Compass Minerals International (NYSE:CMP): An alternative play of Agriculture: Part II

So I have covered my qualitative thesis on CMP in Part I - now I want to talk a little about valuation.

Risks:

Debt.

Debt is high in CMP - it looks very high against current comps at 65% of capital and 4x EBITDA but this only captures one partial first year of Produquimica in the equation and the full balance sheet year end debt.

However debt levels are still high. CMP were downgraded one notch by Moodys to Ba2 following the acquisition due to the elevated debt levels of the company. They have bonds totalling $500m issued in the market but funded most of the acquisition by expanding their revolving credit facility. Some $130m is due for repayment/refinancing this year but most of the credit is not repayable before 2021 so there is decent headroom to pay down debt and drive up profitability in the meantime.

CMP Annual Report 2016

The total debt load means interest payments should be north of $50m this year alone. The company has a reasonable ability to generate free cash flow but a lot hinges on the success of Brazil and firmer salt prices. You can carry this kind of leverage in a utility (i.e a stable business like salt) but it is dangerous in a cyclical commodity stock which CMP is becoming.

Amiable Minotaur CMP Model - Net Debt & ROE projection

With reduced Capex expected in 2017 down 25% at ~$130m there should be decent free cash flow generation to pay down some debt whilst still maintaining the dividend.

Dividend.

The dividend from CMP is high for a US company. They do not buy back stock instead they pay a dividend which was $2.76 a share last year with a yield of 4.2% that is quite high. The total cash payout was $94m in 2016. The risk is FCF generation is too low this year and that dividend gets cut. It is generous anyway but a cut in the dividend could seriously harm sentiment toward the stock despite not changing its real intrinsic value. On the other hand should it be maintained the chance to own an option on higher fertilizer and salt prices from cyclical lows, that pays 4.2% a year, seems quite attractive.

Amiable Minotaur CMP Model - EPS/DPS history and estimates

Honestly I think they should halve the dividend and pay down some debt for three years even as an equity investor. I don't think they will though due to the signalling.

Pensions.

Not a big risk. They have a legacy defined benefit scheme in the UK but it is fully funded (albeit with a slightly high discount rate around ~3.8% - high for the UK anyway) -  the total liability is relatively small at $60m or so. Therefore pension blow up risk is muted.

Margins.

The current picture for margins is slightly problematic. The company discloses an EBITDA margin in Salt of  25% last year and it has been steadily improving despite cyclical weakness. In North American ferts the margins are disclosed as 28% for 2016. The South American margins are much lower at 18.8% last year diluting the combined ferts margin proforma to 22%. So from a margin perspective the Brazil acquisition is not immediately accretive. There may however be significant improvement in future from synergies and best practices. 

Generally I should note the history of CMP is one of excellent capital allocation with 10 year median ROIC at 13.9% so I feel they have a good track record of growing by acquisition and organically.

The Valuation:

I see a tough year in 2017 for CMP trading at around 21x PE due to weak salt pricing and low margins in Brazil following the acquisition. So near term it looks a little expensive but looking further out on my DCF and DDM models I see good upside with price targets of $114 and $75 respectively. Ultimately I think CMP is worth around $80 a share without cyclical improvements in fertilizer prices and with a slight recovery in the salt segment pricing in the high debt risk to that DCF valuation.

[My assumptions are a Ke of 6.7% (RF 2.5%, RP 6%, Beta 0.7) and a Kd of 5.5% pre tax giving a WACC of just 5.17% - which accounts for the lower target price on the DDM despite the relatively high payout ratio. DDM growth rate was 3%]

Portfolio:

Therefore I think CMP offers reasonable upside of 20% to fair value with a 4% yield and potential as a leveraged option to higher fertilizer prices and better than expected synergies with Brazil. I like the macro positioning, annual share price depreciation to date, decent moats in Salt and SOP and a stable dividend.

From a Porfolio perspective this adds exposure to a new sector; Basic Materials, it has diversified economic risk across North and South America and it has exposure to the agricultural cycle which none of my other investments presently do.

Disclaimer: I am long NYSE:CMP at present. These are opinions only, not investment advice. If in doubt read my disclaimer.