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Prisma Capital Markets - Equity researchJuly 31, 2008

-1- Israel Chemicals Two good years

Israel Chemicals extracts the natural resources of the Dead Sea and the Negev to yield a

variety of fertilizers (potash and phosphate), bromine based products, and magnesium

based products.

We estimate that the demand from China and India, coupled with the limited

supply of potash, will have the biggest impact on the short term prices of potash.

In our opinion the price that will be determined by the new contracts with the two

states will be significantly higher than the price dictated by the current contracts.

Given the limited supply and the possibility of depleted inventories in China

potash is indeed significantly less than the demand, and so we may see ascenario in which the price of potash reaches levels above $1,200 per ton.

However, a necessary precondition of such an increase is the rise in the price of

grain.

Nevertheless, in the immediate short term the continued drop in commodity

prices, particularly the price of grain, will have a negative effect on stocks in the

sector. The weakening of commodity prices cannot be simultaneous with rising

Potash prices indefinitely. One will need to give!

Whilst we estimate that the near future will provide positive headlines for the

potash sector, the increase in supply (predicted for 2012 and beyond) presents a

completely different long term perspective. In our opinion the increase in the

global output will lead to a sharp decrease in the price, while the entry ofnew participants into the club of potash producers will only accelerate the

process. We remind you that in recent weeks the arrival of two companies

(EuroChem, Rio Tinto) into the potash industry has been announced.

In the eyes of the companies, money invested in mining projects becomes a sunk

cost. Accordingly, as long as the marginal quantity is selling at a profit over the

variable costs, it makes sense to sell it unrelated to the issue of whether or not

the profit constitutes a suitable return for the fixed cost. As mentioned, this factor

can intensify the pressure on prices.

In our opinion, the years 2008-2009will be two of the best years for ICL , as a

result of the ideal convergence of the high price of potash and ICL's ability to sell

amounts beyond their production capacity (by tapping into their reserve). Ourestimation model predicts that in these years the company will sell close to

900,000 tons over their production capacity, and these sales will yield $750M in

income.

In our opinion, the fact that ICL's current right to utilize the resources of the

Dead Sea expires in 2030 cannot be ignored. Although we are dealing with

quite a long time, the issue raises the basic question: do we capitalize and

estimate the value of a company whose production activities are indefinite, or do

we perhaps regard the company as having a finite endpoint?

Using the DCF model to evaluate the company, we set a target price of $19.5 (68.00NIS) and a neutral recommendation.

Uri Waisbord, Head of Sell Side Research |Tel: +972-3-7567633 |[email protected]

Israel Chemicals The good years, and beyond

Israel Chemicals

Bloomberg: ICL IT

Target Price

ILS 68.00

Current Price

62.22

High-low (12 months)

31.02 81.10

Market Cap

ILS 85.283 mil.

Daily turnover (20 d.av.)

ILS 345.3 mil.

Recommendation

HOLD

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We believe that the operations of Israel Chemicals are well known to our clients and, as a

result, we felt that we did not have to describe the areas of activity and the basic variables

impacting on the company. Therefore, we will move on to a discussion regarding the

major data impacting the value of the Company.

And we will start from the end.

Let's meet in 2030

We believe that the analysts who cover Israel Chemicals have been ignoring the issue ofthe concession under which the Company operates.

Without overburdening the readers with history (which begins during the British Mandate),

Israel Chemicals has been operating under a concession initially granted to it by the State

of Israel in 1961, a concession that was scheduled to conclude in 1999. However, in 1986

(when the Company was still government owned), the concession was extended until

2030.

According to the concession, the Company has the sole right to "obtain by

evaporation.or any other method.the minerals and the chemicalsin and under the

Dead Sea and to prepare them for market" In order to realize the concession, the

Company received far-reaching rights regarding the construction of facilities and the

establishment of the infrastructure required to extract the minerals. In consideration of theconcession, the Company pays a "royalty equal to 5% of the value of the potash chloride,

bromine and the magnesium chloridesold in any given year [based on] its value in the

plant, unpackaged. This value shall be calculated by taking its sales price, during any

given year and by deducting.fair packaging expensesand shipping and insurance

from the plants of the concessionaire and 10% of the amount due him by deducting all

of the aforementioned expenses" A similar formula was set out in connection with the

downstream products. The total of these royalties are insignificant in amount. In 2007,

they amounted to $20 million (0.9% of the revenues of the fertilizer division) and in 2006,

they amounted to $35 million (2.3% of the revenues of the fertilizer division in that year).

The Concession Law stipulates that "at the end of the concession periodthe government

shall receive possession of all of the fixed assets belonging to the concessionaire and the

government shall pay the concessionaire, in consideration of the aforementioned fixedassets, their depreciated replacement value, as of the termination date." The Concession

Law further defines that "the term 'depreciated replacement value' in connection with fixed

tangible assets means the purchase price of similar new assets at their market price on

the termination date, less the depreciation in respect of the usage period of each of the

assets. Such depreciation is based on the technical life span of such asset, taking into

consideration the condition it was kept in by the concessionaire and the conditions in

existence at the Dead Sea." The Concession Law further stipulates that "if after the

expiration of the concession, the government desires to offer a new concession to extract

the mineral saltsto anyone who is not the concessionaire, the government shall first

offer the new concession to the concessionaire at terms that are not less convenient than

those it would have offered the other person."

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The major upshot of the above, for our purposes, is as follows:

The total royalties currently being paid by Israel Chemicals are insignificant in amount.

At the end of the concession period (2030), and in accordance with the terms of the

concession, the government is supposed to receive possession of all of the fixed

assets related to the production of potash and to the utilization of the resources of the

Dead Sea (and which are located in the concession area in the Dead Sea).

In consideration of the assets, the government will pay Israel Chemicals the

depreciated value of the assets.

Israel Chemicals has the right of first refusal on receiving the new concession.

However, receipt of this right shall be done under identical conditions to be offered to,

or conditions to be offered by, a third party. It is likely that the renewed rights will have

poorer terms compared to the current terms (with the new terms possibly taking the

form of a large one time payment for the concession or enhanced royalty payments to

the government, or a combination of these two possibilities).

What significance could there be to an event that is expected to occur in 22 years?

It appears that such an event is quite significant.

The major question is whether the permanent cash flow should be discounted to infinity, or

perhaps should the cash flows the company expects to generate from its operations inIsrael be cut off in 2030 (adding an additional compensation, pursuant to the Concession

Law)?

It is important to emphasize that there is no difference as to the method chosen to valuate

the company. Whether we base ourselves on the operating income multiplier method or

on the DCF method, or on the EV/Ebitda method, it is clear that in each of these methodsit will be necessary to take into consideration the following fundamental question: are we

discounting and valuating the value of a company the horizon of whose operations

is infinite, or are we dealing with a company in which there is significant uncertainty

over its continued operation in another 22 years under present conditions?

We would like to emphasize that the possibility that Israel Chemicals will continue

operating in the present areas of the concession after the end of the concession inanother 22 years most definitely cannot be overlooked. However, will it do so under the

present conditions?

Let each of the readers ask themselves the following question: if they were the Finance

Minister, would they be satisfied with the negligible royalties currently being paid by Israel

Chemicals, or would they try to renegotiate for the concession a high one-time payment or

higher royalties into the public coffers?

While it is true that Israel Chemicals has the right of first refusal and it can elect to

repurchase the concession under its new terms, it is reasonable to assume that such

terms will be significantly inferior to the terms of the current concession.

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How much does it cost us?

The question of the value that has to be deducted with respect to the end of the

concession in 2030 is dependent first and foremost on the amount of the cash flow in that

year. We assumed that the cash flow in the representative year (2015, see below) will

amount to one and a half billion dollars, and we believe that 80% of this amount derives

from revenues generated from the Dead Sea concession (under the assumption that the

major profit and, therefore, the major cash flow, derives from operations surrounding the

Dead Sea). In our opinion, such an assumption is favorable to the Company.

To the future value received with respect to the operations, we added the value of the

fixed assets, net of depreciation, under the assumption that this value constitutes areasonable estimate of market value. Here too we took a lenient approach and we added

the depreciated value of all of the fixed assets of the Company, notwithstanding the fact

that the lion's share is not connected to the Dead Sea concession (and, therefore, no

compensation will be forthcoming from the State in respect thereof).

Taking into consideration the parameters we used (permanent growth of 2%, a discountrate of 8%), the gap between the infinite concession and a time-limited concession

amounts to $4.9 billion (the equivalent of $3.8 a share).

Not an insignificant amount of money, even by Israel Chemicals' standards.

The price of potash when will the party end?

The "variable" (with a capital "T") which impacts the value of Israel Chemicals is the price

of potash. When dealing with the price of potash, we must distinguish between the

current price (in the short run) and the long-run price of potash (the same price which is

used, among other things, in determining the permanent cash flow).

We believe that whereas the near term will provide positive headlines for the potash

segment, the increase in supply will turn this picture upside-down in the long term.

The short term

A number of factors can be expected to have a positive impact on the short-term price,

maintaining its current level and even raising it:

China delayed closing potash contracts for 2008, and was forced at the end of the

day to close contracts providing smaller quantities of potash than required to fill its

needs. We estimate that China will arrive at the 2009 negotiating table with very low

inventory levels and this will have an impact on the quantities that the Chinese will

want to buy and, accordingly, on the price of potash as well. To the best of our

understanding, the negotiations with the Chinese will take place toward the end of

2008. We estimate that the Chinese demand will be the most significant factor in

determining the price of potash over the near term.

India potash contracts with India also conclude at the end of the year, with the price

tag significantly lower than the current market price ($625 per ton vs. current price of

$1,000 per ton).

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Grain inventory The grain inventory continues to be low, with the ratio of inventory

to use at the 20% level, much lower than the average levels of the past few years.

Increasing grain inventory level is not a matter for one year, but a problem that can be

solved only if dealt with for a few years. The low inventory of grain demands increased

use of fertilizers.

Increasing potash production capacity will not happen overnight

Notwithstanding all of the investment plans we read about, potash output over the

short-term is a given which will not change immediately. Quite the opposite is true

significant indicators show that over the short term, there will be problems with a

regular supply of potash (possible strikes in Canada, sink holes and floods in Russia,

etc.).

On the other hand, it is important to note that the price of grains recently began to decline,concurrent with the moderation in oil prices and in the prices of other commodities. The

continued decline in commodity prices, and mainly in the prices of grains, will have

a negative impact on the shares of the sector, also in the short term. This derives

mainly from the erosion in the profitability of the farmers, erosion that has a negative

impact on the price they are willing to pay for fertilizers.

The long term

In our opinion, the long-term picture is significantly different than the short-term.

It was only a year and a half ago, at the beginning of 2007, that the price of potashhovered around $200 a ton. At present, the price has reached $1,000 a ton and there is

no end in sight.

A manufacturer (existing or potential) sees a totally different picture when looking at the

current level of prices. Risks that someone would be wary of taking at $200 a ton look

totally different from a height of $1,000 a ton.

It was the largest potash producer in the world, Potash, which best clarified the picture in

making a presentation on July 17, concurrent with its announcement that it would be

increasing its production capacity by 20% in the near future. The following slide was

included in the presentation, describing the additional output of the well-known potash

producers (we will return shortly to the lesser known producers) in relation to the

expected increase in potash consumption.

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Two points on the slide:

If we turn for a minute to the short term, Potash estimates that the next two years will

reflect a significant shortage in potash (especially if we attach to the graph the low

inventories in China). Under these data, one cannot ignore a scenario in which theprices of potash jump to a level of more than $1,200 a ton, notwithstanding the fact

that a necessary condition for such a jump would be a renewed increase in

grains prices, after the downward correction recorded recently.

And if we return to the long term: the slide indicates that in the opinion of Potash,

assuming an annual growth of 3% in the demand for potash, expanded production

capacity of the well-known players is expected to result in a balance between supplyand demand somewhere in the period 2010 2011. In the event that the increase in

demand for potash is 4%, the supply will catch up to demand in advance of 2012.

And what happens then?

It is important to remember that for potash producers (very similar to all heavy industrial

plants), the money invested in such projects becomes a sunk cost as soon as it leaves the

coffers of the company. From the vantage point of the Company, as long as the marginal

quantity is sold at a profit over variable expenses, it would be logical to continue selling it

regardless of the question as to whether the profit constitutes a fair return on the fixedinvestment or not. This leads to the conclusion that an increase in global potash

production will result in a sharp decrease in its price and new companies getting into

the potash business can only accelerate that decrease.

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As mentioned, the above slide only described the added capacity of the known potash

producers. In the last couple of weeks we learned that two new companies, EuroChem

and Rio Tinto, have decided to enter the potash business. This is an example of two new

players who clearly see an attractive picture where price is concerned, and who are willing

to undertake the risk that the price will erode until it enters this area of operations. In ouropinion, this is not the final word on the subject and it is highly probable that the high

prices will attract additional new players to the industry.

A possible conclusion: the current profitability of potash producers goes beyond the

"normal" economic profitability and it has begun attracting new players to the industry.

The entrance of the latter will result in increased potash production and a sharp decrease

in price.

Some claim that Potash, as the industry leader, will rear on its hind legs and try and

maintain a price of $1,000 a ton. We think those who rely on that assumption may be

bitterly disappointed. Potash will have to recoup an investment of more than $2 billion

(the new expansion plan and previous plans) and if on the way they have to slash prices

they won't even bat an eye. Yes, we said "slash prices", not "reduce prices". When it

comes to commodities, the impact of an increase of supply on the price can be dramatic.

Also, the ability of Potash to stabilize the industry will only be upheld as long as it

maintains its leading role in the market, a role based on it's capacity. Here too, the new

players will undermine the ability of Potash to control the price by regulating the supply.

How much does this cost us?

Our price assessment model assumes the following prices for potash (average annual

prices for Israel Chemicals):

Year Price (dollar per ton) Comments

2008 650Average price in Q1/08:

$400 a ton

2009 1,050

2010-2011 1,100

2012 800

2013 and thereafter 500

Decrease in price, concurrent

with an increase in globalproduction capacity. Thedecrease is expected to return

the potash companies closer tothe historic profitability that is

significantly lower than the

present level.

Of course, it is possible to dispute all of the figures we used in our model, as well as the

timing of the decrease in the price of potash (as well as the actual decline itself).However, we believe that a model that does not assume a "slash" in the price of potash

suffers from irrational exuberance. We attached at the end of this work an appendix which

contains a sensitivity analysis of the economic value of Israel Chemicals in which the

parameters that are connected to the price of potash are slightly varied.

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A price of $500 a ton returns the potash companies to a level of profitability that is slightly

higher than their historic level. In relation to Israel Chemicals, the future level of

profitability from the fertilizer operations will be higher than the historical level, due to the

transition to natural gas use, a transition that will save an amount of $100 million a year

(once fully operational).

A mountain of potash

The delay in negotiations with the Chinese government in 2006 caused a reduction in

potash sales quantities and amounts in that year. On the other hand, the sun at the DeadSea doesnt rest for a minute, and Israel Chemicals quickly started hoarding mounds of

ready potash. The jump in the price of potash could not have come at a more opportune

time as far as Israel Chemicals is concerned. It found Israel Chemicals with mountains of

potash ready for shipment at high price levels.

As a result, we believe that the years 2008 2009 will be good ones for Israel

Chemicals, due to the combination of the ability to sell quantities in excess of Israel

Chemical's production capacity (by reducing inventories) and the high price of

potash. Our valuation model assumes that in the said years, the company will sell an

aggregate of almost 900 thousand tons in excess of its production capacity, and these

sales will generate revenues of almost $750 million.

However, it is important to emphasize that these revenues do not join the company'srevenue base since they are of a one-time nature and constitute a reduction of inventory

and a conversion thereof into cash flows. After these years (commencing in 2010 in our

model), we estimate that sales of potash will stabilize at a level equal to Israel Chemicals'

production capacity. We believe that the effective production capacity of Israel Chemicals

will amount to almost 6 million tons of potash a year in 2010 (as opposed to the theoretical

production capacity which at present exceeds 6 million tons). This will most definitely

result in a reduction in quantities sold and therefore, to a reduction in revenues, even if

one assumes (which we do not) that the prices of potash will remain at their high level.

In computing production capacity, we assumed that the company will carry out all of its

plans of freeing up bottlenecks, but we did not include the large plan to increase annual

production capacity by a million tons, due to the uncertainty regarding its cost and the

dates of commencement and completion.

Readers with sharp eyes and good heads for calculation may have noted that we

assumed a very sharp and rapid decrease in the potash inventory, from its current level of

1.115 million tons to a level of around 500 thousand tons in 2010 alone. Obviously, this

assumption favors the company (since a slower decrease in inventory or a decrease to a

higher level will result in a reduction in the rise of cash flows, a rise which appears in the

first years of our model, thus impacting the model).

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How much does this factor for us?

Our valuation model includes the following assumptions regarding production quantities,

sales, and inventory of potash (in thousands of tons):

2015E2014E2013E2012E2011E2010E2009E2008E20072006

6,6766,5136,3546,1996,0485,9885,8145,4085,0785,086Production

2.5%2.5%2.5%2.5%1.0%3.0%7.5%6.5%-0.2%-3.4%Change

6,6706,5096,3516,1986,0376,0006,1765,8275,4554,148Total sales

2.5%2.5%2.5%2.6%0.6%2.8%- 5.9%6.8%31.5%Change

643111(12)(362)(418)(377)938

Entrance/(exit)

of inventory

5175115075045034925048671,2851,662

Closing

inventory

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Risks to our valuation

The positive risk: an increase in the price of potash in excess of the assumptions taken

into consideration in the model, or a stabilizing of potash prices at a high level for a period

that is longer than the one taken into consideration in the model, will indicate that the

result of our valuation is skewed in a downward direction. We would like to emphasize

that the current limited supply, together with the low potash inventory level in China,

increase the probability of an additional price increase in the short term. However, we

believe that a jump in the direction of the levels used in the model will not occur without

the prices of grain renewing their journey northward.

The negative risk: an early decrease in the price of potash will indicate that the result ofour valuation is skewed in an upward direction.

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Appendix

Summarized Model

2006 2007 2008E 2009E 2010E 2011E 2012E 2013E 2014E 2015E

Total Revenues 3,258.2 4,100.3 7,626.7 10,918.2 11,531.8 11,787.2 10,159.5 8,435.2 8,671.2 8,914.3

Change 9.1% 25.8% 86.0% 43.2% 5.6% 2.2% -13.8% -17.0% 2.8% 2.8% Operating incomebefore others 536.4 714.7 2,417.7 4,247.2 5,062.5 5,086.2 3,342.5 1,982.3 2,037.7 2,094.9

Operating Profit Margin 16.5% 17.4% 31.7% 38.9% 43.9% 43.2% 32.9% 23.5% 23.5% 23.5%

EBITDA 711.0 910.1 2,620.2 4,458.9 5,281.1 5,307.5 3,561.5 2,198.9 2,254.3 2,311.5

Percent of Revenues 21.8% 22.2% 34.4% 40.8% 45.8% 45.0% 35.1% 26.1% 26.0% 25.9%

CAPEX 144.1 195.1 303.8 275.2 262.4 199.2 197.1 216.6 216.6 216.6

Net Cash Flows 282.2 231.9 637.6 2,400.8 3,882.8 4,070.1 3,313.4 2,293.1 1,573.4 1,617.0

Percent of Revenues 8.7% 5.7% 8.4% 22.0% 33.7% 34.5% 32.6% 27.2% 18.1% 18.1%

End of

ConcessionPerpetual

ConcessionTargetPrice

Total Discounted CashFlows 14,772.0 14,772.0

Total Future Value 9,113.1 14,010.5

Total value 23,885.19 28,782.51 26,397.46

Less: FinancialLiabilities

-1,202.03

Value of NetShareholders' Equity 22,683.15 27,580.48 25,195.43 USD

Value of NetShareholders' Equity 78,869.32 95,897.31 87,604.51 NIS

Quantity of Shares 1,287.3 # shares

Value Per Share 17.621 21.425 19.557 USD

Value Per Share 61.27 74.49 68.00 NIS

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Cost of Capital

7.50%7.75%8.00%8.25%8.50%

1.50%71.6769.4567.3965.4663.65

1.75%71.9569.7167.6365.6863.86

2.00%72.2569.9967.8865.9264.08

2.25%72.5770.2868.1566.1764.31

2.50%72.9170.5968.4466.4364.56

2.75%73.2870.9268.7466.7164.81PermanentGrowth

3.00%73.6771.2869.0767.0165.09

Prisma Investment House Ltd. (the Company) and its subsidiaries and affiliates, hold and trade in the securities and currencies mentioned in thereviews for themselves and for their clients. The reviews are for informative purposes only, and should in no way be deemed as an offer orsolicitation to buy or sell the securities and currencies mentioned herein. The reviews are based on publicly available information and on sources ofinformation which we deem reliable. However, the information included herein has not been verified, for which reason we do not guarantee itscompleteness or accuracy. The information in the reviews should not be deemed as factual or as the entirety of the information known, andtherefore its provisions should not be relied upon as such. Any opinion and/or recommendation and/or forecast which appear in this review reflectour opinion on the date of publication of the review and are therefore subject to change at any time. Any liability of the Company, the Companysemployees, the members of the Companys Board of Directors and the Companys subsidiaries and affiliates, for any claim made based on theprovisions of the review or based on any information appearing in the review, is hereby excluded. It is prohibited to copy or distribute the reviews or

parts hereof without the Companys prior, written and explicit consent.

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