Valuation Gains In Potash Offsetting Potential Uncertainty

RBC Capital Markets upgraded Potash Corporation of Saskatchewan (USA) POT to Outperform from Sector Perform on its merger with Agrium Inc. AGU.

Last month, Potash and Agrium announced a merger of equals, with the new company set to be a leader in the fertilizer industry with 2015 pro forma net revenue of about $20.6 billion and EBITDA of $4.7 billion before synergies.

Analyst Andrew Wong says the combination “will create a stronger business to better handle current market challenges, capitalize on strategic opportunities, and still provide significant leverage to long-term market recovery.”

The deal is expected to close during mid-2017, subject to the satisfaction of customary closing conditions.

“We think there are significant strategic advantages to NewCo that should not be underappreciated and could prove to be just as important as the synergies in the long-run,” Wong wrote in a note.

The merger is expected to generate up to $500 million of annual operating synergies, which the analyst termed “ambitious, but achievable.”

“Assuming NewCo is able to accelerate the Retail M&A strategy and that the acquired businesses are vertically integrated with Wholesale, we think there is potential to increase overall potash sales volumes by ~500Kt by 2020,” Wong highlighted.

Further, Wong noted that the regulatory concerns around the deal were overblown as he expects the merger will be approved given limited overlap and real-world competitive dynamics.

“We think the benefits from a combined AGU/POT outweigh potential risks related to changing potash exposure,” Wong continued.

That said, the analyst cut his 2016 and 2017 EPS estimates to $0.47 and $0.52, from $0.54 and $0.68, respectively. However, he added that PotashCorp’s unused capacity is well-positioned to gain market share as demand grows.

Wong raised his target price to $19 from $15.