2023-05-14 05:35:36 ET
Summary
- Intrepid Potash's share price is in free fall.
- Fertilizer prices are down ~30% year-over-year, and the decline is hitting Intrepid's revenue and cash flow.
- The company has a number of high-capex projects in flight that it will likely need to fund with fresh debt.
- Despite difficult capital allocation decisions, Intrepid is trading too cheaply relative to the value of its assets and normalized cash flow.
- I think Intrepid Potash should trade at ~$40/share by the end of 2024.
I last wrote about Intrepid Potash ( IPI ) one year ago, when the stock was trading at $65/share. In that article , I let readers know that I had exited my position. At the time, I was worried about two things: a drop in fertilizer prices and management's capital allocation priorities. Both of my fears materialized. IPI's net realized sale price of both potash and TRIO are down about 30% year-over-year, and management began a number of capital-intensive projects to boost production in an environment of falling prices. The market reaction has been vicious; IPI's share price is sitting at about $19 at the time of this writing.
Despite the problems with the company, I think the market is overly punishing IPI. IPI has a robust asset base and cash flow that is being artificially suppressed by temporary capital investment. At $19/share, IPI is trading at liquidation value, giving investors an ample margin of safety. A return to more robust free cash flow could act as a catalyst for share price appreciation in the next year or two. I think IPI's assets and normalized cash flow support a share price of at least $40.
IPI Has Problems
IPI is facing two major difficulties. First, fertilizer prices have dropped significantly in the last six months. My favorite site to track general trends in US fertilizer pricing is Progressive Farmer 's weekly article. These values don't match IPI's net realized price for potash and TRIO sales exactly, but the trend is always similar. At the start of 2023, prices were starting to dip but were within 10% of 2022's pricing level:
Fertilizer prices have continued to decline in 2023. Average price per ton has dropped to $623 as of May 5th, a 30% drop year-over-year. IPI's net realized sale price per ton for Q1 is down a similar percentage:
Lower potash prices mean lower revenue for IPI, despite an uptick in total tons sold. Margins have contracted as well due to increased labor and energy costs:
Lower revenue, contracting margins, and increased capital expenditures (more on that later) resulted in negative free cash flow of $13mm in Q1. Operating cash flow was $8mm, but capital expenditures clocked in at $21mm. Management has guided $60-75 mm in total capex for 2023, so we should expect at least another $40mm in cash to be used in the remainder of the year.
High capital expenditures is another problem. On the back of improved fertilizer pricing between 2020 and 2022, IPI was able to amass $200mm in total cash from operations. Where did all of that cash go? $105mm was used for capital expenditures, $80mm was used to pay off debt, and ~$20mm was used for share buybacks at an average buyback price of $35/share. With another $40mm in capital expenditures on tap for 2023, IPI is facing a negative net-cash balance despite nearly two years of favorable fertilizer pricing.
While I am somewhat critical of management's capital allocation strategy, there is a logic to their decisions. Repaying debt reduces interest expense, buybacks were done at reasonable prices, and capital expenditures were needed to address faltering fertilizer production rates. It is frustrating to see over $100mm go into mining expansion products, a failed experiment in water recycling, and investment into an unproven new business line (frac sand), but IPI's infrastructure truly was in need of improvement. Annual potash production has been steadily falling since 2017, and this hurt IPI in 2021 and 2022 when they could have sold more tons at higher prices if their production had been more robust:
Annual Potash Production (Author's Spreadsheet)
IPI's Cashflow Potential Is Hidden Beneath Capex
IPI operates in an unappealing industry, but that doesn't mean the company is worthless. In the current pricing climate, I think IPI can still generate meaningful free cash flow once it has completed its capex-heavy projects. I estimate "normalized" annual capital expenditures at $35mm. This value roughly matches IPI's annual depreciation expense and average capital expenditures over the last three years. Quarterly, that works out to about $9mm, which roughly matches Q1 operating cash flow. IPI also saw receivables tick up $12.5mm while lowering payables by another $5mm. That is a cash flow swing of nearly $18mm due simply to the timing of payables/receivables. Q1 is generally the highest-revenue quarter of the year, making up 30-33% of total annual revenue. With that in mind, in a world where payables and receivables balanced perfectly over the year and capex was "normalized", then based on Q1 performance IPI would be on track for annual free cash flow in the $50-60 mm range. I don't want to pretend that I can predict fertilizer price trends or IPI's future production levels with any degree of accuracy; this is not intended to be a precise estimate. I simply want to highlight that even with lower fertilizer pricing and depressed margins, IPI can generate free cash flow when it has completed its high-capex projects.
IPI's Assets Provide Ample Margin Of Safety
Estimating the value of IPI's assets is much easier than modeling their future cash flow, and on this front, I think it is clear that the company is being undervalued by the market. At the end of Q1, IPI had assets of $800mm against total liabilities of just $81mm. Book value is just over $56/share. At face value, IPI is trading at a 66% discount to the value of its equity. There is very little "fluff" in these assets; there is no goodwill or intangible asset to be found. If I try to be pessimistic, inventory might be worth less if fertilizer prices continue to fall, as would the short-term value of their mines and operating equipment. There are also significant tax assets of $184mm, which only have value as long as IPI is profitable.
Book value is still $48/share without the tax assets, and even a 30% haircut to inventory and PP&E on top of that still results in a book value of ~$37/share. IPI's $19 share price is equivalent to an extreme liquidation event; cash and short-term investments, receivables, inventory at 50% of stated value, and PP&E at 50% of stated value minus all liabilities still works out to about $18/share.
Investment Thesis
IPI might not be the best business out there, but it is trading too cheaply relative to the value of its assets and cash flow potential. From my perspective, the driver of an IPI investment is the downside protection provided by the company's assets. I am comfortable saying IPI isn't on the verge of liquidation, but knowing that in that worst case you are likely to get all of your money back gives me confidence to wait for uncertain upside. I put IPI in the "low-risk, high-uncertainty" bucket.
By mid-2024, IPI should be wrapping up its capital-intensive projects and beginning to reap the benefits of increased production. This should improve margins, reduce capital expenditures, and lead to meaningful free cash flow. Even just $50mm in free cash flow for full-year 2024 should warrant a market cap of $500mm at a 10x multiple. This translates to a share price of nearly $40. This target is supported by IPI's asset value as well, so I'm comfortable using it as a 18-24 month price target. I like an investment that gives me 100% upside potential with limited downside risk in the event of a full-scale liquidation. Heads I win, tails I don't lose much.
Risks
The worst case for IPI is an extended period of low fertilizer prices and cash burn, which will force the company to take on debt and erode book value. Fertilizer prices are on the decline, and recent history suggests they can go much lower. In my last article, I noted that global production of potash was ramping up and the application season in the US this year was poor. Both of these factors put pressure on potash prices. Management's commentary on the Q1 conference call suggested that they expect demand to pick back up due to favorable crop pricing, but there is no guarantee that prices don't fall back to 2018/2019 levels.
I don't think IPI is facing short-term liquidity risk, despite their aggressive capital spending plans. The company can borrow up to $150mm on their credit facility at SOFR plus 1.5-2.25%, which would more than cover the remaining $40-55 mm capex target and any other short-term cash needs.
Conclusion
I'll say it again: IPI might not be the best business out there, but it is trading too cheaply relative to the value of its assets and cash flow potential. The company's performance is lagging due to decreasing fertilizer prices and capex drag, but a $19/share price indicates that the market thinks they are headed for liquidation. I think this is a highly unlikely scenario and that a share price closer to $40 is more reasonable. If I am wrong and IPI somehow goes belly-up, I think investors will still come away with minimal capital loss due to an $18/share liquidation estimate.
For further details see:
Intrepid Potash: Back In The Bargain Bin