Summary
- Intrepid Potash delivered results below my expectations.
- Despite everything slowing down, and prices coming down, EPS was very strong in the quarter.
- As I look at 2023, just around the corner, there's every indication that potash demand will return higher.
Investment Thesis
Intrepid Potash ( IPI ) was a stock that I had doubts about heading into the print. I had seen commentary throughout Q3 that fertilizer prices may have caused farmers to defer their potash purchases.
And that's exactly what happened. Yet, despite farmers deferring their purchases, revenues were still up 26% y/y.
So what's happened here is that as prices become too high and farmers didn't come to the market, potash prices trended lower throughout Q3.
But farmers will not be able to defer their potash purchases for many more quarters. Farmers will have to return to the market to replenish their stock inventory.
On the one hand, this has deferred that ''stellar'' quarter, I wanted to see. On the other hand, despite all this, earnings in Q3 were very strong.
I continue to believe that next year, Intrepid Potash's free cash flow will reach approximately $120 million. That puts the stock priced at approximately 5x next year's free cash flow.
Also, keep in mind that this business has no debt and is already sustainably profitable.
Here's why I'm bullish on Intrepid Potash.
What's Happening in Potash?
Investors, myself included, got too interested in the potash shortage story. Prices for potash were going up and up.
This saw farmers on mass push back against higher potash prices and delay their purchases. Farmers steadfastly refused to entertain the idea that potash prices will remain elevated.
What you can see above is that earlier in 2022, the price of potash jumped higher. Hence, farmers didn't want to pay higher prices, so they deferred their fertilizer purchases.
This led to inventory becoming tight.
The graphic above shows how the past several years have fared in terms of the global grain stocks-to-use ratio. It's a proxy for supply-demand. And although it does not pertain directly to potash, it does reflect the overall environment where there's a very limited amount of fertilizer available.
While the next graph shows the expected demand for potash over the coming few years.
What you see here is that in 2022 demand is down relative to 2021. But you also see that demand is expected to be higher in 2023 compared with 2022.
Yet, for now, investors are so accustomed to investments in potash companies being so disappointing, that investors simply struggle to get behind ''yet another'' lackluster quarter.
Or perhaps, better said, it's not so much that the quarter was lackluster. It was that investors know that potash companies are in a favorable environment, that they could possibly be over-earning, and if this is as good as it's going to get, investors want nothing further to do with potash companies. The fear that this is a rerun of 2007 is palpable.
Meanwhile, both Intrepid and Nutrien ( NTR ) contend that 2023 should remain tight leading to strong fundamentals.
Revenue Growth Rates Decelerate
The bearish case is that potash companies have already had their best days last year and early this year.
However, I don't believe that's the case. In fact, I believe that even though Q3 was poor and Q4 2022 may also be poor, I'm reassured by the following.
After everything that happened in Q3, with high inflation and farmers pushing back against the high prices, Intrepid still saw 26% y/y revenue growth.
And that is against the tough comparisons of last year! That was the most challenging quarter to overcome, and even in this case, Intrepid still grew y/y. Despite the poor evaporation season, plus low volumes being sold.
Earnings Per Share Figure Jumps +220% y/y
As I've discussed throughout, despite all that's happened including lower volumes being sold, Intrepid's adjusted EPS was up 223% y/y. This compares with a 135% y/y increase for Nutrien.
Or put another way, Intrepid's EPS was higher by more than 100% compared with Nutrien's.
Yes, I admit, this still didn't live up to analysts' expectations of $1.74 for Intrepid. But when we look back at the $0.30 of EPS Intrepid reported last year, that's a dramatic improvement to $1.74, I'm confident you'll agree!
If we assume that analysts' estimates for Q4 are also slightly too bullish, and EPS for Q4 reaches $2.00 rather than the $2.14 that analysts currently expect, that would mean that this year Intrepid would report $7.03 of EPS. That would put the stock priced at approximately 6x this year's EPS.
IPI Stock Valuation -- 5x to 6x Free Cash Flow
Note, Intrepid Potash's midpoint capex points to $70 million.
Further, we know that for the first 9 months of 2022, Intrepid's EBITDA is up 177% y/y. If we assume that Q4 sees its EBITDA moderate significantly, and only grow by 75% y/y, that would see around $45 million of EBITDA.
Hence, 2022 as a whole would report $164 million. Meaning that this year's free cash flow on a normalized basis would reach $94 million.
Even if we round this down slightly to $90 million, that would still put Intrepid potash on a path to 7x this year's free cash flow.
But again, this is after farmers were not in the market purchasing fertilizer . But if we assume that farmers return in 2023, as they'll be forced to do so given the strong crop prices in the US, I continue to believe that Intrepid will make around $120 million of free cash flow next year.
That puts Intrepid priced at 5x next year's free cash flow.
The Bottom Line
There's no doubt that I was taken by surprise by the reduction in potash being purchased by farmers this quarter. There had been signs that this was a possibility since last quarter.
But now, I'm very optimistic, that with this news now out and widely acknowledged in the market, what was once an uncertainty facing Intrepid Potash, is now a ''known known''.
With this in mind, I believe that over the coming few days, investors will be back to appraise Intrepid on its extremely cheap valuation of approximately 5x next year's free cash flow.
When I look around at what is happening outside of the fertilizer market, where tech is imploding day by day, I'm more than willing to keep my capital invested in Intrepid.
Even the best companies are getting shot from the sky in tech. That's clearly not happening here, as expectations are low, and valuations are very compelling, as you can see.
It's not about value versus growth investing. It's just about what makes sense. And Intrepid Potash at less than $1 billion market cap makes a lot of sense to me. I'm sure the market will also see this too.
For further details see:
Intrepid Potash: Why I'm Bullish On This Potash Company