Summary
- K+S, or Kali & Salz, is a company I've been writing about and investing in for about a year at this point, and have covered it for myself for longer.
- The current macro means that fertilizer remains at a premium because everything coming out of Russia and Belarus is suspect. K+S has taken advantage and stands to gain.
- Despite outperformance of close to double digits since my last article, I do believe there is more to be gained here.
Dear readers/followers,
I've been looking at German K+S ( KPLUY ), or Kali & Salz, for a number of years and provided coverage for the company for about a year here or so. The company remains a play on fertilizers, primarily potash, and fertilizer puts it in the same context as companies such as Yara International ( YARIY ). These are very cyclical businesses that go up and down with macro.
On the positive side, we've seen very good trends for businesses like this and their ability to make money. Farmer profitability and fertilizer prices have been hitting records and the roofs for some time now, which is why the companies are seeing such favorable valuations and earnings. The situation in Ukraine only worsened this entire dynamic, meaning the prices went up even further given that Belarus and Russia are primary suppliers of Potash.
It's time to look at K+S for the year 2023, and why I'm quite positive about the company here.
Kali & Salz - not as strong as Yara, but a good fertilizer play nonetheless
So, K+S, for those that don't know, is a chemical business - much like Yara also does things with chemicals, although K+S has been around for longer. The company has, throughout its history, been a major player in potash as well as a player in salts. That's also where the company is today. The company merged with the legacy potash division of the BASF ( OTCQX:BASFY ) subsidiary Wintershall back in the '70s. Most German companies have some sort of common past like this, and you won't find a large-cap German company in this sort of legacy field that has nothing from 100-200-year-old as part of its operations.
The company is big - billions in market cap, and unlike Yara which does not supply Potash as such, is the largest potash supplier in all of Europe, as well as the largest supplier of salt in the entire world. It merged with Morton back in -21, which enabled the company to take this position in the market.
K+S is fully integrated on a vertical basis - it not only does exploring and prospecting, it does all of it down to the S&M for its products. The way this sector has worked for the past few decades is that most potash and salt mining/supplying in Germany has seen a backseat due to it being cheaper to do in Eastern Europe. With much of Eastern Europe now "locked off" due to macro (at least the areas that matter in this context), things are back to potential growth here for K+S.
That's why it's relevant to know that the company owns mining rights for more than another billion tonnes of potash in Germany alone - along with another 1.5B tonnes of crude salt - and that's just Germany. K+S is a holder of plenty of global mining rights, with much of the rest in Canada, where it acquired Canadian Potash in the financial crisis for a measly €300M.
This brought with it large amounts of exploration licenses with the potential to add around 3B tonnes of potash. The company is also involved in Australia, with mining rights/reserves from local investors in order to set up various projects related to solar. In short, K+S is short neither mining rights, resources, nor reserves.
That's why these trends that we're seeing right here are so positive for the company.
And there is little to suggest, near-term-wise, that prices are going down. 3Q22 alone, which is the latest set of results we have, saw a five-fold increase YoY in terms of EBITDA, mostly due to agri pricing. The trends were so good that the company, on a financial debt perspective (net) turned to net cash in 3Q22. And all of this is despite a reduction in volume due to logistical issues.
This illustrates and reflects how "bad" things have gotten in terms of trends for fertilizers. 3Q21 saw EBITDA of €121. The same period 1 year later was at EBITDA of €633.
What I as an investor want to see is how the company is using this sudden influx of cash, to improve its operations and circumstances when we're not seeing these trends. Because eventually, inevitably, as things always do, they reverse.
Yes, the future scenarios for potash and fertilizer overall look bleak. Because Russia is such a major player in this field, and even were the war to end tomorrow things would likely take years to normalize, things are going to be staying in the company's favor for quite some time - at least that's what we're seeing, and that's pretty much what I agree with here.
Even the most optimistic recoveries though show stretched dynamics when put into macro, with levels not returning to normal for 2-4 years. And that optimistic scenario, given it's based on 2022 normalization, is already out of whack.
At this time, K+S is likely to deliver annualized EBITDA which beats the previous records by over €1B on the conservative side. This comes from higher pricing for company products despite cost increases and energy costs, volumes, back-end-loaded tax distributions, and even without the one-off of a €230 repayment for factoring and purchase of Co2-certs, it's a forecast of around €2.4B for the year.
So, let's go to the big question - the use of the capital.
Thankfully, K+S has plans here. These plans include:
- Repayment of factoring (already done, good one)
- Purchase of CO2-certs (necessary, not something I'm a fan of)
- Dividends (always good)
- Early repayment of bonds with maturity dates of 2022 and 2023 (lower debt, score on that one - lower interest payments).
- CapEx and OpEx investments beyond the norm, optimization of Bethune and Werra 2060. (Obviously something we want to see)
- Creation of a war chest for the case of armed conflict or further energy crises, and maintaining a net cash position (excellent news)
- Potential further dividends, subject to gas price caps and defense shields from the German governments, are to be decided in March.
The Werra region is being talked about here - and this is what they're talking about.
So, the investments here are good news because it makes western and central Europe more independent. The expansion of secondary mining operations and all the changes planned, including the new processing methods will result in more stable, higher production out of Werra, with reserves even beyond 2060. There is a significant amount of investment to be made here, which can be viewed here.
These changes increase the estimated NPV of Werra by almost half a billion euros, to €1.5B and above, or an estimated €7.8/share, which with the update implies a current FV of €42.40/share. That's more or less double the current native share price, and higher than we've ever seen the company trade at, barring the financial crisis in -08.
So, what do I think K+S is worth at this particular time?
K+S Valuation - It's still appealing, but there are some considerations to be made
So, the first consideration I want to point out to you is that Yara is available, and it's the better company. At least as I see it. Yara isn't dependent on Potash, has a better and more time-tested dividend policy, Norwegian state ownership, and while not exactly cheap, is competitive here.
But if you're like me, you might already be full to the gills of Yara stock, which would understandably put you in a position of not being able to "BUY" more. This opens the market to K+S, and this is part of why I bought.
And K+S is a good company. It's just that any attempt to give a good valuation analysis here is hampered by a few things.
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 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.
DCF first, and updated. I cap sales growth at 3.5-4% with a 1.5-2% EBITDA growth rate in outlying periods with a steady CapEx/sales ratio over the coming years. I've also increased the risk-free rate as interest rates have gone up, which pushes the FV down. From around 7.8%, I'm up to around 9.5%. This puts me in a price range starting at €31 and going up to around €41. Compared to my previous article, I've decided to actually increase the company's growth rate to more than twice what I previously used - which is why it's logical that we also see significantly higher FVs. It's my stance that if you invest in K+S, you should hold the bullish stance that the company will be a major player in the future of Potash and that the current political macro will prevent Russia from returning to that position for some time.
So, based on DCF, the company is cheap - and we can definitely go higher from here. Peers are still giving us a cheap valuation for this one. K+S trades at less than 1x revenues and 1x sales, and a native P/E of less than 4x. No matter how you slice that, it's far, far too low for what the company offers you here, and the PTs reflect that.
S&P Global gives us a range from €20 on the low side to €37 on the high side - a wide range. 15 analysts follow it, and 8 are positive with "BUY" or equivalent here. There is a risk, but opportunity as well. The average PT is around €26 at this time, implying an upside of over 15% to the native SDF ticker.
And, remember - from a very factual point of view, if you invested based on my last rating, you made the right choice because you beat the market.
I'm never shy about when I'm right - nor am I trying to hide when I am wrong. This company is a volatile sort of play, and you shouldn't expect to see the end of it in the next couple of years. For now, my position is small - under 1%, but I'm adding to it slowly on the back of the forecasts seeing stabilization of the company's income, and raising of the company's dividend, as I expect it.
As such, here is my current 2023E thesis for K+S.
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 give the company a conservative €30.5 PT based on conservative growth rates, mixed NAV/peer valuations, and conservative multiples and forecasts.
- 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 Remains A Good Investment And Play On Fertilizer In 2023