DBRS Confirms Potash Corporation Ratings at BBB (high), R-1 (low)

DBRS has today confirmed the BBB (high) Senior Unsecured Debt rating and the R-1 (low) Commercial Paper rating, both with Stable trends, of Potash Corporation of Saskatchewan Inc. (Potash or the Company). The Company is the leading producer of potash fertilizers and has a strong U.S.-based phosphate fertilizer/industrial product supply business and a low-cost nitrogen-based fertilizer/industrial supply business focused on North American markets. This makes Potash, in aggregate, the largest fertilizer enterprise in the world. Strong 2010 earnings drove a large increase in operating cash flow, to $2.4 billion from $1.3 billion, but $2.0 billion in capital expenditures and share buybacks ($2.0 billion) led to 45% gross debt in the capital structure at the end of 2010, higher than at the end of 2009. Improved earnings resulted in an improvement in coverage metrics in 2010. DBRS views the Company’s current financial metrics as solid, even for the R-1 (low) Commercial Paper rating, but it has been aggressive with large share repurchase programs and high investments in its potash capacity expansion program, even during the 2009 downturn. Despite the Company’s prospects for strong operating cash flow and its good liquidity in 2011, DBRS is maintaining the BBB (high) Senior Unsecured Debt rating and the R-1 (low) Commercial Paper rating with Stable trends until the sustainability of the recovery of fertilizer markets and the Company’s spending profile become more evident.

Potash’s operating income, at $2.3 billion, was almost triple 2009 results, in the progressively improving market environment of 2010. Net income was up 84% to $1.8 billion. Fertilizer markets, particularly potash, recovered sharply in 2010 from a severe downturn in 2009. This was reflected by higher sales volumes in each of the Company’s segments and higher average pricing for phosphate and nitrogen fertilizers, although not back to record 2007-2008 price levels. Average prices for North American and international potash sales declined in 2010 as sales volumes remained well below industry production capacity and due to the lag effect of certain contract pricing formats. Additionally, pricing to industrial users of phosphate and nitrogen products failed to surpass 2009 levels.

The Company continued to aggressively expand its potash production capacity even during the 2009 downturn, when sales were less than 30% of potash operational capacity. High capital expenditures and several share repurchase programs have increased the proportion of gross debt in the Company’s capital structure to 45% from under 20% at the end of 2007. Although the Company’s recent credit metrics have been strained by higher debt levels and the earnings impact of the 2009 downturn in fertilizer markets, the 2010 business environment was significantly improved and further improvement is expected in 2011.

The outlook for 2011 is positive and DBRS expects a continuing recovery in all sectors of Potash’s business. Very high agricultural commodity prices have improved the economics of fertilizer application. As a result, an upswing in demand and prices for most fertilizer products was noted in the second half of 2010 and a firm market tone is expected in 2011. In potash, North American producer inventories had been drawn down by 35% from the end of 2009 and Chinese contract buyers were active in the market (in contrast to their relative absence in 2009). In phosphates, strong demand, particularly from India, led to an 8% rise in shipments of solid phosphate products in 2010, leaving producer inventories in North America at record lows and companies challenged to meet rising demand. North American nitrogen-product producers are reported to be operating at near capacity as low domestic natural gas prices help deter offshore nitrogen-based fertilizer imports.

The positive market environment is expected to allow Potash to improve shipment volumes and margins in 2011 compared to 2010. Improved cash flow is expected to be more than sufficient to fund a $2.0 billion 2011 capital budget and higher dividends, resulting in a reduction of debt (barring any acquisitions or added share repurchases). Coverage financial metrics are expected to improve somewhat in 2011, as is leverage.

Over the longer term, the outlook for fertilizer markets is positive and the Company is expected to increase its potash production capacity to 17 million tonnes by 2015 from 11.3 million tonnes in 2011. An unquantifiable, but potentially positive development in the potash sector is the proposed merger of two large Russian potash producers (already important players in the international markets), further consolidating the industry. These developments and the healthy outlook for phosphate and nitrogen markets lead to DBRS’s expectation that there will be an ongoing improvement in Potash’s credit metrics.

That said, deterioration of the Company’s credit metrics due to an unforeseen reversal in the positive tone of fertilizer markets or a too-aggressive approach to debt-finance expenditures for expansion projects, share buybacks or acquisitions may negate the generally positive outlook for the Company.

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.