015, if it chooses to delay completion.
This approach is called “earnings management.” Companies will often try to smoothen earnings so they look more attractive to investors. Plus, the purpose of an income statement is to show how profitable the business is and how much each expense contributes to the total sales or revenue. If earnings were lower than normal during a year because of increased depreciation expense that wasn’t exactly used, it would understate earnings.
Given that Uralkali just broke away from its partnership with Belaruskali and crop prices have fallen due to favorable weather and solid output projections, we could see further weakness. But we’re seeing some plans to delay capacity additions, so some of the potential downside should have already been priced in, because companies’ decisions often lag customer demand.
While there is risk, the likelihood of a substantial increase in capacity is limited—unless competitive pressure increases if BHP enters the industry. This is positive for Potash Corp. (POT), Agrium Inc. (AGU), Mosaic Co. (MOS), and Intrepid Potash Inc. (IPI), as well as the Market Vectors Agribusiness ETF (MOO).
© 2013 Market Realist, Inc.