Israel Chemicals: The Cream Of The Crop In Q1

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About: Israel Chemicals Ltd. (ICL), Includes: CMP, MBII, NTR
by: Silver Coast Research
Summary

Israel Chemicals reported strong Q1 '19 earnings and raised its dividend (4% yield at present).

The company makes the most of its competitive advantages.

The remaining life of some concessions needs monitoring.

Valuation looks cheap given the company's prospects.

Israel Chemicals (ICL) stood out among the large fertilizer producers with very solid Q1 results, and a dividend hike resulting in a 4% annualized yield at the current share price ($5.41 on the NYSE).

The Israeli company is not just an income play, though. Its end markets are growing, and it benefits from cost-advantaged assets and a dynamic Israeli agri-tech ecosystem. Valuation is reasonable, making Israel Chemicals a solid candidate for investors looking for international diversification.

Solid Q1 results

Q1 earnings were strong across the board, despite disruptions in the Israeli Railway Services that reduced potash sales volumes for the quarter. A virtuous combination of improved pricing for the company's main products (bromine, potash and phosphate) and cost control measures resulted in much improved operating performance:

  • Operating income of $227 million, or adjusted operating income of $241 million, an increase of 65% over Q1 2018 adjusted operating income excluding divestments- Q1 2019 EBITDA increased by 39% over Q1 2018 to $350 million
  • Quarterly EPS of $0.11 compared to $0.73 in Q1 2018, which included a capital gain from divestments. On an adjusted basis, EPS amounted to $0.12 compared to $0.08 in Q1 2018
  • Profit margins expansion fueled by focused strategy execution & cost controls

Source: Q1 earnings press release

The chart below shows the strong incremental contributions of the Potash and Industrial Products (mainly bromine) segments:

Israel Chemicals Q1 2019 bridge Source: Q1 earnings call slides

Q1 '19 was by no means an outlier, as Israel Chemicals' operating results have been on an upward trend for the past few quarters, on the back of improving fertilizer prices and favorable market conditions for bromine in China.

Israel Chemicals quarterly results Source: Q1 earnings call slides

Generally speaking, the company has been reaping the benefits of its streamlined product portfolio, served by well-entrenched competitive advantages.

A streamlined product portfolio

Over the past few years, Israel Chemicals has divested a number of non-core businesses, and now finds itself with four business segments: Potash, phosphate, Bromine and Innovative Agricultural Solutions:

Israel Chemicals products and applications

Source: company's 2018 annual report

All of these segments are supported by macro tailwinds. Potash and phosphate obviously benefit from the growing demand for fertilizers globally, on the back of a growing world population and improving diets in emerging countries. Bromine, as a flame retardant (among other industrial applications), has seen increased demand due to more stringent safety standards. China, in particular, has become a huge market for the product.

Apart from Innovative Agricultural Solutions, which encompass specialty products, most of Israel Chemicals' products are commodities, and the company has no control over their prices. In this space, competitive advantages are key in order to remain on the low end of the cost curve.

Israel Chemicals' well-entrenched competitive advantages

Fortunately for the company, it enjoys durable competitive advantages. The main one, by far, resides in its Dead Sea assets in Israel. The very high mineral concentration of the Dead Sea provides a low-cost source of potash and bromine. In its corporate presentation, the company sees itself as the third lowest cost potash producer globally. The data comes from 2016, and I think that companies like Nutrien (NTR), which has been lowering its cash cost by reallocating production to its most modern mines, and Russian newcomer EuroChem, could challenge Israel Chemicals' ranking. However, the Israeli company's costs are definitely among the world's lowest.

Producing in Israel comes with a second significant advantage: From a logistic perspective, the production facilities are close to the company's main markets in Europe, India, and, to a lesser extent, China. This advantage applies not only to the potash and bromine segments, but also to phosphate, since Israel Chemicals mines phosphate rock in the Negev desert.

Israel Chemicals geographic cost advantage

Source: corporate presentation

The access to phosphate rock creates another advantage, in that Israel Chemicals controls the entire value chain (see chart below). It's worth noting that the company also has a joint venture in China, the YPH JV, which is fully integrated too.

Israel Chemicals phosphate chart

Source: company's 2018 annual report

Last but not least, Israel Chemicals benefits from Israel's technological edge. Agriculture has become a matter of technology, and the largest players are scrambling for R&D expertise, as shown by Nutrien's acquisition of Actagro earlier this year (Seeking Alpha Essential subscribers can refer to this article by Donovan Jones which discusses that acquisition). In the same way, Compass Minerals (CMP) will collaborate with Marrone Bio Innovations (MBII) to develop specialty plant nutrient products enhanced with microorganisms. In this environment, Israel Chemicals is fortunate to have a vibrant agri-tech ecosystem in its own backyard:

Israel agri-tech eco system Source: corporate presentation

Concession risks to keep an eye on

Competitive advantages should not make investors complacent as there are always some risks in any investment. In Israel Chemicals' case, I've noticed that the remaining lives of its concessions in Israel are relatively short (in a worst case, non-renewal, scenario).

According to the company's annual report, the current concessions for the phosphate assets in the Negev desert expire in 2021. Of course, Israel Chemicals has applied for a renewal, and will most likely obtain it. But there could be changes to the terms of the concession, even if the recent agreement with the Israeli Authorities, which put an end to a decade-long dispute over past royalties, is a step in the right direction.When it comes to potash and bromine, the Dead Sea concessions expire on March 31, 2030. Should the concessions not be renewed, investors might be entitled to financial compensation, which, on paper, could be substantial:Israel Chemicals replacement value Dead Sea assets

Source: company's 2018 annual report, Risk Factors

However, at this stage, these are only recommendations from a committee appointed to determine "governmental activities to be conducted towards the end of the concession period". As the annual report also indicates:

As a local company, Israel Chemicals will certainly be able to renew its concessions, but as long as the terms are not known, a discount is probably warranted.

An attractive valuation

At the current share price of $5.4 for the NYSE-listed shares, Israel Chemicals looks cheap. The company trades at an EV/EBITDA ratio of 8. There is no major growth CapEx on the horizon, which bodes well for free cash flow generation in the years to come.

The company's net debt, meanwhile, is well under control, helped by the growing free cash flow and a few divestments in 2018:

Israel Chemicals debt ratios

Source: Q1 earnings call slides

On the back of the strong Q1 '19 and with a solid balance sheet, the company decided to raise the quarterly dividend to 5.8 cents per share, which represents an annualized yield of 4% based on the current share price.

Technical picture

The shares reacted well to the Q1 earnings announcement. However,given the tense markets last week, the shares couldn't confirm their breakout. If sentiment improves, the recent upward move could resume:

Israel Chemicals stock chart Source: finviz.com

Takeaways

Israel Chemicals tends to fly under the radar, but it is an attractive company that stands to benefit from supportive macro trends, be it in its fertilizers business, or in industrial applications.

The company enjoys valuable competitive advantages, both natural (its Dead Sea assets and privileged location) and human-capital-related (Israel's agri-tech ecosystem). Its current valuation is not demanding, and investors can count on a 4% dividend, one of the highest in the fertilizer space.

Disclosure: I am/we are long NTR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The opinions and views expressed in this article are for information purposes only and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation to buy, sell or hold any security, investment strategy or market sector.