Share price of Potash Corp. (POT) has declined by 14% over the past 12 months. At $39.64, the stock is trading near its 52-week low of $36.73 and offers a decent 2.9% dividend yield. Investors should consider picking up the stock at this low level based on the following 5 reasons:
1. Potash shares are inexpensive based on the company's strong financial performance relative to its primary peers'. According to the chart shown below, the company's 2-year consensus revenue, EBITDA, and EPS growth rates are considerably above its peer averages, but its long-term EPS growth rate is slightly below par. On the profit side, Potash again demonstrates a superior performance as most of the company's profitability and capital return metrics are significantly above the peer averages. In terms of debt, Potash carries a relatively higher level of debt load as reflected by its above-average leverage ratios. However, due to the strong profitability, the firm was able to maintain a healthy interest coverage ratio. Both Potash's current and quick ratios are below par, but they are still within a healthy range.
Given Potash's strong financials in almost every aspect, I believe the stock should reasonably command a solid valuation premium over the peer-average level. The current price multiple at 13.0x next 12-month EPS is 20% above the peer average of 10.9x, suggesting a reasonable valuation on a relative basis (see chart above).
2. Potash's forward EPS multiple has started deviating from the multiple of S&P 500 Index since early 2013 and is currently trading at a 12% market discount (see chart below).
I believe the below-market valuation presents a great entry opportunity as the stock should at least trade in line with the market provided that 1) Potash's long-term earnings growth rate at 8.2% is in line with the average estimate of 8.1% for the S&P 500 companies; 2) the company offers a market-leading profitability and has been able to sustain its margin performance over the past 5 years (see chart below); 3) Potash also possesses a solid market share in the potash sector given its significant production level and limited industry competitors; and 4) the stock also offers a 2.9% dividend yield which exceeds the average yield of 2.5% for the S&P 500 Index.
3. Market sentiment appears to have stabilized. The current consensus revenue, EBITDA, and EPS estimates for 2013 and 2014 have mostly experienced modest upward revisions since a month ago. Analysts' average long-term earnings growth estimate was raised from 5.2% to 8.3% in 3 months ago and has trended steadily since then.
4. Potash's dividend yield and dividend growth prospect are very supportive to the share price. Since 2012, the company has raised the dividend per share twice by 100% and 50%, consecutively. Given that Potash's annual dividend payment only represented less than a half of the annual free cash flow generated in the past few years and the current earnings payout ratio is only at 23%, the company would still has an ample capacity to sustain a double-digit dividend growth at least in the near term, and the robust growth rate may even drive up the yield (see chart below).
5. In a research note dated March 18, Jeffrey Stafford at Morningstar elaborated on his view on the potash price trend, which I tend agree on (sourced from Thomson One, Equity Research):
"The potash industry functions as an oligopoly with the top six producers controlling about 80% of capacity. This leads to a cartel-like situation where production decisions are typically rational. In periods of slow demand, producers shut in production to better match supply with demand and support prices. As a result, potash prices have tracked well above marginal costs of production. Not only is Potash Corp the world's largest potash producer, the company also controls some of the lowest-cost potash assets in the business, and its position on the low end of the cost curve allows for attractive returns. Recently, results have been dented by slow buying from China and India, but volumes are set to expand in 2013 with those buyers coming back to the market."
Bottom line, in the light of Potash's solid financials, promising prospects, and inexpensive valuation, investors should buy the shares on the price weakness.