Rumors about a possible merger between Potash Corp (NYSE:POT) and Agrium (NYSE:AGU) have sent shares of the companies up 13.4% and 7.9%, respectively. The global fertilizer industry is struggling with pricing as slowing demand, particularly from farmers in China and India, has led to a situation of excess potash capacity and weighed on the earnings of fertilizer producers. The merger would make sense for both firms, but we would not recommend trading on the news as there are sizeable regulatory hurdles to clear.
Falling crop prices and lower farmer incomes have reduced global demand and weighed on industry pricing. POT’s average selling price for potash fell 44% y/y in the latest quarter. Slowing demand has compounded the issues stemming from the termination of a pricing agreement between two of the world’s largest producers, Uralkali and Belaruskali, in 2013, which created a more competitive pricing environment. Agricultural chemical producers are looking to consolidate (see Dow/DuPont, Bayer/Monsanto, and China National Chemical/Syngenta), and POT has been on the prowl since last year’s acquisition of German rival K+S AG fell through due to regulatory issues.
A POT/AGU merger would make sense, especially for POT. The company has historically relied on its large-scale and geographically advantageous Canadian potash mines for its low-cost position, but major currency movements have undermined this advantage relative to peers in Eastern Europe. Over the past two years, the Russian rouble has depreciated more than 50% against the US dollar while the Canadian dollar fell just 20%. By merging with AGU, POT could lower its unit costs by leveraging greater scale and reducing redundant costs and bolster its competitive position. But forward integration with AGU would arguably provide an even bigger benefit. AGU is the largest agricultural retail operator in the US, and a merger with AGU would allow POT to sell directly to farmers (rather than wholesalers and retailers) and improve the company’s pricing power. The merger would also make sense for AGU, which, like POT, produces potash, nitrogen and phosphate fertilizers. AGU’s access to low-cost natural gas at its Alberta nitrogen mines has been a key source of advantage, but increased shale production in the US and falling natural gas prices have undermined competitiveness. Integrating with POT would allow AGU to trim redundant costs and give the firm even greater barraging power over input at its retail operations.
A POT/AGU merger would improve pricing and lower costs for both companies, but investors should be wary of the significant regulatory hurdles standing in the way of this deal. POT is the world’s second largest producer of branded fertilizer and the world’s largest producer of potash, with approximately 20% market share. AGU is the third largest potash producer in the US, and the largest retailer of agricultural products. The newly consolidated industry would have significantly more pricing power, and fertilizer is a strategically important commodity group. The worry is that the merger would translate into higher food prices for consumers at a time when global growth is slowing and poverty has become a bigger issue. While we do think the merger is possible, we don’t think investors should make any trades on this news.