Can potash fertilise your portfolio?

"The future has never looked brighter for Sirius Minerals (SXX)," the firm's chairman, Chris Catlow, said in mid-November.

However, things have changed somewhat since then. With shares doubling over the past year, is it time for investors to take profits? Or will the stock continue to fertilise your portfolio?

The good

2011 was a year of good fortunes for the potash group, which has four potash exploration projects, including one in North America and two in Australia. However, it is the York Potash Project in England that is the jewel in the crown, accounting for approximately 20% of current global potash production.

Potash, the common name for crop nutrient potassium chloride, is an agricultural 'super' fertiliser as it is a source of soluble potassium, one of the three key plant nutrients. It is only mined in a handful of countries, with Canada, Belarus and Russia accounting for majority of the world's production and exports.

The company successfully completed coring of its first borehole at the York Potash Project in October and revealed "outstanding" chemical assay results from that borehole a month later.

This followed a £2.8 million award from the UK government's Regional Growth Fund for Sirius to build a "living laboratory" around its York Potash Project, before it was given the go-ahead for three additional planning applications on the project.

The bad

Grain prices are a key driver of fertiliser demand.

Growing food and grain demand, especially from emerging economies, created strong demand for potash and macro nutrients in 2007, which saw prices for the fertiliser rocket from $150 (£96) a ton to almost $1,000. However, when the financial crisis hit, demand for food and thus fertilisers dropped and prices plummeted.

And there are now concerns of a repeat of the crisis with high food inflation, eurozone worries and a slowdown of the emerging economies playing a downbeat tune on food and fertiliser prices.

Potash Corp (POT), for example, has announced a shutdown at two of its facilities in Saskatchewan after experiencing weaker-than-expected potash demand.

Additionally, fertiliser giant Mosaic (MOS) warned of "very cautious buyer behaviour" as lower food prices have prompted dealers and farmers to hold off on fertiliser orders in the hope that prices would weaken. It added that profits for the December-to-February period would decline due to "near-term macroeconomic uncertainty and cautious distributor purchasing behaviour".

However, Mosaic was "confident of the strong long-term demand prospects for our products", adding that the market would get over its near-term lull in potash to witness a strong spring application season and "record global shipments" in 2012.

This view is echoed by the International Fertiliser Association, which estimates that annual potash demand growth will continue at 3.5%, equivalent to two million tonnes, or one new mine each year.

Macquarie's analyst, Christian Faitz, agrees. Not only does he believe that potash demand will grow between 3% and 5% per annum due to the growing world population, growing wealth and declining availability of arable land, but that potash prices would remain "firm" due to "excellent supply-demand".

"For the time being, global farmers have an excellent cash position, and hence we see no issue on the [fertiliser] demand side well into 2012," he commented.

In addition, investors must not forget that floods in North America and droughts in Eastern Europe and Russia have led to declining global food stockpiles. This, coupled with the still-robust emerging market growth will mean that these stocks will need replenishing in 2012.

Sirius as an M&A target?

The fertiliser industry, has, in recent years, seen acceleration in merger and acquisition (M&A) activity as high potash prices lead existing players to look for new areas of growth.

In August 2010, for instance, mining heavyweight BHP Billiton (BLT) made a $40 per share bid for Potash Corp, following the acquisition of Canadian explorer Athabasca Potash in January the same year. A week after BHP withdrew its bid for Potash Corp, K&S announced a friendly $427 million takeover of Canadian junior Potash One.

"Management and directors own about 25% [of Sirius's stock]," noted Ash Lazenby, analyst at Liberum Capital. "As such, we see an acquisition of more than 50% as likely, but an outright 100% acquisition as less likely," he added.

Lazenby states that Sirius will need financing help of strategic partners to develop York Potash. "The construction of a large-scale potash operation is highly capital intensive and we estimate that Sirius will need to raise up to about $6 billion in order to realise three million tonnes per annum production from York Potash," he calculates.

According to Lazenby, potential strategic partners include BHP (which is looking to spend $80 billion on growth in the next five years), second-largest mining company Vale, Potash Corp, Russian behemoth Uralkali, Israel Chemical (which already owns the potash operation adjacent to York Potash) and K&S.