Does Making Winter Driving Safer Make for a Safe Investment?
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Companies with asset light business models have been favored by investors in recent times. But I prefer to own asset-heavy stocks, if the assets themselves are the source of structural competitive advantages that are not easily replicated. Based in Kansas, Compass Minerals International (NYSE: CMP), a producer of highway deicing salt and specialty fertilizer sold to customers in the U.S. & U.K. and farmers globally, is such a company.
Products benefit from stable and non-cyclical demand
Compass Minerals is the largest salt producer in North America and the United Kingdom, deriving 43% and 32% of its fiscal 2012 revenues from the sale of highway deicing products to governments and packaged and bulk products to consumer & industrial customers respectively. Rock salt is typically used to remove snow from road surfaces during winter, in a process termed as deicing. Governments are unlikely to turn a blind eye to highway deicing even in tight budgetary environments, because of road safety issues and the economic impact from road closures.
For Compass Minerals’ consumer & industrial rock salt segment, its products are used in the areas of animal nutrition, food, water conditioning and other industrial applications. Its customer base and product offerings are diversified, with end-demand relatively non-cyclical in nature. Compass Minerals’ revenues are recession resistant to a large extent, notwithstanding changes in weather patterns. This is evidenced by Compass Mineral’s stellar financial track record, having delivered positive earnings and free cash flow in every single year in the past decade.
Structural cost advantages
Compass Minerals owns the world’s largest rock salt mine in Goderich, Ontario. This mine gives Compass Minerals the bragging rights as one of the most cost efficient rock salt producers globally, as a result of its scale.
Weight-to-value ratios separate profitable producers from their loss making counterparts, with transportation costs being a key element of profitability. The Goderich mine’s proximity to Lake Huron allows Compass Minerals to ship its products to customers in the Great Lakes regions using convenient and cost efficient water transportation. Also, similar to North American cement producers, Compass Minerals faces limited foreign import competition because the high weight-to-value ratio of salt makes transportation across long distances uneconomical.
Compass Minerals achieved a good set of results for the first quarter of fiscal 2013, growing quarterly revenue and net income by 22% and 17% respectively. This was the result of a recovery in deicing demand, following the return of winter weather in the quarter.
Given that the U.S. rock salt industry exhibits characteristics of a slow growth, stable market, its specialty fertilizer segment, which accounted for close to a quarter of fiscal 2012 revenues, will be a key area of growth in the mid-to-long term. Compass Minerals is the largest sulfate of potash specialty fertilizer producer in the Western Hemisphere, benefitting from the higher margins associated with for sulfate of potash. Sulfate of potash generally sells at a premium to potassium chloride, because of higher yield quantity and better harvest value for crops.
Compass Minerals’ peers include Agrium (NYSE: AGU) and The Mosaic Company (NYSE: MOS). I prefer Compass Minerals over its peers, as Agrium and Mosaic’s fertilizer businesses are more cyclical in nature, with fertilizer demand and prices dependent on crop prices and production capacity respectively.
Mosaic is the world’s largest combined producer of potash and phosphate, having delivered close to 19 million tons of fertilizer to 40 countries globally in fiscal 2012. It is a proxy for increased food demand from a growing world population, as potash and phosphate are key crop nutrients used to increase crop yield. For the fourth quarter of fiscal 2013, Mosaic’s quarterly net income fell to $486 million, down from $507 million a year ago. This was the result of weaker pricing offsetting the positive impact of stronger volumes. Management is optimistic that more favorable demand-supply dynamics will be positive for prices going forward. With close to $3.7 billion of cash and only $1 billion of long-term debt on its balance sheet, timely share repurchases and the optimal use of debt capacity will be potential catalysts for the stock.
Agrium is one of the few listed fertilizer producers that sells its products through both wholesale and retail channels. In addition to producing potash and phosphate fertilizers like Mosaic, nitrogen fertilizers also account for about a third of Agrium’s revenues. Its wholesale business benefits from low production costs and proximity to end markets; while a strong distribution network spanning North & South America and economies of scale derived from its status as the largest global agricultural retailer are critical success factors for its retail business. Agrium achieved the highest first quarter Adjusted EBITDA in its history at $351 million for fiscal 2013, partly boosted by its record breaking first quarter gross margin per ton -- $231 -- for its nitrogen business. Going forward, Agrium is well-positioned, as the world’s third largest nitrogen producer, to further capitalize on its cost advantaged competitive position on the back of low North American natural gas prices,
Compass Minerals sets itself apart from its commodity producer peers, which are typically dependent on cyclical demand and lack any sustainable competitive advantages. However, its valuations seem to be quite rich at 18 times forward P/E and 1.6 times PEG. I would prefer to take another look at the stock when valuations go below 15 times forward P/E.
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Mark Lin has no position in any stocks mentioned. The Motley Fool owns shares of Compass Minerals. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!