2023-05-07 01:02:44 ET
Summary
- I've been covering K+S for about a year at this point and would consider my position in the company a long-term one.
- While macro has changed somewhat since my last piece back in February, the company remains an attractive prospect in the current market.
- K+S has dropped, but I believe the upside is still there and non-trivial.
Dear readers/followers
K+S Aktiengesellschaft ( OTCQX:KPLUY ), or the Kali & Salz, is far from the most attractive play in fertilizer and isn't the most qualitative in the entire segment either. However, the company does offer a double-digit upside in a difficult market and trades at very conservative overall multiples.
Potash is an attractive play, even if Yara International ( OTCPK:YARIY ) has a far more attractive mix - but the company also comes with salt exposure, which I view as attractive in context here.
We're in a reversal here - farmer profitability and fertilizer prices are slowly declining once again after hitting ATH's not that long ago. The dynamics are still stretched due to Ukraine and similar issues, but they're not as stretched as they were a few quarters back. It's what we've seen in the competition as those companies have reported results.
So let's look at recent results and see what we have going for us here.
Kali & Salz - Remaining a good fertilizer play, but with lower yield and good prices
The main arguments for K&S are fairly clear, and something I've covered in my previous articles on the company. Aside from the meager yield, these recent years have put K&S in one of the best situations in history . And this shows in the company's financials and results. The company has one of the best margins in the entire fertilizer businesses. Its segment is agriculture/fertilizer, a sector where on the basis of gross margins, operating margins, net margins, RoE, RoA, and ROIC, the company showcases 80-91th percentile positioning in the sector. On a comparative basis, this is when looking at peers like Corteva ( CTVA ), Nutrien, FMC, Mosaic, Yara and others.
K&S is a relatively small player in this field in terms of market cap - it's around a third of Yara by comparison, but it's a qualitative player with even better underlying financials, if not operational specifics on a future-proof basis (potash versus Yara's product focus).
But K&S has everything a good company could want, with some small exceptions. It has insider buying, it has superb interest coverage, it has high financial strength. What do I mean by high financial strength? I mean that with an interest coverage of 111.8x, an equity/asset ratio of 0.68x, and no debt , the company is very attractive. This is especially the case when looking at things like the revenue growth rate, as well as the book and FCF growth rates, and how the company has been growing its cash and profitability.
Here is profitability, or at least a relevant way of looking at it.
The company has also been apt at growing shareholder equity in an attractive manner. At a net income margin of 26.6%, this is one of the most attractive companies in the entire industry - from that perspective, at least.
What's more, recent insider activity confirms to a high degree that people with the "know-how" consider the company's equity to be undervalued at this point. Thousands of shares were bought since December, with very recent buys in April of 2023 as well.
This in itself does of course not make for a "BUY" thesis, but I don't see it as a bad sign. Recent results also confirm the upside that exists here. In March, K&S reported the very best results in the company's history.
This is also what has allowed K&S to become completely debt-free. Yes, I'm re-emphasizing this, because not many companies are in a situation where they can claim to be completely debt-free in this macro.
This also resulted in three full notches of rating upgrades. It's only one notch left until investment-grade rating, with the company currently at BB+.
This has also resulted in a combination of dividends and share buybacks, delivered by the company in the form of €200M worth of repurchases this year, with another near-€200M worth of dividend payouts. Combined, it represents a 40% FCF payout ratio.
Outlook for 2023?
Less positive than for 2022 - but still a massive upside. The company expects EBITDA up to €1.5B, and at least €1.3B, with adjusted FCF in the €700-€900M range, with a comparison of around €932M for 2022. Some normalization is expected to occur, same with Yara, which will drive prices down somewhat. Prices are expected to increase as well, with further inflation for logistics, personnel, and materials.
The reason for continued high levels in these prices is simple - low stocks-to-use ratios, as well as unfavorable climate trends, are bound to keep things at a high level in terms of pricing. Even if some normalization occurs, the pricing for something like Corn is still at a high level.
The second thing that's driving potash up, and likely to have it remain at a high level - is geographical macro. With Russia and Belarus cut off, which are the by far largest producers of potash at 16% of global and responsible for most of the capacity expansion, K&S is left in the enviable position of owning much of the assets needed to provide potash to say, Ukraine. Ukraine is the largest wheat exporter in Europe, and one of the largest on earth, at 28% of total, including Russia. But Russia is obviously closed for now as well. This begs some questions regarding the likely outcome of these export changes. As things look now, we're looking at the "pessimistic scenario" as things stand here, and there is no real end to the conflict in sight.
Even based on optimism , we won't see full recovery for potash until 2026E, and this is a very good upside for K&S given their current position. I've reviewed company operations on a more basic level in previous articles - and refer you to these for a more high-level overview of things like their salt operations or various asset lifetimes/forecast.
The company is now present in two parts of the world and has 11,000+ employees making sure that Potash and Salt are delivered to its customers. K&S, as of 2022, works with an EBITDA margin of over 40%.
The global population development means that the consumption of protein will go up significantly. While the consumption of food will go up, the amount of arable land per person has gone down significantly. From 1960 looking at 4,300 square meters per person, we're now down to 2,100 in 2010 and will be down to an estimated 1,800 per person in 2050E.
The type of demands this puts on things like food production and the companies involved in this value chain is immense - and K&S is one of them.
This will also, I believe, lead to significant profit.
Let's look at an updated valuation thesis for K&S.
Potash & Salt - Valuation remains very appealing
I won't mince words here. K&S has the very real potential for triple-digit RoR in the next few years. The right sort of development and continued demand could see the stock soar far higher than 100% from this point.
Much of the uncertainty about K&S is related to the company it was - not the debt-free reality of the company it now is, and likely to remain at these commodity trends. That is why I own the stock. There are valuation problems with K&S, but those aren't related to current fundamentals.
The company has excellent foundations to go into a market that's characterized by rising potash prices, but at the same time, a massively rising valuation for the company wreaking havoc with the comparables. I continue to use DCF, NAV, and public comps as well as other analyst comparisons to reach a consensus and try to understand how K+S is viewed by the market today, even if DCF is problematic with this sort of volatility.
Better than you think is a term that describes K&S pretty well. 16 S&P Global analysts give the company a conservative PT range of starting at €17 and going up to €30/share, with an average of around €24/share. This means that there is still an above 38%+ upside from today's share price of €17/share. The company still trades at a below 1x sales multiple, at 0.7x, and doesn't reach a 1x tangible book value per share but only a 0.5x/share. That means you're essentially buying the assets the company has at less than the replacement costs of those assets in the current market.
Granted, I have a lot more capital pushed into Yara. I like Yara better than K&S simply due to the product and market cap. The company also doesn't share K&S's problematic history in the near historical term. Profit and margins have been volatile for this company.
For EBITDA, based on current commodity trends and flows, I expect the company to manage over €1,000M this year, but less than €1,500M, with that number declining over the coming years. However, I expect the level to normalize based on the current macro at a level of that €1,000M over time, or €1B. I am far from the only one to do this, with S&P Global analysts expecting at or about the same level until 2027E. I expect this will mean a GAAP EPS in euros for the native, of at least €1.4/share until 2027, every single year.
While this means that the company can't deliver the same sort of share buybacks or dividends it has this year, the current dividend level of €0.2/share which is a 400% increase from 2021, is more than sustainable on GAAP numbers and makes that 1-2% yield, depending on when you bought, extremely covered. It also means a 14% GAAP EPS payout ratio - the company could easily double that and still remain conservative.
The math works in Kali & Salz - and that is why I am positive about the company and willing to put more capital to work here.
Here is my current thesis for the business as of May of 2023, and going forward into 2H23.
Thesis
- K+S is one of the largest players in Potash remaining after Russia and Belarus are sanctioned off to most of the modern world. This makes this German fertilizer and salt giant an attractive play, and a good time for the company to flex its expansionary muscles. Despite a lack of an IG rating, I view this as an interesting play.
- In the right environment, which we have today, it's not inconceivable that the company could rise closer to its fair value, which I view as being valid close to €40/share.
- I remain at my conservative €30.5 PT based on conservative growth rates, mixed NAV/peer valuations, and conservative multiples and forecasts. This is above the average, but I consider it fair.
- I, therefore, view it as a "BUY" here.
Remember, I'm all about:
- Buying undervalued - even if that undervaluation is slight - companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime.
- If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.
- If the company doesn't go into overvaluation but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows.
- I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.
Here are my criteria and how the company fulfills them ( italicized ).
- This company is overall qualitative.
- This company is fundamentally safe/conservative & well-run.
- This company pays a well-covered dividend.
- This company is currently cheap.
- This company has a realistic upside based on earnings growth or multiple expansion/reversion.
For further details see:
K+S Aktiengesellschaft: After A Drop, There Is Upside To Be Had Here