Potash prices remained weak during the second half of 2012, largely due to the contract delays with India and China. International buyers also stalled their purchases in the hopes of procuring lower prices in the future. Despite the poor international demand, North American demand remained high during the period. However, 2013 starts with much uncertainty removed as China has now settled contracts for 1H13 and India is expected to follow in the near term. There are a couple of agriculture stocks which we think will outperform in 2013. Today we will focus on The Mosaic Company (MOS).
The Mosaic Company
Mosaic is the world's largest integrated phosphate producer and one of the largest producers of phosphate-based animal feed ingredients in the United States. MOS is also the third largest producer of Potash by capacity in the world. The company sells phosphate and potash to over 40 countries in the world.
For reporting purposes, the company organizes its business into two segments: Phosphates and Potash. While the phosphates segment provided the largest share of revenue (70%) for any segment, the biggest portion of the operating earnings (55%) in FY 2012 came from the potash segment. During the fiscal year 2012, Mosaic's phosphate production accounted for approximately 13% of the global production and 58% of the North American production. During the same year, MOS's potash production accounted for 12% of the global potash production and 39% of the North American potash production.
MOS, headquartered in Plymouth, Minnesota, was formed in October 2004 through the merger of IMC Global and the fertilizer business of Cargill, the largest privately-owned company in the U.S.
Source: Company documents, Price Point research
Why we like Mosaic
We like this North American fertilizers producer for the following reasons:
- Attractive valuations.
- Significant upside potential.
- Low cost producer.
- Largest fully integrated phosphate producer.
- Attractive growth (expansion) profile at low capital costs.
- Strong balance sheet.
- Significant return of capital to shareholders post May 2013 Cargill transaction restrictions.
- Positive agriculture fundamentals.
Mosaic offers investors an attractive mix of diversified operations, attractive valuations, and significant upside potential post elimination of legal restrictions in May 2013. The low cost fertilizers producer has an attractive pipeline of growth projects and controls a significant amount of potential potash expansion at low capital costs.
MOS has made it clear several times that it intends to put its balance sheet into work post May 2013. With approximately $10 billion in liquidity against a $23 billion market capitalization, we think Mosaic's most likely actions would be a series of share repurchases together with modest dividend increases. We believe the market continues to underestimate the scope of Mosaic's balance sheet optionality. According to a GS report (December 11, 2012), if MOS were to bring leverage metrics to levels consistent with its BBB credit rating, the company could repurchase up to 40% of current market capitalization.
Mosaic's primary markets, potash and phosphate, also continue to improve. The recent 1 million tons settlement by China has reduced some of the uncertainty surrounding the potash market, and after a weak 4Q12, volumes should now begin to flow more smoothly, and possibly tighten in the second half of 2013. The settlement should also serve to put a floor below global prices and mitigate global buyer's aversion to inventory price risk. The Chinese contract has paved the way for a near-term Indian contract, and the Chinese contract price should serve as a floor for the potential Indian contract price. Inventory levels in India remain low and with no domestic production, India needs to buy. The South Asian country might have to settle at a price higher than the Chinese contract, as China gains first-mover advantage. All these developments should prove to be favorable for Mosaic and should have a positive impact on the stock price and earnings.
As for phosphate, the resilient demand trends and limited new capacity coming online should keep the global operating rates elevated. Given healthy product prices and lower ammonia costs, the margins for integrated producers like MOS should improve over time.
We expect positive favorable agriculture fundamentals to persist over the long term, including tight inventories; elevated crop prices as global grain (corn and wheat) inventories reached critically low levels in 2012, robust farmer income, and increased fertilizer application rates in the developing countries.
Below is a detailed analysis of MOS's potash and phosphate operations, including the current capacity and expansion projects.
Mosaic operates three potash mines in Canada, including two shaft mines with a total of three production shafts and one solution mine, as well as two potash mines in the United States, including one shaft mine and one solution mine. The company has a current annual capacity of 11.6 million tons, including tonnage produced at Esterhazy under the tolling agreement.
Mosaic has a current potash annualized proven peaking capacity, excluding tonnage produced at Esterhazy under the tolling agreement, of 10.3 million tons, which accounts for approximately 13% of world capacity and 37% of North American capacity.
Out of the total 11.6 million tons of capacity 9.9 million tons comes from the Canadian mines and 1.7 million from United States' mines.
Mosaic's potash mines locations
The company expects to add 3 million tons of annual capacity in the next 5 years and another 2 million tons by the end of the decade.
The company has substantially completed its expansion project at its Esterhazy mine K2 shaft and mill and expects to add an incremental 0.7 million tons to annual capacity in the fiscal year 2013. Additional projects that are in progress include Belle Plaine, which is expected to come into service by FY 2015-2016 and add 0.6 million tons in annual capacity. The Colonsay expansion project in Saskatchewan, Canada, is expected to come into service by FY 2014-2015 and add 0.5 million tons in annual capacity. Another expansion project (K3) at the Esterhazy potash mine in Saskatchewan is expected to add 0.9 million tons of annual capacity once in service by FY 2017-2018.
The projects which are not yet approved by Mosaic's Board of Directors include a Belle Paine expansion project and a Colonsay expansion project, expected to add 1.5 million tons and 0.5 tons of annual capacity respectively.
The company is positioning its expansion projects with flexibility in timing, enabling it bring the additional capacity on line when the market demand warrants.
Source: Company documents
As of end of FY 2012, the company has recoverable potash reserves of 2079 million tons out of which 1789 are in Canada and 290 in United States.
Source: Company documents
Mosaic is the world's largest producer of concentrated phosphate crop nutrients and animal feed ingredients. The company's phosphate segment owns and operates mines and production facilities in Florida, which produce concentrated phosphate crop nutrients and phosphate-based animal feed ingredients, and processing plants in Louisiana, which produce concentrated phosphate crop nutrients.
The company's U.S. phosphate operations have annual production capacity of approximately 4.3 million tons of phosphoric acid, which is about 9% of global capacity and 45% of North American capacity. 3.5 million tons of the company's annual phosphate capacity comes from its Florida operations and the remaining 0.8 million tons from Louisiana.
Phosphate production facilities, plants, and mines
Source: Company documents
Mosaic's phosphate rock production of 12.1 million tons in FY 2012 accounted for approximately 6% of the global production and 43% of estimated North American production. With annual capacity of ~16 million tons, Mosaic is the second largest miner of phosphate rock in the world.
Source: Company documents
The company has proven and probable phosphate reserves of 547.8 million tons (active mines: 154.3 million, planned mining: 393.5 million tons).
Source: Company documents
Financial and credit analysis
MOS is trading at very attractive valuations (discount). The stock is trading at a price-to-earnings ratio of 13.3 compared to the industry average of 14.8 and Mosaic's own 5-year average of 21.9, representing significant upside potential.
The stock has a forward P/E of 10.4, whereas compared to Mosaic S&P 500 has a forward P/E of 14.2. Potash Corp. (POT) is trading at a price-to-earnings ratio of 15.2 and a forward P/E of 12.6.
MOS has a PEG ratio of only 1.5; PEG ratio is a better indicator of a stock's potential value as it takes into account the company's expected growth rate. The company has a consensus five-year revenue growth rate of 14% and EPS growth rate of 36%.
The stock has price-to-book ratio of 1.9 compared to the industry average of 3.0 and Mosaic's own five-year average of 2.5. MOS has price-to-sales ratio of 2.3 (industry average: 2.5, Mosaic 5-years average: 2.8), and price-to-cash flow ratio of 9.8 (industry average: 10.6, Mosaic 3-years average: 11.8).
MOS is trading at $57.5. It has a mean target price of $84.5 and high target price of $102, representing a huge upside potential of 47% and 77% respectively. Even the lowest price target of $72 represents an upside potential of at least 25%.
MOS has a strong balance sheet; it ended the most recent quarter with cash and cash equivalents of $3.6 billion and total debt of $1.0 billion. In addition, to cash and cash equivalents of $3.6 billion, the company has a credit facility of $750 million out of which $730 remains unused as of the most recent quarter. The company expects to finance expansion projects and strategic initiatives for the remainder of fiscal year 2013 from cash generated from operations and cash and cash equivalents.
The company has a debt-to-equity ratio of only 0.08 compared to 0.42 of POT, 0.21 of AGU, 0.27 of CF, and the industry average of 0.37. Mosaic's current ratio of 3.9 is also significantly higher than the industry average of 1.73. POT, AGU, and CF have current ratio of 1.46, 1.87, and 2.5 respectively.
Mosaic is also boasting very healthy profitability ratios. It has a profit margin of 17.4%, operating margin of 23.7%, return on assets of 11%, return on equity of 14.8%, and return on invested capital of 13.8%.
The credit rating agency Moody's has a rating of Baa1 for Mosaic with a positive outlook. Standard & Poor's has a rating of BBB on both foreign and local long-term debt of Mosaic. Like Moody's, S&P also has a stable outlook on MOS.
China settles, India awaits
On Monday Canpotex, the major Canadian potash export consortium representing MOS, POT, and AGU, signed a six-month (1H13) supply agreement with Chinese distributor Sinofert for 1 million tons of potash at a price of $400 per ton, a reduction of $70 from the last year's contract (March 2012). While the reduction in price was expected, the $400 per ton settlement came slightly lower than the average Street expectations. On a positive side, the contract volume of 1 million ton is higher than the expectations (March 2012 contract volume: 500,000 tons of potash) and more than offsets the lower contract price.
The settlement should provide a floor to the global potash prices and should provide some clarity on the market for early 2013. The volumes should start to flow more smoothly now and possibly tighten towards the second half of 2013, leading to a possible price recovery in 2H13. 2013 starts with some uncertainty removed and strong demand compared to a widely expected weak 4Q12. The high volumes of shipments also indicate that inventory levels in China are not as high as previously thought.
The Chinese contract came earlier than expected, and it should prove to be a positive catalyst for global potash demand. India and the other big potash consuming regions can now also settle new contracts in the near term (earlier than previously expected). The Chinese contract should set a floor for any Indian contract price. China might end up gaining a first-mover advantage. As a reminder, in July/August 2011, China settled the contract first for $470 per ton and India paid a premium of $20 to $30 for settling second.
The North American inventory levels, which have risen in recent months due to a drop in exports, most notably to China and India, should also witness a favorable impact of these new contract settlements.
We have a buy rating on MOS. We believe MOS is trading on attractive absolute and relative valuations, and has a significant upside potential. MOS is a low cost and the second largest producer of high margin nutrient potash. It is the largest fully integrated phosphate producer in the world, with 13% of global and 58% of North American share. Mosaic has an attractive pipeline of expansion projects and controls a significant portion of the potential potash expansion at low capital cost. The company is set to return significant amount of capital to shareholders once the Cargill transaction restrictions lapse on May 25, 2013. The agriculture market fundamentals remain strong. The severe drought in the U.S. last year has significantly reduced crop production and extended the current agriculture cycle for another year. In the long term, robust farmer income, increased fertilizer application in the developing countries, elevated crop prices, and tight gain inventories should continue to support our positive thesis on MOS.
Risks to our analysis
Although the Chinese contract is already settled, any longer than expected delay in Indian contract can have a negative impact on potash prices and Mosaic's earnings. MOS is a low cost integrated phosphate producer; an unexpected increase in input costs can have a negative impact on Mosaic's earnings. Corn prices influence farm plantings and fertilizer demand, a sharp decline in crop prices could lead to lower farmer incomes and reduced spending on fertilizers. Lastly, mine-related operational problems can also negatively impact earnings and our thesis on MOS.