Intrepid Potash... Fertilizer for the Portfolio?
Though his thesis was cunningly morbid in itself, Malthus was unable to predict that technological and scientific growth was also in itself exponential, as seen in Moore’s law. One company that strives to keep Malthus’ grim future from occurring is Intrepid Potash (IPI) of the NYSE. Based on current market conditions, and company fundamentals, IPI should be considered a buy with an average upside potential of 11.6%.
Fertilizer is comprised primarily of three core elements that crops need to thrive: nitrogen, phosphorus and potassium chloride (potash). Like food for human beings, fertilizer serves to stimulate growth and quality in crops. It is said that without readily obtained fertilizer, 33% of the world would experience severe food shortages. With that in mind, 95% of potash produced is estimated to be used exclusively for the purposes of fertilizer. However, there are other uses for potash, such as industrial usages, and in livestock feed. Nonetheless, the usage of potash is critical to several different industries that enhance the standard of living for people globally.
The potash industry itself is driven by a variety of factors, ranging from, but not limited to, population growth, dietary patterns, farm acreage, agricultural prices and global economic conditions. Generally, as populations grow, the amount of arable land decreases, and as such, a greater yield per acre of planted crop must be achieved to sustain growth. Furthermore, as income levels increase around the world, people demand greater quality both from luxuries and nutrition alike.
As such, based on current population growth, potash consumption is projected to grow 5% annually from 2012 to 2016. The industry itself is competitive, as global production of potash occurs from 20 primary commercial deposits. Other deposits that may have been feasible are compromised by high mining costs, or located in politically unsavory places such as the Congo. The key metrics maintained in the industry are particle size and potassium oxide content. Potash prices peaked in 2009 at levels hovering around $900, but collapsed to two-thirds of that value to around $300 in early 2010. Prices are now hovering around $470 per ton. Reuters recently reported that potash inventories fell in April, but inventories are still 25% above the five-year average.
Serving as the largest producer of potash in the U.S., Intrepid Potash supplies 1.6% of global potash consumption, and 9.3% of the U.S.’s consumption. In terms of their operations, Intrepid Potash owns five potash facilities with an operational capacity to produce 870,000 tons of potash, and 270,000 tons of langbeinite, another active ingredient in fertilizer. The firm itself is relatively young, incorporated in 2000, with its initial public offering in 2008.Their business model is primarily oriented around the production and sale of potash, accounting for 89% of net sales in 2010 and 90% in 2011. Langbeinite accounts for the rest of their sales, and is marketed as Trio in the marketplace. Intrepid Potash strives to compete via “timely service, and a focus on the markets in which we have a transportation cost advantage.” The following are competitive advantages enjoyed by the firm:
1. Assets located near customers: Unlike its Canadian counterparts, Intrepid achieves cost savings from transportation costs due to being located in the U.S. 95.4% of their net sales in 2011 were to U.S. customers.
2. Reserve life – Mines owed by Intrepid have reserves ranging from 28 to 157 years, which allows it to sustain its operations for the foreseeable future.
3. Three markets for potash – Intrepid diversifies its customer base into three primary segments: agricultural, industrial and feed usages.
Like any business there are operational risks, with the following being critical due to the nature of the business:
4. Potash production occurs primarily in the Western U.S. and as such, is subject to weather and civil disruptions that may occur in the region.
5. Intrepid Potash produces only potash, which exposes the firm to both price and demand volatility.
6. The industry is subjected to federal, state and local laws with regard to royalties, safety, environmental impact and wildlife impact.
7. Fertilizer application rates are directly based off of the decision of farmers every season.
8. Larger competitors can leverage their size and network to achieve economies of scale, and negotiate more beneficial rates for themselves.
Financially speaking, the firm is relatively solid. A glance at Intrepid Potash’s most recent quarter yielded key factors to be considered. In terms of income metrics, the company booked sales at $112 million, which is 6.9% higher then the $104.98 million posted in the first quarter of 2011. However, between the same two periods, gross margins declined from 39.2% to 36.7%. According to their 10-Q filing, lower production due to unforeseen problems at the east mine was the primary agent of this decline. Profit margin also fell to approximately 18% during this quarter. Earnings per share totaled in at $.27, versus 2011’s earnings at $.38.
A closer look through the foot notes demonstrates that in the first quarter of 2011, approximately $12.5 million was recorded as net income due to an insurance settlement from a 2006 event. As such, the normalized EPS is quite comparable between these two periods. At the moment, Intrepid Potash does not have any plans for dividends in the near future, as they prefer to plow as much of their earnings as they can back into the firm. It must be noted that without a dividend, however, and other metrics, numerous funds may be prohibited from investing into IPI due to charter laws.
In terms of the balance sheet, the firm is and has been historically liquid, with a current ratio of 6.31. Subtracting the inventory yields a quick ratio of 5.14, which is still an astonishing high number. Intrepid Potash has no long term debt, and thus, has a very low debt ratio. In terms of free cash flow, for the first quarter of 2012, the firm generated negative free cash flows which paralleled the results in first quarter of 2011. When annualized, however, the firm generated positive free cash flows for both years.
Looking forward, the firm has two major projects in development. First, the firm has commenced construction of the HB Solar Solution Mine, which has an estimated project cost between $200 to $230 million. The project is expected to be complete in 2015, with an output estimated between 150,000 to 200,000 tons annually. The firm has also made headway into their Langbeinite Recovery Improvement Project, which has an estimated cost of $100 million. This project is slated to increase their recovery of langbeinite by nearly 50%. Both projects are expected to increase efficiency and production, so higher margins can be expected after completion of these projects.
The following chart is a comparable analysis of IPI and its three main competitors within the industry.
The following charts and table demonstrates the multiples used to render the valuations as followed. The average price rendered of the five multiples is $21.98, which is an upside potential of approximately 11.6%. It should be noted that valuations utilizing the P/E ratio should be scrutinized carefully, due to the inherent nature of management to “manage” earnings.
The outlook of the firm is stable, with projects that will improve productivity and margins once they are completed. Potash is a commodity that is widely utilized in the production of fertilizer. Under three of the five valuation multiples, there is an upside potential to be had. As such, an investment into IPI should be considered for investors looking to diversify their portfolio.