DBRS Confirms Potash Corporation of Saskatchewan at BBB (high), Stable Trend

DBRS has today confirmed the Senior Unsecured Debt rating of Potash Corporation of Saskatchewan Inc. (PCS or the Company) at BBB (high) and its Commercial Paper rating at R-1 (low), both with a Stable trend. As expected, the Company has turned in a strong operating performance in up-cycle conditions for the fertilizer industry. Despite an increase in debt leverage, favourable operating earnings and internal cash generation maintained all debt coverage ratios, which are compatible with the current ratings.

The fertilizer market was volatile in 2008: strong demand in the first half followed by a sharp decline in Q4, mirroring the gyration in crop prices and farmers’ sentiment during the year. Despite the volatility, the Company achieved record earnings in 2008. The key driver for the record performance was high product prices, which have more than offset the impact of lower shipment and rising input costs. High grains prices in the first half of 2008 drove up the demand for fertilizers as growers wanted to optimize yield. A tight supply condition globally further helped potash prices. However, worsening global economic conditions led to a sharp decline in crop prices in the last half of 2008.

North American farmers deferred their purchase of fertilizers due to a late harvest and uncertainty regarding crop prices. The demand for fertilizers was made worse by South American farmers’ lack of access to credit in their primary planting season (Q4).

Fertilizer shipment dropped precipitously in Q4 2008. Nevertheless, strong prices were able to boost gross profits to record levels in all three nutrients (potash, phosphates and nitrogen). Near term, there are conflicting factors clouding the demand picture. The positive factors supporting stronger demand for fertilizers include: (1) Cash margins for most crops remain attractive for farmers to optimize yield; (2) The purchase deferral by North American, Chinese and Brazilian farmers last fall necessitates a “catch-up” on fertilizer use to replenish depleted nutrient levels; and (3) China was behind in its purchase of potash due to a late contract settlement. However, concerns about worsening global economic conditions may continue to depress crop prices. Uncertainty with crop prices, in turn, causes farmers in North America to reduce planted acreage and, consequently, fertilizer usage. De-stocking by dealers has also depressed demand.

The impact of lower demand is reflected in the Company’s Q1 2009 results which were weaker than the prior year period but in line with DBRS expectations. On balance, the demand for fertilizers in 2009 is expected to decline moderately from 2008 levels. Producers, especially potash, matched supply to demand support prices. DBRS expects that higher input costs and export tax imposed by governments to secure domestic supplies would also lead to higher nitrogen and phosphate prices. Fertilizer prices are likely to remain relatively stable near current levels, well below the average in 2008 for phosphate and nitrogen, but above 2008 for potash. The Company’s operating performance is expected to be weaker than the record in 2008 but still above the pre-2008 levels. Medium- and longer-term outlook for fertilizers is favourable. The factors supporting increasing use of fertilizers include: (1) Rising crop prices due to low stocks-to-use ratio supports attractive cash margins for farmers; (2) Global population growth and improving diets lead to higher need for grains and more planted acreage; and (3) The need to optimize yield due to limited arable land available further drives up the use of fertilizers. The Company is well positioned to benefit from the uptrend in fertilizer usage especially in potash. The Company has significant potash reserves.

The Company’s financial risk profile remains respectable. Cash flow from operations was a record, in line with earnings, and the Company continued to generate free cash flow despite a nearly doubling of capital expenditures. The Company was very active in buying back shares, spending over $3.3 billion in 2008. The partly debt-funded share repurchase boosted gross debt (adjusted for operating leases) to exceed 48% at the end of 2008. This leverage is aggressive for a cyclical company. Nevertheless, all debt coverage ratios were still at favourable levels supported by the Company’s strong operating results and cash flow.

However, the aggressive debt leverage is a key risk to the current ratings, especially the commercial paper rating. The high debt leverage limits the Company’s financial flexibility as the industry is facing a near-term decline. However, the recent term debt issuances will free up some short-term borrowing capacity and better position the Company to weather the current weakness in fertilizer markets. The Company has an ongoing expansion program to increase its potash production capacity, and capital expenditures are expected to be at about $1.8 billion in 2009. Notwithstanding the higher capex, the Company expects to generate about $1 billion in free cash flow. The Company has been active in share repurchase. However, PCS did not announce a new program to replace the one that expired in January 2009. DBRS deems the Company’s action to be positive, allowing PCS to strengthen its balance sheet from the expected free cash. Absent any major debt-financed acquisitions, DBRS expects the Company’s financial profile to strengthen and its debt leverage to moderate.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The applicable methodology is Rating Mining, which can be found on our website under Methodologies.

This is a Corporate rating.