Analysts Ideas of the Week Uralkali Considers Dropping out of Cartel

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1 Week of August 6, 2013 Analysts Ideas of the Week Uralkali Considers Dropping out of Cartel Sid Rajeev, B.Tech, MBA, CFA Head of Research and Nicole Engbert, BSc (geology) Research Associate Mining Uralkali Considers Dropping out of Cartel Sending Potash Shares for a Nose-dive Up until last week, the global potash market was dominated by two marketing syndicates that controlled a combined 70% of global potash supply. However, on July 30, the Russian company, Uralkali (LSE: URKA), announced that it was considering separating from the European potash cartel, Belarus Potash Company ( BPC ). BPC is composed of Uralkali, and the Belarusian company, Belaruskali. This has sent the global potash industry into a nose-dive, with shares of Uralkali, Potash Corporation of Saskatchewan Inc. (TSX: POT), The Mosaic Company (NYSE: MOS), and Agrium Inc. (TSX: AGU) each dropping 19.09%, 16.04%, 17.28%, and 5.00% respectively, on the day of announcement. Together POT, MOS and AGU make up Canpotex, the other major global potash marketing group. Uralkali stated that they had been unable to come to an agreement with BPC after the Belarusian presidential decree No.566 came in effect in December The decree has allowed Belarus to market its potash through organizations other than BPC, effectively removing limitations on production for the Belarus partner in BPC. As a result, Uralkali has decided to market its potash through its own trading firm, Uralkali Trading. This will allow Uralkali to increase annual production. A Uralkali spokesperson has stated that the company predicts that potash prices could drop below US$300 per tonne (which is approximately 24% below current prices) due to the expected increase in supply in the potash

2 Page 2 market. The Russian company has stated that they plan to increase production from the current rate of 10 million tonnes of potash per year, up to 13 million tonnes of potash per year. Uralkali currently holds approximately 20% of the global market share of potash supply. Uralkali, being one of the lowest cost producers globally, is hoping that they should be able to increase profits, even if potash prices drop, by increasing production. The chart below shows potash prices over the past five years: Source: infomine.com Historically, the cartels were able to control supply, but now the potash industry may be opening up, creating more opportunities for companies to market themselves. This will generate more competition as potash producers vie for market share, putting downward pressure on potash prices. As prices drop, mines with lower operating costs will have an advantage over more expensive operations. Mines with lower operating costs will stand a better chance of surviving, and proposed projects that are expected to have low costs are more likely to be brought to production than their pricier counterparts. There has been some speculation as to whether this announcement is a bluff by Uralkali as they attempt to force BPC into an agreement. It remains unclear what the final outcome will be, but Uralkali has stated that future cooperation on a mutually beneficial basis is not completely out of the picture yet. Two junior potash companies we cover are Western Potash (TSX: WPX) and Passport Potash Inc. (TSXV: PPI). Both have potash projects in North America, Passport in Arizona and Western in Saskatchewan. As can be seen in the table below, PPI was down 7.14% to $0.13, and WPX was down 7.37% to $0.44, at close on July 30, PPI and WPX have fared well compared to many of other potash companies such as Karnalyte Resources Inc. (TSX: KRN) that dropped by 46.19% in one day. The following table shows how potash stocks were affected by the Uralkali news on July 30, 2013.

3 Page 3 Company Price Change Uralkali $ % Potash Corp $ % Mosaic $ % Agrium $ % Western $ % Passport $ % Karnalyte $ % Verde $ % Encanto $ % Allana $ % Sources: tmx.com, londonstockexchange.com and nyse.com Shares of Agrium were least affected, which is unsurprising as Agrium is diversified across the agriculture supply chain, covering everything from fertilizers to seeds and pesticides. Both Passport and Western shares fared better than most as well, although shares of Passport did already fall by 12.5% on July 29, for no apparent reason. Revising fair value estimates on WPX and PPI We believe most of the development stage potash projects are not attractive, if long-term potash prices drop below US$350 per tonne. Therefore, we do not expect long-term prices to drop below US$350 per tonne. Until we have more clarity on the final outcome of the recent developments, we believe it is prudent to evaluate development stage projects based on a range of possible long-term potash prices. The following table show the sensitivity of our fair value estimates on WPX, and PPI, to long-term potash prices between US$350 and $425 per tonne. Up until the Uralkali announcement, we were using a long-term price of US$425 per tonne for our models. The average fair value of WPX at various potash prices is $1.17 per share. Fair value of WPX Average $350 $375 $400 $425 $1.17 $0.50 $0.94 $1.39 $1.83

4 Page 4 The average fair value of PPI at various potash prices is $0.38 per share. Fair value of PPI Average $350 $375 $400 $425 $0.38 $0.09 $0.33 $0.48 $0.63 Therefore, based on the above, we have adjusted our fair value estimate on WPX from $1.83 to $1.17 per share, and on PPI from $0.63 to $0.38 per share. We have maintained our BUY rating and risk rating of 5 (Highly Speculative) on both companies. Daniel Iwata, BA, Dip. Fin. Mgmt. Equity Research Associate Energy Outlook So far in 2013, the energy sector of the S&P 500 has been average compared to the other S&P sectors. I have discussed in previous articles, our positive outlook on energy service providers. I believe that the energy sector will be a strong performer over the short term. New data also shows a positive outlook for energy stocks. Year to date, the S&P 500 index is up 19.8%. Sectors driving the increase are financials, consumer discretionary and health care. Energy stocks have lagged the index with a YTD return of 14.6%, which is right in the middle of the pack for S&P 500 sectors. Sector performance is shown below.

5 Page 5 Source: Yardeni Research In data reported by Factset, they compiled over 11,000 analyst S&P 500 stock ratings. These stock ratings had an increasing outlook for the energy sector. Energy had the most upgrades to buy ratings and the highest percentage of buy ratings compared to sell or hold. Energy stocks are rated as 60% buy, while healthcare was second with 53%. Source: Factset

6 Page 6 Energy stocks also have the highest average target upside. Factset compiled the average sector target compared to current sector price. The energy sector had a target upside of +14.2%, other sectors are shown below. Within the energy sector, the Exploration and Production (E&P) industry has far outperformed the rest of the industries. Year to date E&P is up 22.7%, while Refining & Marketing is second at 13%. Source: Yardeni Research I feel that Oil and Gas exploration and production will continue trending upwards, outperforming the other industries. Investors can take advantage of this through an exploration and production ETF like the SPDR S&P Oil and Gas Exploration and Production ETF (NYSE ARCA: XOP). I also think that service providers continue to provide good upside.

7 Page 7 Pooneh Ruintan, MEcon. Msc. Finance Equity Research Associate Toronto housing market The Toronto housing market is known for its downtown skylines and high valued single-family homes. However, recently, an increasing number of available-for-sale condos has been raising concerns regarding the issue that supply additions are expected to outpace underlying demand. Currently, Toronto s housing market is cooling in response to rising inventory, affordability pressures, changes to mortgage insurance rules and stricter lending policies. Housing demand has dampened- According to the Toronto Real estate Board, there were 5,984 condominium apartment transactions through the Toronto MLS system in Q2-2013; down by approximately 6% compared to Q This was mainly attributed to high home prices, tougher mortgage insurance rules and underwriting guidelines, and moderate employment and income gains, most notably among first-time buyers. Construction activities have slowed- Due to provincial policies which support high density construction, condos have accounted for 70% of total building activity since However, during the first four months of 2013, the total number of condos starts decreased from 48,100 to 28,900 units Project timeline will add to current inventories- Currently, completed and unsold homes are not high from a historical perspective. (Bar chart below).

8 Page 8 However, a record number of condo units are currently under construction, and are set to come onto the market in 2013 and 2014 (about 16,000 units on average) Demographic Trends is Favorable- Toronto is one of the fastest growing CMAs with population growth of 9.2%, from 2006 to 2011, in the Canada. Population growth in Toronto mostly comes from immigration which accounts for about 80% of the population growth. Due to the mentioned growth, it is estimated that the Toronto CMA can absorb close to 40,000 new housing units (rental plus ownership) annually. Growing rental market- According to Toronto Real Estate Board, 5,853 condominium apartments were rented through the Toronto MLS system in the Q2-2013, up by approximately 23% in comparison to Q It is anticipated that, due to the growing rental demand and tight rental markets, the majority of newly completed condominium units will be added to Toronto s rental stock. Investors activity is slowing down- It is estimated that more than 25% of the Toronto housing stock is held by domestic investors. However, currently lower the expected returns are tempering investors activities. Indeed, due to the rising prices over the past years, the carrying cost of an average condominium unit in the region now exceeds that the average rent. Looking ahead, the outlook for housing demand in Toronto is mixed. However, mainly due to an increased supply of condos, prices and construction activity are expected to dampen during the following year. Overall, Toronto existing home prices are expected to fall by about 6% by early 2014 (Source: TD Economics).

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