Potash Risk Rises on Bond Sale to Fund Buyback: Canada Credit

Potash Corp. of Saskatchewan Inc.’s borrowing costs may rise after the company sold $1 billion in bonds to help it buy back stock following Canada’s rejection of BHP Billiton Ltd.’s $40 billion bid for the fertilizer maker.

Potash Corp.’s first debt sale in 14 months consisted of $500 million each of 7- and 30-year bonds. The world’s biggest fertilizer maker said on Nov. 17 it planned to repurchase as much as $2 billion in shares after Melbourne-based BHP abandoned its hostile bid.

Yields on Potash debt have fallen relative to government bonds since the BHP bid was announced in August and may not reflect the higher balance-sheet risk posed by the share repurchase, said Carol Levenson, an analyst with Gimme Credit LLC in Chicago. The company’s credit default swaps have been among the worst performing in Canada in the last five trading days, reflecting increased credit risk.

“Now that a takeover is off the table, the buyback and other potential shareholder enhancement actions increase the company’s risk profile, despite the fact that its business outlook is improving,” Levenson said in an e-mail response to questions.  “I don’t believe that bond trading levels sufficiently compensate investors for this risk.”

The offering yesterday consisted of $500 million of 3.25 percent, 7-year notes that yield 122 basis points more than similar-maturity U.S. Treasuries, and $500 million of 5.625 percent, 30-year bonds that pay a spread of 152 basis points, OR 1.52 percentage points, Bloomberg data show.

Corporate Spreads

The yield on Potash’s 4.875 percent bonds due in March 2020 ended yesterday at 4.04 percent, according to Trace, the bond- price reporting system of the Financial Industry Regulatory Authority. That’s 123 basis points over similar-maturity Treasuries. The spread widened to as much as 170 basis points on Sept. 21, the most since the bond started trading a year earlier.

Elsewhere in credit markets, the extra yield investors demand to hold the debt of Canada’s corporations rather than its federal government, was unchanged yesterday at 135 basis points, or 1.35 percentage points, according to Bank of America Merrill Lynch data. Spreads reached 134 basis points Nov. 16, the narrowest gap since May.

Relative yields on U.S. corporate bonds ended Nov. 19 at 175 basis points, the Merrill data showed. Global corporate spreads were 165 basis points.

Canadian corporate bonds have lost investors 0.9 percent in November, poised for the worst month since December 2009. U.S. company debt has lost 1.1 percent in November. Global corporates were down 1 percent through Nov. 19.

Budget Deficits

In provincial bond markets, relative yields widened 1 basis point to 53 basis points. They reached 51 basis points on Nov. 16, the tightest spreads since April, from as wide as 71 basis points on May 21. Yields narrowed to 3.20 percent from 3.24 percent on Nov. 19.

Provincial bonds have lost investors 1.7 percent this month, the biggest loss since September 2008. Canada’s government bonds are down 1.4 percent in November.

Alberta’s deficit will be C$5 billion （$4.9 billion）, C$257 million more than budgeted because of lower income tax and non- renewable resource revenue, according to financial documents posted yesterday on the government’s website.

New Brunswick’s deficit will be more than C$800 million for the fiscal year ending March 31, greater than the C$749 million forecast earlier this year, because spending has been higher than projected, Finance Minister Blaine Higgs said in a statement yesterday on the government’s website.

Retail Sales

Canada’s consumer price index, a measure of inflation, rose at a 2.2 percent annual pace in October, from 1.9 percent in September, according to the median estimate of 22 economists in a Bloomberg survey. Statistics Canada is due to release the report at 7 a.m. today in Ottawa.

Retail sales climbed 0.7 percent in September, compared with 0.5 percent the month before, the median forecast in a Bloomberg survey of 22 economists showed. The statistics agency will release that report at 8:30 a.m.

Government debt rose, pushing the yield on Canada’s benchmark 10-year bonds down 6 basis points, or 0.06 percentage point, to 3.09 percent. The price of the 3.5 percent security due in June 2020 gained 48 cents to C$103.40.

Spreads have tightened, even as Potash’s “credit outlook has gotten worse,” Levenson wrote. She said the bonds “would begin to look interesting” if the spread widened to 150 to 160 basis points over Treasuries.

Negative Outlook

Standard & Poor’s lowered Potash’s outlook to “negative” from “stable” on Nov. 18, citing the fertilizer maker’s use of debt to finance the share repurchase. Potash’s long-term corporate credit rating of A-, S&P’s seventh-highest, is unchanged.

The rates could be cut further if Potash “shows no tangible progress in the next two to three quarters” in improving financial measures such as the ratio of adjusted debt to earnings before interest, taxes, depreciation and amortization to about 2, S&P said. After the debt sale, Potash’s debt-to-ebitda ratio at the end of 2010 will be about 2.5, S&P said.

“The debt-financed share buyback will lead to a weaker- than-expected financial risk profile, with credit metrics not likely to come in line with the rating until year-end 2011 assuming market conditions for fertilizers remain positive,” S&P analyst Jatinder Mall said in a Nov. 18 note.

Moody’s Investors Service affirmed its grade of Baa1, one step lower than S&P’s rating, and said on Nov. 19 that it had a positive outlook on Potash.

As of Sept. 30, Potash had $2.72 billion in debt due in more than one year.

Shares Rebound

Potash shares have risen about 1.4 percent since BHP withdrew its offer. The stock is still 9.4 percent below its 12- month high of C$158.17, reached Aug. 23.

Chief Executive Officer Bill Doyle “is under pressure to get the stock price back up,” Sadiq Adatia, who oversees C$12 billion of assets, including shares of Potash, as Toronto-based chief investment officer at Russell Investments Canada, said in a telephone interview. “You only do share repurchases when you’re confident the shares are undervalued.”

Potash’s credit default swaps have been the third-worst performing in Canada in the last five trading days. The swaps rose 4.03 basis points to 106.2 basis points on Nov. 19.

Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.