MOS - Mosaic Stock: A Very Bullish Message For Shareholders

2023-11-08 08:45:02 ET

Summary

• The Mosaic Company has experienced a significant decline in stock prices, but recent earnings suggest a potential turnaround.
• Tightening global grain markets and increasing fertilizer demand could drive a recovery for Mosaic.
• Factors such as geopolitics, weather conditions, and the shift toward renewable fuels could positively impact the future of MOS.

Introduction

The Mosaic Company ( MOS ) has been with me since 2020. While I have known the stock for much longer , it was in 2020 when I was part of a team that got a major hedge fund to invest in the fertilizer industry.

Back then, MOS was below $10. It was briefly after the first wave of COVID-related lockdowns when investors jumped in everything related to tech, growth, and weird stuff like non-fungible tokens, cryptocurrencies with funny names, and whatnot.

It was a weird time, and holding stocks like MOS below $10 still felt like a career-ending move.

However, what followed was a massive rotation from growth to value, fueling a steep increase in the stock prices of fertilizer companies, oil and gas producers, banks, and many other companies.

The war in Ukraine added to the bull case, although there was no way I could have predicted that.

Now, it feels like I'm holding the bag again. MOS has fallen from >$75 per share in early 2021 to the low $ 30 range, fueled by easing global fertilizer supply issues, lower crop prices (hurting farm income), and overall lower inflation expectations.

The chart below compares the MOS share price to the price of WTI oil ( CL1:COM , blue line).

We see a very high correlation, which is interesting because Mosaic does not produce oil!

This shows the complexity of the fertilizer trade. Energy and agriculture go hand in hand for many reasons.

• Agriculture crops like corn and soybeans tend to trade very close above production costs. After all, competition is fierce, and they are very generic commodities. Oil is a big driver of production costs.
• More than 40% of corn production and a big part of soybeans/sugarcane/others are used for the production of ethanol and other energy/industrial commodities. This adds a cyclical/inflationary factor to the agriculture trade.
• Higher energy prices often lead to higher inflation expectations. This tends to push investors into value stocks. Fertilizer producers are value stocks.

Now, MOS is down 27% year-to-date, which has improved the risk/reward tremendously.

Its just-released Q3 earnings confirmed it, as the company sees tight global grain markets, rising fertilizer demand, and depleted inventories, paving the way for a bottom in earnings.

With that said, let's dive into the details!

Price Declines Offset Strong Demand

Third-quarter revenues totaled $3.5 billion, reflecting a 34% decrease from the previous year, primarily due to lower selling prices. The gross margin rate dropped to 11.5% from 28.1% in the same period last year.

As a result, the company reported a net loss of $4.2 million in the third quarter, a significant difference from net earnings of $842 million in the previous year.

Adjusted EBITDA for the quarter was $594 million, down from $1.7 billion in the third quarter of 2022.

• Potash: Potash operating earnings were $200 million, a decline from $793 million in the prior year quarter. Adjusted EBITDA was $267 million, compared to $871 million in the same period last year, mainly due to lower prices. Note that the Colonsay potash mine was restarted to meet North American demand during Esterhazy's planned turnaround in July.

• Phosphate: The phosphate segment reported an operating loss of $58 million, compared to operating income of $131 million in the prior year period. Adjusted EBITDA was $201 million, down from $481 million in the third quarter of 2022, primarily due to lower prices and production impacts from Hurricane Idalia and a power outage.

• Mosaic Fertilizantes: The Mosaic Fertilizantes segment reported operating earnings of $77 million, down from $323 million in the prior year period. Adjusted EBITDA was $147 million during the quarter, a decline from $343 million in the third quarter of 2022, primarily due to lower nutrient prices.

To reiterate, as we can see in the tables above, sales volumes were strong across the board. However, that doesn't matter, as it's all about prices.

Sure, volumes matter, but the impact on prices is much higher. Demand fluctuations often differ by a few %. Price fluctuations are much wilder.

Demand is dependent on how much fertilizers farmers need. Prices are dependent on so many other factors and often fluctuate in very wide ranges.

For example, when Russia invaded Ukraine, fertilizer prices exploded, causing demand destruction in certain areas. However, it didn't matter, as most North American producers reported blow-out numbers.

• A $10 per ton price change for MOP prices (potash) results in an EBITDA change of $60 million for Mosaic.
• A $10 per ton price change for DAP prices (nitrogen) results in an EBITDA change of $90 million.

Looking at the chart below, we see how violent the decline in prices was.

Now, it looks like we're seeing stabilizing prices, which brings me to the bigger picture.

Market Fundamentals Present A Strong Risk/Reward

Speaking of prices, even more important than 3Q23 results are the company's forward-looking comments.

During its earnings report, the company noted that the global fertilizer market is undergoing significant changes, driven by a range of factors that are expected to shape the industry in the coming months.

These factors include geopolitical unrest, extreme weather conditions, changes in crop production, and evolving consumption patterns, particularly driven by renewable fuels.

• Mosaic believes that global grain and oilseed markets are to remain tight well into 2024. This tightness is primarily due to various pressures, including the challenges posed by geopolitical unrest and weather-related disruptions to crop production.

As we can see below, the global stocks-to-use ratio remains severely subdued.

• Related to that, the demand for fertilizers is expected to grow as crop production struggles to meet the robust global demand. This demand is driven by demographic changes and increased consumption of renewable fuels, indicating a long-term trend in the industry.

• After two years of underapplication, growers are actively seeking to replenish soil nutrients. According to Mosaic, this trend is even stronger in North America, where a strong spring application season was followed by a successful summer fill program and a strong application of fertilizers in the fall.

As we can see in the chart below, under-application has hurt yields.

• Across major growing regions worldwide, inventories of both potash and phosphates have been depleted and need to be replenished in 2024. This suggests that the market is poised for a significant uptick in demand for these essential fertilizers. While demand alone won't save the bottom line, I believe this also bodes well for prices.

Using the data below, we see a confirmation of the company's comments, as both MOP and DAP inventories are below their 2-year averages.

With that said, the potash supply remains uncertain.

As Belarusian exports in 2023 are projected to decrease by 3-4 million tonnes from pre-sanction levels, modest increases in exports are expected for 2024.

However, logistical constraints and geopolitical events are limiting other producers' capacity to compensate for the shortfall.

In the phosphate market, China's exports are anticipated to remain capped as domestic agriculture and industrial demand take precedence over fertilizer exports.

This scenario contributes to Mosaic's expectation that the global phosphates market will remain tight throughout the remainder of 2023 and into 2024.

Finding Deep Value In Mosaic

On a full-year basis, Mosaic expects total capital expenditures to be in the range of $1.3-$1.4 billion for 2023.

Mosaic has returned $893 million of capital to shareholders through the third quarter of 2023. This includes share repurchases totaling $150 million.

The company remains dedicated to effectively returning all excess cash to shareholders in 2023 through a combination of dividends and share repurchases.

It can do that because of its healthy balance sheet.

It has an investment-grade BBB credit rating and expects to refinance $900 million of long-term debt that matures this year.

Furthermore, the company is expanding its footprint in Brazil by constructing a one million-ton distribution facility in Palmeirante.

It plans to expand its MicroEssentials footprint, which is a higher-margin product and looks to enter the market for lithium iron phosphates. While it needs to be seen how much money the company can make in the red-hot battery market, it certainly opens up new opportunities.

As reported by Fortune Business Insights , this market is expected to grow by almost 26% per year through 2028, potentially growing to a size of $50 billion.

Having that said, MOS appears to be very attractively valued.

Using the (data in the) chart below:

• MOS is currently trading at a blended P/E ratio of 6.5x earnings.
• This year, EPS is expected to fall by 65% (consensus estimates).
• Next year, EPS is expected to fall by 8%, followed by a potential recovery of 9% in 2025. Please note that these numbers have been significantly revised (lower) over the past six months.
• I believe these numbers are too conservative, as I expect an upswing in inflation next year, potentially leading to higher fertilizer prices (also backed by favorable industry developments).
• Over the past five years, MOS has traded at a normalized P/E ratio of 18.1x. This includes both very strong and very weak years.
• A return to this valuation by incorporating weak growth expectations could result in a fair stock price of roughly $70.

I do believe that MOS should not trade below $70, with an upside to $90-$100 in the event of rising crop and energy prices.

The current price is $32. The consensus price target is $42.

However, in order for that to happen, we need a bottom in economic growth, which could take one to two quarters.

So, my rating remains unchanged ( Strong Buy) .

However, I do need to reiterate that MOS is volatile. It could take until we see a bottom, and it's not unlikely to encounter about 10% to 15% more downside.

If that were to happen, I expect a wave of new money to enter the business, similar to 2020. At least, that's what I get from fund managers I've worked with in the past.

I remain long and hope to sell at much higher prices over the next few years, as it's a long-term investment for me.

Takeaway

With a 27% decline year-to-date, MOS presents an improved risk-reward proposition. The latest earnings report indicates potential for a turnaround, driven by tightening global grain markets and increasing fertilizer demand.

However, the future of MOS hinges on a range of factors, including geopolitics, weather conditions, crop production, and the shift toward renewable fuels.

The depletion of essential fertilizer inventories suggests rising demand, which may positively impact prices.

While MOS remains a volatile stock, it's important to keep an eye on the potential for higher prices in the future, which would significantly improve an already attractive risk/reward.

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