2023-12-16 09:38:08 ET
Summary
- K+S, a fertilizer and salt company, has experienced a decline in earnings due to a contraction in the fertilizer market.
- The company's annual expected EBITDA is significantly lower than previous years, but sales volumes are expected to remain stable.
- Despite the current macroeconomic trends, the company is considered a solid investment with potential upside.
Dear readers/followers,
K+S, a fertilizer and salt company, has seen a decline in its earnings due to a contraction in the fertilizer market. The company's annual expected EBITDA is significantly lower than previous years, but sales volumes are expected to remain stable.'
We've seen yet another 10% negative RoR since my last article on the company. Am I worried about this? No - my investment thesis for these sorts of companies is based on the long-term appeal of fertilizer fundamentals.
I've been covering this business for about 18 months at this point. This is an updated article compared to the last one, which you can find here.
My key thesis for this company for the past few articles has been that the fundamentals have made this company a long-term buy.
While in many ways among the market-leading fertilizer companies out there, and while I remain heavily invested in basic materials, chemicals, and fertilizer here, I would still be careful investing too much or at the wrong price or in the wrong business.
So let me show you why the company is, as I see it, not the "wrong" company at this time.
The continued appeal of Salt and fertilizer, with K+S at a cheap price.
It's difficult to say just how low this company could potentially go. But the company has certainly gone down even further compared to my last article. SDF is the native ticker here and the company's fundamentals are, for the sector, absolutely superb. SDF has a BBB rating, and while it does have a very complex set of earnings trends, I see a good chance for an eventual upside.
Why is that?
Let me show you.
Since my last article, we've seen the 3Q23 results, and much like with my last article on Yara International ( YARIY ), another fertilizer business, the current macroeconomic trends dictate a problematic sort of overall trend for these sorts of companies.
Why is that?
2022 was a record year. This is not just for K+S, but it was a record year for most companies in this sector. Even the high energy prices suffered by many of these businesses could do nothing to downplay the record-high sales prices and product prices enjoyed during the period.
That is what is now coming inevitably back down.
I've shown you how these trends look for other companies, now I'm going to show you the bridge development for K+S.
While there are factors that are making sure that earnings and results will go up in the near future - such as sales price realizations across some geographies not yet being included, the overall large-scale picture is of a firm downturn here - again, not just for K+S but for the entire sector.
This macro picture is influencing the current long-term trends for companies in this segment and muddling what is actually a very good environment. We have to remember that these companies are just coming out, usually very cash-heavy out of an environment that enabled them to sell record levels. Managing a downturn like the one we're seeing isn't going to be breaking the backs of good companies here.
Fundamental KPIs if you follow farming and agricultural trends are very good. The historic profitability that they are currently enjoying is not only a potential argument for investing in fertilizer, but also investing in farmland, which I have been doing since my last article.
Agricultural commodity price levels, while currently in a shorter-term decline pattern have been rising on average in a linear fashion for the past 20 years (Source: World Bank), and whatever input cost increases have to be managed has been able to be managed thanks to the higher selling prices.
It's no secret that grocery shopping for most people over the past 3 years has seen significant increases for your average "grocery bag". The trends seen here suggest that this is not a trend that's going away, but rather one that might be increasing even further. We should get used to the idea that we're paying more and more for our groceries, and because of this, we can also expect that fertilizer and crop nutritional companies are going to be earning the fruits of this trend, no pun intended.
The company will also enjoy the positive trends of the imbalance of the world potash production with Belarus and Russia taken out of the mix. However, that doesn't mean that if this capacity comes back, that there will be significant downturns due to overcapacity.
Why?
Even with these capacities added back, the worldwide potash market was at capacity before the war. Until 2021, Russia’s Uralkali and Belarus each accounted for approx. 16% of global potash production (28 mt in total). Most of the future capacity expansions (11 mt) would have come from these producers - but now many of these expansions have been postponed. New capacities are currently needed to meet the future demand for potash.
The company has also been able to confirm its latest set of full-year outlooks. 2023 is going to see a massive YoY decline in earnings but still generate between €600-€800 in EBITDA. When we put this into the context of the longer-term results, these are actually very solid results. Only the 2022 results on a comparative basis make this year's results look bad.
The main negatives are the company's inflation in costs related to materials, energy, personnel, and other trends - these cost increases are likely to persist, so price increases are necessary here. The company seems to be managing this.
The company has also accepted a new distribution policy.
As you can see, the company will become a more generous dividend payor as well as with continual buybacks, while also maintaining an extremely conservative balance sheet - much like other companies in this sector. Because the company's leverage is so low, the company's interest expense is extremely low - less than €32M for 2023 so far.
To say that K+S is the best investment in the sector would be an exaggeration. To say it's a solid investment with an upside though, that's a different story and a different stance. Given the upside inherent to the stock relative to the company's risk profile, my conviction is high that this company is in fact a solid investment - despite the current macro.
Risks & Upside
The primary risk to the company here is not operational - it's macro. The global agriculture and fertilizer market is a volatile environment characterized by extremes, as evidenced by the past few years in this market and these companies. As an investor, you can see several years of underperformance only to suddenly see a massive upside once things improve, that even in a short time can really turn it into a multi-year market outperforming trend. That's the tricky part about these companies and the primary risk.
They're simply not stable. Even if they are safe, they are not stable in earnings, which means the share price can be unstable (though more stable than the trend might suggest).
The upside is exactly that upside. If you buy this company cheap, you can, with patience and following macro, see outperformance in the triple digits here. That's what I'm trying to do. I'm trying to buy the companies at what, even in the longer term, is an undoubtedly solid price to invest in.
Let's look at the company's valuation at this time, and following this double-digit decline.
Company Valuation
The company is at a low price at the moment - and there's low visibility, unlike with Yara, for clear adjusted EPS improvements for the next few years. The company is BBB-rated with a high current yield due to extraordinary dividends.
A few things I want to make clear in this section.
First of all, I believe in a significant underlying improvement in earnings/EBIT for the next few years following the 2023E period.
You can see the outlier status of 2022 in this forecast in terms of EBIT and where things might be going.
I believe the improvement in EBIT will come both due to price and demand increases, as well as improved fundamentals for the sector. Even if K+S is not as good as Yara - and it's not in my view, or I'd own much more than I am - and the yield isn't as clear or as good, there's still an upside.
With the native SDF currently trading at less than 0.6x to trailing revenues, and sales and less than 0.4x book value, there's a massive undervaluation to fundamental multiples here. As an example, the mean Book value per share/share price on an LTM basis comes to 1x - it's currently 0.39x and has been as high as 4-5x. The same sort of disparities are clear in the other multiples we see here.
S&P Global analysts consider the company to be a clear "BUY" here. From an average share price of almost €30/share from a range of €20 to €50/share, we're now down to a range of €13 to €25/share with an average of €18/share. However, out of 16 analysts, 9 have the company at a "BUY" or similar positive rating, implying a 33.6% upside to a very conservative price target of €18.
I have no issue with this price target - I'm cutting my own a bit to €25/share which better represents the long-term upside I see for the company, but I would now agree that going in, I had too exuberant expectations for where K+S might go, even with how positive things for this company are.
So, while I'm at a "BUY" here and believe myself seeing a potential triple-digit upside, I believe this will be a long time in coming, and we might see ups and downs until then. Given the current market environment, I believe there is much to be said here for being careful as to what you're investing in.
Here is my current 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 now have at my conservative €25 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 as of December of 2023.
- 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 expansions/reversions.
My one change is that I now view K+S as "cheap" here, fulfilling all of my criteria.
This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
For further details see:
K+S: I See The Bottom, But I'm Cutting My Price Target.