Reversion To the Mean Will Lead to Gains
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When a dominant company suffers temporary setbacks that do not erode its sustainable competitive advantages but do hurt its share price, I see a great opportunity to pounce on an investment with above normal return potential but with lower than normal risk. Just such an enviable risk/reward opportunity is currently presenting itself with shares of Compass Minerals International, Inc. (NYSE: CMP). Shares are down by more than 25% in the past twelve months as the company has been hurt by mild winter weather in the Midwest United States, excessive rainfall in the Southwest United States, and tornado damage to its facility in Ontario Canada.
Compass Minerals is a leader in production and marketing of highway de-icing salt and also produces salt for consumer and industrial uses with the production of sulfate of potash, or SOP, comprising a third business segment. The company has also recently begun offering document storage and hazardous waste management services that make effective use of the company's idle caves at its United Kingdom rock salt mine. These businesses contribute a very minor share of revenues but lower net costs of the facility. Compass Minerals does not have any direct salt mining competitors that are publicly traded but Cargill Inc. in the U.S. and K+S Aktiengesellschaft in Germany are large private companies in the market. Potash Corp. of Saskatchewan, Inc. (NYSE: POT) does compete in the SOP market and is much larger at $37 billion market capitalization compared to Compass Minerals at $2.4 billion.
The company's preeminent asset is the world's largest rock salt mine in Goderich, Ontario, Canada. This facility's value is tremendously enhanced by its access to a deep water port connecting to the Midwest United States. The abnormally warm winter just ended is expected to result in flat pricing in the coming months when municipality customers bid contracts for salt for the next winter season. This anticipation of lower demand and revenue from Goderich has hurt the share price as has the disruption of operations and extra costs from a tornado that damaged the facility in August 2011. Another weather related issue for Compass Minerals is the rainfall experienced at its Great Salt Lake SOP facility in Utah that was 50% above normal levels in May and June last year. This will lessen the SOP supply available to meet demand this year but next year supply should return because more than 85% of the time annual rainfall in the region is 33% or less above average. Each of these issues is a statistical outlier which is temporary and even occurring together they have not damaged the company to any meaningful degree. As stated, management expects salt pricing to be flat rather than negative, the cost related to tornado damage is expected to be recouped from insurance proceeds, and rain patterns are certain to normalize, very likely this year or next.
Positive developments from the company's expansion and acquisition efforts have been masked over the past twelve months by the unfavorable weather. The competitive advantages that the Goderich mine gives Compass Minerals are lower shipping costs due to deep water access and more efficient mining due to extraordinarily thick mine walls. To exploit these advantages, the company expanded capacity at the facility by about 20% in 2010 from 7.5 million tons produced annually to 9.0 million tons. Compass Minerals' Great Salt Lake solar evaporation facility is an energy efficient facility that is likely the lowest cost producer of SOP. The Great Salt Lake facility is one of only three all-natural solar evaporation SOP plants in the world and Compass Minerals has exclusive access to the highly concentrated brine at the north end of the lake. These factors give Compass Minerals a clear advantage over its rivals engaged in chemical process SOP production. The company is leveraging this advantage through capacity additions and began adding 220,000 tons of annual capacity with Phase I of the Great Salt Lake expansion project. Phase II is underway and when complete the company will increase production capacity per pond acre without increasing its current solar pond acreage. This project will also boost the facility's production of magnesium chloride which is sold by both the highway de-icing and SOP segments. On the acquisitions front, Compass Minerals acquired Big Quill Resources, Canada's leading SOP producer, in 2011 to add to its SOP production and the company plans to expand this plant as well. Once the weather reverts to the mean this year or some time in the future, Compass Minerals will be able reap outsized returns by using its improved competitive position from facilities expansion and acquisitions to leverage both increased demand and cessation of nonrecurring expenses and operating disruptions.
Compass Minerals has been a consistent financial performer with revenue growth averaging 6.9% compounded annually since 2004. By controlling operating costs and to a lesser extent by improved gross profit which expanded to 28% in 2011 from 27.2% in 2004, the company has been able to grow net income and earnings per share by about 16% compounded annually during that time. Operating cash flow and free cash flow growth have also exceeded revenue growth due to margin improvement, growing on average by 14.1% and 10.3%, respectively, compounded annually since 2004.
At a recent price of about $72 per share, Compass Minerals trades at a 2012 P/E ratio of about 15.6x and a 2013 P/E ratio of about 11.9x. Analysts' estimates seem reasonable in calling for earnings growth of only 3.6% in 2012 as the company recovers from the Goderich tornado and abnormal weather. The price to earnings to growth multiple (PEG) for 2012 is high at 4.3x but the PEG for 2013 is an attractive 0.4x based on analysts estimates of 31% earnings growth. This may seem like an aggressive growth estimate for 2013 but after stalled growth in 2010 and 2011, it brings growth back in line with the 16% annual compound rise in earnings since 2004. If earnings estimates are accurate, and I do believe they are, this low PEG multiple is extremely bullish for any company, especially one like Compass Minerals that has a great franchise with natural assets that can not be duplicated by competitors. Now is the time to buy shares of Compass Minerals and reap the outsized rewards that will come from the inevitable reversion to the mean.
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