Equity research: The Mosaic Company (Part 4 of 5)
The Mosaic Company (MOS): Overview of catalysts and key value drivers
Cargill Class A ownership overhang close to being over
Cargill’s ownership of 128.8 million Class A shares comes with certain restrictions pertaining to MOS share buybacks. The conversion of these Class A shares into common stock occurs in three equal installments, the first of which occurs on November 26, 2013. MOS is not permitted to engage in open market or negotiated share repurchases until after November 26. This has been an overhang for years (after the partial spin-off from Cargill) on the MOS stock price, with many investors blaming this partial ownership as the main reasons for the multiple discount between Potash Corp (POT) and Mosaic. This overhang is very close to being over.
Esterhazy tolling agreement expiration
For years, MOS was subject to a Tolling Agreement at its Esterhazy mine, which essentially forced the company to sell 1.1+ million tonnes of potash each year to Potash Corp essentially at cost. This, obviously, was a drain on gross margin since ~10% of potash volume was being sold at 0% margin. Said Tolling Agreement expired on December 31, 2012, which enables MOS to now sell over a million tonnes of potash at market price. The company only received five months of benefit of this added margin in FY2013, so margins will increase from here (all else equal) as MOS gets a full year’s benefit. As capacity utilization rates increase, this will, again, add more of a positive impact re: Esterhazy.
MOS is on the precipice of some impactful share repurchases (re: November 26 date above). About 30% (128.8 million shares) of currently shares have been locked up for years, and the first batch can be repurchased (at MOS’s discretion) come November. Over the next few years, MOS can deploy ~$5.5 billion (based on today’s share price) in cash to buyback roughly a third of all the company’s shares. MOS currently has $3.7 billion of cash on the books, churns out ~$1 billion in cash per year, and also has a revolving line of credit. This has been a pent-up strategy that management can finally start deploying, and at these depressed levels of MOS stock, these buybacks will be a great use of capital, especially if capacity expansions are delayed.
MOS has also grown its dividend very impressively over the past few years, which now equates to a ~2.4% yield. Nothing to write home about, but still in the range of treasury yields.
Lower cost structure re: Fort Meade
Last year, the company reached a settlement agreement with the Sierra Club over permitting for mining phosphate rock at the large South Fort Meade mine in Florida, thereby lowering its purchased rock requirements and reducing its cost of phosphate rock meaningfully for several years. The Fort Meade facility is one of the most efficient and cost-effective phosphate mining operations in the world, which had historically accounted for nearly 20% of U.S. phosphate rock production. The full impact of this lower-cost rock procurement will be fully baked into FY2014 result, hence benefiting MOS margins.
Long-term thesis makes sense
The longer-term thesis for MOS just makes sense from a global demand perspective. The evidence and demographics are there, and if you are comfortable putting your money away for a while to jump on these compelling global trends, then MOS is an appropriate investment. As both MOS and POT management highlights, the three keys to the global fertilizer thesis are:
- Population growth: World population is expected to reach 9+ billion people by 2050
- Need to improve yield: Limited arable land; Crop nutrients directly account for 40% to 60% of crop yields
- Long-term sustainability: Optimum use of crop nutrients is essential to growing the food the world needs today and tomorrow
Attractive valuation and replacement value support
MOS currently trades at ~6x forward EV/EBITDA. For reference, the long-term average for this stock is 8x forward EV/EBITDA, with it bottoming at just under 5x forward back in 2009. The 22% drop in price on July 29 (down to $41/share) was a reaction by the market when Uralkali’s CEO warned that potash prices could suffer a 25% drop from current levels. However, it’s interesting to note that the last time potash prices were 25% lower than they are today was in 2010, and MOS stock touched a low of $40/share (very briefly during the summer), but traded pretty regularly in the $50-to-$60-per-share range.
Although I have not been able to model our proprietary thoughts on replacement value of MOS’s assets since I do not have the resources nor the time, Wall Street (specifically JP Morgan and Morgan Stanley) estimate the replacement value of MOS’s assets are about $100 per share. There is clearly a value gap between market value and asset value here. Not to mention, if there were further M&A (mergers and acquisitions) in this space, I doubt MOS shareholders would agree to a takeover price that is below replacement value.
Near-term fertilizer volumes and pricing will be volatile. However, I do feel that the market has overreacted (as per usual) in a recent panic selloff. What you’ve got on your side are irreplaceable assets with large replacement value, pending share buyback support in a matter of months, operational improvements that still have a couple more quarters to show themselves in results, and a compelling secular (long-term) story. I have a $50-per-share MOS target in mind based on a ~7x forward EBITDA multiple, which is still a ~15% discount to its long-term multiple average. Also, any type of relatively positive compromise on the Uralkali drama will provide an instant pop to fertilizer stocks across the board.
The Market Realist Take
In an analyst day presentation in October, the company said it will hold a 25% stake in its Saudi Arabian joint venture with the Ma’aden company. It will contribute to technical and engineering knowledge to build a facility and will have a 25% uptake agreement for that product. This will put the company in a position to serve the Southeast Asian markets as well as give a product that will be among the lowest-cost manufactured phosphate in the world. Mosaic stated that the Esterhazy mine in the past year has set production records, and it has another solid increase in sales of MicroEssentials. It added that Esterhazy today is the largest underground potash mine in the world. With an efficiency to scale as well as the potential to eliminate brine inflow cost, it expects this will be one of the lowest-cost potash mines in the world this decade.
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