Unlocking Value in Growth

By Mark McMillan

When investors are looking for growth, it usually refers to securities that will achieve better than average capital gains as opposed to dividend yields. When farmers are looking for growth, they are looking at ways to produce better than average crop yield using the same amount of land. The most decided advantage to increasing crop yields is fertilizer.

When people improve their financial status, one of the first things they do is improve their diet. This leads to increased primary and secondary demand for crops. The three primary macronutrients in fertilizer are Nitrogen (N), Phosphorous (P), and Potassium (K). The latter two are primarily obtained by mining deposits or the minerals.

The need for food has risen dramatically in recent years with the fast paced growth of the emerging markets. The need doesn't rise linearly as is driven by the rise in the primary demand for the plants that people consume. The accelerated demand comes from the secondary demand for additional crops as feed for larger livestock herds. It is this increased demand for more meats in the diet that causes potash (the contributor of potassium nutrients) demand to surge.

The world's largest known reserves of potash are found in Canada (11B), Russia (2.2B), and Belarus (1B) tonnes of reserves. The United States has the seventh largest known reserves at about 300M tonnes and produces around 1M tonnes annually. Demand for Potash in the United States is around nine times the amount produced so most of the demand is met through imports. The economic advantage to domestic producers becomes clear when significant transport expenses, delivery risks, political risks, risk of potential future cross border taxation and other uncertainties or costs are taken into account. In the 1980s, the U.S. Commerce Department accused potash suppliers of “dumping” and imposed huge tariffs on imported sources.

The marketplace for potash supply is dominated by the Potash Corporation of Saskatchewan POT. It is a Canadian supplier and is the leading supplier of potash, and is the third largest supplier of nitrogen and phosphate, the other major nutrients used to make fertilizer. In 2010, BHP Billiton attempted an acquisition of Potash Corporation of Saskatchewan and the Canadian government decided it was not in Canada's best interest and nixed the deal. Potash Corporation of Saskatchewan is valued at over U.S. $50B and is one of Canada's largest companies.

Another large supplier of potash is Mosaic MOS which is a U.S. based company. Like Potash Corporation of Saskatchewan, it is a company with global reach and produces both potash and phosphate. It is valued at approximately $35B.

Agrium Inc AGU is another competitor based in the U.S. It is valued at approximately $15B. Like the other large competitors, it supplies potash, phosphate, and nitrogen.

While a number of the market leaders are based in North America, there is insufficient production in the United States to meet demand for potash. The latest data that is available shows North American potash inventories remained relatively flat in February 2011, increasing by three percent from January 2011 levels. That is seven percent below year earlier levels and twenty-one percent below the five-year average. The result has been a regular increase in the price of potash where March 2011 prices were at $581 per metric ton.

Securing a reliable supply of potash is a requirement for U.S. fertilizer producers and will be quite lucrative to the supplier. Providing a reliable supply in the United States along major rail transportation routes will provide a lower cost, better featured product producing higher margins for the supplier.

We have located a company well positioned to deliver potash to the fertilizer producers in the United States of America. Prospect Global Resources Inc PGRX is a company engaged in the exploration and mining of potash in the Holbrook Basin in eastern Arizona. The company's strategy aligns well with the opportunity provided to potash suppliers in the United States.

Specifically, the Company has a 50% equity stake in leasehold positions consisting of approximately 32,000 gross acres in the Holbrook basin. The company is the exclusive operator of the project. While this isn't the Company's only acquisition candidate, it is a key area to focus on to bring the leasehold to production status.

Estimates for potash production costs by established North American producers is approximately $100 per metric ton. The margin on potash in North America is very high. In the Holbrook basin, production costs may be even lower than average due to the shallow nature of the deposits, at only around 1,200 feet.

With global economic growth likely to continue, there will be increased pressure on crop yields as well as to increase land committed to crop production. All of this signals more demand for fertilizer and the limited supplies of potash in the United States. With potash inventories more than twenty percent below 5-year averages, demand is being generated not just to meet supply needs but to bring inventories current as well. This sort of pent-up demand will continue to move potash prices higher for the foreseeable future, which will make domestic potash production that much more lucrative. If you are looking for an undervalued stock in a sustainable growth market, Prospect Global Resources Inc. may fit nicely into your long term portfolio. The key is to establish a position before the Company is able to bring production on-line when the stock begins to receive analyst coverage and stock moves up toward a valuation more in-line with the fundamentals.

Mark McMillan blogs daily for Equities Special Situations and may be contacted at mmcmillan@equitiesmagazine.com.

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