Wolverine Asset Management

Potash One Investment Analysis

Recommendation: Hold

The enormous returns made by potash producers in 2008, like potash corp. (graph 1) has attracted a lot of
attention from players looking to enter the industry as well as investors looking to share in the potash
industry’s profits. Potash One, although not operating any potash mines currently, is an attractive suitor for
investors as it had moved early and secured permits for potash exploration and mining; including land
sitting on reserves that feed one of the biggest potash mines in the world, The Belle Plains Mine being
operated profitably by Mosaic Co producing 2.8 million tons per year. Potash One is scheduled to begin
building their flagship ‘legacy project’ mine, on that land in Q4 this year and begin potash production in
2013. The plans entail a similar solution mine to the one operated by Mosaic, characterized by lower initial
capital expenditure but higher marginal costs. With 29 million tons of measured reserves and 222 million
tons inferred reserves, P1 is well placed to graduate from a junior potash player to a senior one in the next 5
years. It also plans to be the first to production of several planned greenfield projects.

The management has admitted that the $1.9B price tag is too much for the company to undertake on it’s
own. However, there are members on the board of directors who are known to be connected in the mining
industry, and are reportedly capable of attracting the desired capital from Asia. China and India as some of
the world’s leading and fastest growing consumers of potash, have significant incentive to gain a foothold in
the world’s largest potash basin and one in such a politically and economically stable climate. More likely is
an acquisition by one of the larger potash producer who have shown appetite for junior potash companies.

A large part of the reason the industry and indeed the legacy project are getting so much attention is the
sudden and enormous upward price shock in potash prices over 2007/2008, reaching up to $1,050/ton.
Investors have acknowledged the tripling of price within 12 months as a sign that the old days of potash
production at less than 70% of capacity are over as world demand catches up to supply. The situation last
year, while unique, does offer several insights into the future of the potash market. Specifically we saw two
of Potash Corp’s mines strike, record low inventories and sold out contract volumes. In a demonstration of
market power, Potash Corp could have cranked up capacity and supply at other mines but instead chose
not to, and raked in humongous profits along with the other major potash players. The same graphs reveals
the striking correlation between potash prices and the earnings of potash producers and thus a very high
‘potash price beta,’ βpp, i.e the movement of the stock price with the price of potash.

More recently however, potash prices tumbled down to a low of $350/ton, agreed between Belaruskali
Potash and China. The deal was heavily criticized Potash Corp’s CEO, who described the Russians as
“panic sellers”. The rapid decline in price is attributed to the flexing of market powers by buyer cartels,
enabled largely by the ability to forgo potash use for up to 2 years without significant decrease in yields.
Canpotex refused to ink deals with China at the rock-bottom price and negotiated later for an undisclosed
and ‘competitive’ price; supporting the view that potash prices are set to stabilize above their FOB
Vancouver price of $380 currently. However it is the enticing long-term demand growth for potash that
makes investors optimistic about future prices of, and therefore profits of, potash producers. India and
China have been strong sources of growing demand for fertilizers in the past decade, and are projected to
be a large portion of the estimated 20 mm tons of increased demand by 2020 1 (40% above current levels2).
The key drivers of this growth are: the growing ranks of the global middle class and identifiable shift to
protein rich diets across the board, the historical underutilization of fertilizers in emerging economies like
India,China and Brazil coupled with the world’s rapidly declining arable farm land will result in massive
demand for increased yields, fuel price have tripled since 2003 3 leading to rising food/crop transportation
costs, hence the need for increased food production in proximity to it’s final consumption destination, and
the lack of commercial substitutes for potash, all point to substantially higher demand in the long-run.
The risks associated with investing in Potash One is unique, i.e their exposure, pre-production and post-
production, to potash prices are very high but differentiated in underlying risk. In the pre-production stage,
the potash prices will determine their ability to find financing for a project of this scale, which will in turn
determine the attention (and hence premium) paid by the senior potash producers considering acquisition.
Once the mine is in production, the βpp should fall back in line with the large potash producers. Even those
who hold mining operations portfolios diversified outside of potash, like Mosaic, are subject to very high βpp.

The potash producing industry is characterized by high concentration of suppliers in the market as well as
high concentration of demand (facilitated by governments), no substitutes and no differentiation amongst
products from different producers. This gives rise to a competitive market where producers compete
primarily by volume instead of the conventional price-wars. Even with prices at the levels they were in 2008,
the senior potash producers cut their capacity utilization, a metric that had been growing gradually over the
past two decades (table 1). With yet some 17% capacity not-in-use, Canadian producers have a lot of
ground to cover before demand can once again push prices above their long-term trend. This commodity
price risk is the main reason this company is recommended as a hold. Even though it has capital
expenditure per ton (graph 4) advantages over the junior potash producers and some senior ones as well.

CIBC world markets estimates that current world capacity for potash production is approximately 61.8
million tons, and with current plans brownfield projects will add 5.6 million tons of capacity by 2015, any
incremental capacity from greenfield projects would have to be justified by faster rising demand volumes.
Unfortunately, based on Morgan Stanley’s bearish, base and bullish estimates for global potash demand
(table 3), only the bullish potash demand scenario makes greenfield projects viable in the short term. The
Morgan Stanley analysis was conducted before 2009 saw total potash trade shrink to almost 32 million
tons from 48 million tons the previous year. It seems as if the price shock has attracted over-investment
(albeit still in pre-production planning). Long-run demographic trends may exert upward pressure on prices
if capacity utilization rates reach 90%, although now an unlikely scenario, given announced projects.

The low traded volumes in 2009 (graph 5) have lead to estimates of reduced capacity utilized in 2010.
Farmers and Industry experts surveyed4 say that even though many suspended use of potash while prices
were unreasonably high, they expect to revert back to normal potash consumption this year. With no
projects adding capacity in 2010, this creates a unique scenario that paves the way for a smaller temporary
rise in potash prices in the near future. This hypothesis is also supported by the relatively diminished
inventories of 2008 (graph 6) and following low trade volumes of 2009. This inflated potash price would
have a positive effect on share prices, but would also provide incentive for acquisition. While the possibility
exists of Potash One’s value appreciation in the short term, potash over-supply will place a long-run cap on
profits to be made in the industry, just as chronic over-supply had in the years prior to 2007.

A DCF valuation of the legacy project being financed and built on schedule, and taking into account
parameters reflecting long-run over-supply scenario, justifies a share price of 3.95. The current price of 3.23
tells us two things. The 12-month target price return is 24.1%, and it provides us with a benchmark
minimum probability of the legacy project reaching production on time with adequate financing, of 82%. The
legacy project cannot justify its investment if the perceived probability is below the benchmark probability.

In conclusion, while Potash One is perfectly positioned for optimal returns in the potash industry, however it
is the bleak outlook for equilibrium price in the coming decades that ultimately places too much risk on a
non-producing assets such as Potash One’s reserves and permits. It is not clear whether all the planned
projects will reach production stage, but it is less clear that price signals in the potash market will deter the
‘optimal’ number of projects from being undertaken, to create strong potash price growth. Other Risks that
complicate return certainty are weather and environmental factors affecting the cyclical agricultural industry;
Mine disruptions and the possibility of the Saskatchewan provincial government attempting to recover re-
cent massive budget deficits created by depressed potash trade, by restricting future supply to put upward
pressure on future prices.

1 Potash by Kevin Stone, Natural Resources Canada

2 Morgan Stanley Research North America
3 Reuters-CRB energy price index
4 Scotiabank commodity price Index
 mean $ 361.6 million �US dollars�

highest $ 3.495 billion �US dollars� �Wednesday, December 31, 2008�

�$ 412 million �US dollars� �Friday, December 31, 1999�

Mosaic net income time series
lowest

Appendix
volatility 1210�
Input interpretation:

History:
Mosaic net income time series
$4B
$3B
Result:
$2B
$1B
mean $ 200.9 million �US dollars�

$ 3.528 billion �US dollars� �Sunday, November 30, 2008�

$0
agriumi net income time series
�$highest
1B

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Graph 1
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interpretation: 1901�
PotashDecCorp.
1988 toNet
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Agrium,
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12 months net income time series
History:
$4B
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million �US
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$ mean $ 217.6 dollars�
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2B

$ 1.37 billion �US dollars� �Tuesday, September 30, 2008�

© Wolfram Alpha LLC—A Wolfram Research Company
$1B
highest

�$ 110 million �US dollars� �Sunday, June 30, 2002�

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�$ lowest
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�from
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Generated by Wolfram|Alpha (www.wolframalpha.com) on March 11, 2010 from Champaign, IL.
$ 0 LLC—A Wolfram Research Company
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Generated by Wolfram|Alpha (www.wolframalpha.com) on March 12, 2010 from Champaign, IL.
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© Wolfram Alpha LLC—A Wolfram Research Company

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Table 3
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Graph 5
Consumption Shipment and Production of Potash

6:&'#(%)*&D4E64(#:.&
North America Potash Producer Inventory

2300
2100
('000's tons) - KCL basis

1900
1700
1500
1300
1100
900
700
500
300
Jun-08

Sept

Oct

Dec
Aug

Jan

Feb

June
Mar

Apr
July

Nov

May

Av g 03-06 06-07 07-08 Av g 96-06

!Graph 6 !
Potash producer Inventory (2008)

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