Description

 First to Concede Intrepid was able to benefit from Potash Corp's game of "chicken" by riding industry price up, but IPI does not have the "staying power" that POT is able to wield because of its geographically isolated exposure to North American markets. Future demand is rooted in developing countries like China, India, Malaysia, Indonesia and Brazil where there are significant deficiencies in P+K (phosphate and Potassium). Intrepid services North American customers exclusively, and these farmers have been applying fertilizer religiously for decades. Intrepid is, therefore, more exposed to "soil mining" and localized inventory build that will cause it to cede pricing long before its more geographically diverse competitors.

 Asset Poor Intrepid Potash was formed in January 2000 for the purpose of acquiring the Moab Mine from Potash Corp. In POT's view, the mine had reached the end of its useful life, but IPI, through "novel mining industry techniques", was able to bring the mine back to life. Intrepid has been able to profitably operate Moab and other second-rate mines in an environment of record high potash prices; however, these mines will not be able to adequately ramp production to offset deteriorating price.

Valuation / target

75M shares @ $28.10 = $2.1B mkt cap

+ $0 debt

- $93M cash

= $2B EV

 IPI will earn between $0.50 and $1 in 2010 based on 580 million short tons sold at $390 per short ton. I think the stock is worth $20.  Consensus is $360M top line / $1.30 eps.

I am recommending a short of Intrepid Potash (IPI).  In 2008, IPI benefited from the huge price spike in potash and in 2009 it has benefited solely as a result of the price discipline of the major producers. Potash price has fallen significantly down to ~$400/tonne from $1,000/tonne and the industry (Potash Corp) has talked about price stability all the way down. Now the bulls have conceded on price and believe that volume will offset further price erosion. This puts IPI in a bad spot, because (A) it doesn't have the potash reserves to increase capacity and (B) Potash Corp is doubling capacity by 2012 which will undoubtedly have an affect on price. The gig is up on IPI as price collapses back to "normal" $200-400/tonne levels because its margin structure is the worst in the industry.

 The two most recent datapoints for IPI were Mosaic's (MOS) earnings release and POT's earnings release. Mosaic continues to tell investors that the bottom in potash sales has arrived -- "potash demand is on the brink of a recovery" -- yet still refuses to provide guidance on potash sales and potash selling price "until potash market conditions improve". Management, however, is quick to point out that phosphate demand has picked up AND backed it up by providing FY2010 guidance for phosphate sales and price. The conference call was littered with management double-talk on potash demand, but the bottom line is that demand continues to wane (especially in North America), because farmers are under the impression that potash pricing will continue to drop the longer China defers its contract.

Mosaic's decision NOT to provide potash sales volume guidance (again) -- an indication that management cannot tell if a bottom has actually been set. All  eyes are now focused on the North American market ahead of the fall planting season, and I expect ZERO demand from North American farmers because of potash-rich soil and high-priced potash. IPI's unsolvable problem is its 100%  geographic exposure to the "healthy" fields of North America and farmers' unwillingness to pay for expensive potash. IPI will make between $0.50 and $1.00 in 2010 at potash prices of $400/tonne and pricing could end up being closer to $350/tonne.

Potash reduced guidance a few months ago after the close on a friday night.  While lowering  guidance on Friday evening (after options expiration) is incredibly sketchy, it was the wording in the press release that spells disaster for Intrepid.

Potash Corp stated: "Potash inventories ... have been largely eliminated and potash levels in soils around the world have been significantly reduced. This creates a progressively higher risk to crop yields as soil fertility is continually diminished. While the immediate impact has been masked by good weather and residual soil nutrient levels in markets with healthy long-term fertilization and agronomic practices, such as the US and Australia, yields for key crops in several other growing regions are expected to be substantially below 2008 levels."

Potash Corp is saying that 2010 potash demand will come from outside the US -- admitting that inventories remain high and demand non-existent in the US. This statement is crucial to IPI because it supplies potash ONLY to US markets. The catalyst for IPI is broad based EPS misses and continued downward earnings revisions through 2010.  As a reminder, Intrepid has the highest fixed costs in the industry (under-producing mines that were bought from Potash Corp at the top of the potash cycle), so if demand wanes, production is cut, earnings fall to pieces.

Bulls say potash demand has to aggressively return because yields are being adversely affected because of reduced potash application. Clearly yields have not suffered as the USDA now expects yields to IMPROVE by ~5% in 2009 despite a 60% reduction in potash application.  Farmers are rational people and will wait to see degradation in  yield before spending $$$ on potash next year (especially in the  "soil-rich" US).

The big risk to the short thesis is the USD / inflation trade ... which is exactly why I like the short here. USD / hard asset bulls are bidding up the stock but the company fundamentals cannot keep up.

Catalyst

earnings below consensus