Description

Recommending Nutrie­n

Nutrien has not been written up on VIC, although writeups of its predecessor companies, Agrium and Potash Corp provide some reference. Potash Corp was written up as a short at a higher valuation. At present I think the market underappreciates the legacy Agrium retail network. That franchise generates roughly $2 billion in EBITDA with limited capital expense, and has reliably compounded EBITDA at more than ten percent over the last fifteen years. The business still has room to expand in the US, and has a much larger expansion opportunity in Brazil, where the market remains fragmented. NTR’s thousands of retail outlets also have growing clout in the supply chain, given substantial private label sales.

In addition, I think the market likely underestimates the company’s ‘normal’ earnings trajectory and likely earnings in the next downcycle.

Nutrien’s businesses are currently lapping record earnings that resulted from disruptions to the supply of fertilizer and natural gas from the Ukraine war. Even on more normalized earnings valuation is attractive. Consensus estimates for this year are $8.5 billion in EBITDA and $8.90 in EPS (7.5x P/E, 5x EV/EBITDA). I calculate down-cycle earnings closer to $6 billion of EBITDA and $7 of EPS, with continued reinvestment lifting that base over time. If that proves correct, the stock trades at 10x downcycle earnings and 7x downcycle EBITDA today, and at a single digit multiple of ‘normal’ earnings in 2027. By division I estimate near-term downcycle EBITDA as follows: retail $1.7 billion, potash $2.4 billion, nitrogen $1.9 billion, phosphate $500 million, and corporate -$500 million.

For its first three years as a public company (prior to the earnings spike which started in 2021) Nutrien traded at a high teens PE. I think it’s likely the share multiple will expand as investors get better visibility on earnings past the current period of supply chain disruptions.

That said, there is some art on when to buy this name, as it tends to trade with published fertilizer prices. Recent fertilizer price realizations have been in a downtrend, accounting for weak recent share price performance. Also, there is new nitrogen capacity likely to come online over the next few years. I’ve reflected that by assuming 20-year low nitrogen prices and gross margins in my down-cycle estimates. New potash capacity will likely be slower to come online, as most new capacity was in Russia and Belarus and has likely been delayed by several years as a result of the Ukraine war.

I model 2027 ‘normal’ EBITDA of $9 billion ($12 EPS) implying mid-teens or higher IRR

For 2027 I model ‘normal’ retail EBITDA reaching $2.5 billion, by assuming down years in 2023 and 2024  followed by 9% percent growth, while potash and nitrogen fertilizers will likely contribute close to $6 billion of ebitda, assuming cycle low pricing of $250/ton for potash on 17 million tons (18 million target by 2025, 20 by ’27, assume 85%-90% utilization) and $350/ton ($100 gross profit/ton) for Nitrogen on 12 million tons (co forecasts adding 1 mil brownfield tons near term). Phosphates will likely add close to $700 million of EBITDA, less corporate costs of $600 million, implies ‘normal’ 2027 EBITDA of $8.8 billion and EPS north of $12 per share (assuming 2% annual share repurchases). Applying the mid-teens multiple the stock has traded at historically implies a value around $180, representing a 21% CAGR in addition to a 3% dividend yield. If there is no multiple expansion, the return would be 7% on the stock price and 10% including dividends. I’d argue that’s too conservative, since it’s applying a PE based on near peak cycle earnings to a more normalized number.

Capital Return, Uses of Cash

While NTR’s price is up $20 from the end of 2020 (after trading flat post 2018 merger), the company generated operating cash flow from 2020 to 2022 of $15 billion, or $30 per share, which funded the retirement of 13% of shares outstanding for roughly $6 billion ($12/share) as well as $3 billion ($6 per share) of growth-oriented capital expense and $700 million of acquisitions (in addition to $4 billion in maintenance cap ex and $3 billion in dividends). Going forward the company expects to divide free cash between share repurchase and growth investments, including continuing retail acquisitions. For 2022 the plan is $1.2 billion maintenance cap ex, $2 billion growth cap ex, $1 billion dividend, $4 billion share repurchase. To date the company has been rationale in its capital allocation choices, and has a wide range of attractive ROI choices.

A few notes on the industry

Ag stocks have their own cycle, although they do tend to correlate with commodities broadly.

Grain prices (corn, wheat, soybeans) are near multi year highs, and grain inventories are low, with the grain stocks/use ratio (measured as inventories relative to one year demand) at 13.7%, its lowest level since 1997. Low inventories and high prices should support farm income, which is an important driver of Nutrien’s results, particularly retail sales.

Demand growth for fertilizers has compounded at 2.8% per year since 2001, roughly in line with global GDP growth. Demand growth for potash and phosphates has outpaced the demand for nitrogen by roughly 2% annually, largely on demand in China and South America. The majority of NTR’s potash is exported to China, Brazil and Argentina. Population growth and increased consumption of meat both support longer term demand growth. There have long been bear arguments around seed technologies reducing the need for fertilizer and organic alternatives (manure for example). Thus far those do not appear to have had much impact on long term use. Precision ag, including soil testing, has likely improved use efficiency, but this is likely a diminishing benefit over time.

Divisional Notes

Retail

Nutrien’s most predictable asset is its retail network, which is expected to earn about $2 billion in EBITDA this year. That represents about a quarter of current firm EBITDA, but roughly a third of ‘normalized’ EBITDA. This is a highly cash generative business, with an estimated $300 million in annual maintenance capital.

Nutrien has dominant market share in North America, where I estimate its 1,200+ retail stores and $13+ billion of retail sales represents roughly 40% of the US market. The company also has a fairly mature retail network in Australia with more than 400 farm centers and other distribution outlets. There is significant greenfield opportunity in Brazil, where the company still has a high single to low double digit market share in a highly fragmented market, with fewer than 200 points of retail distribution. The company is investing heavily in expanding its Brazil retail footprint, and I expect will gain significant market share over time.

The business is divided between fertilizers (34% of gross profit), crop chemicals (37% of gross profit), service (14% of gross profit), finance, and merchandise. While the segment is likely overearning somewhat due to likely elevated fertilizer and crop chemical prices, this is a ‘sticky’ business with some pricing power, supported by long term relationships between retailers and growers, a growing service component (retailers do substantial chemical spraying and soil testing), long term push of lower cost but higher margin private label product. Private label products have 2x the margin of third party product with 61% gross margin, and currently represent 24% of NTR’s total gross profit, with 55% of that from crop protection and 14% from seed. Longer term private label could likely represent at least a third of NTR’s retail mix. In addition, I expect that continued M&A will support ongoing growth. So while the company has guided to a 15% drop in EBITDA this year for retail from 2022 levels (from $2,300 to $2,000), I’d expect the trendline to return to growth over the next eighteen months, absent very depressed farmer demand, which seems unlikely given grain inventories.

From 2015 to 2020 retail EBITDA steadily grew from $1 billion to $1.4 billion, averaging roughly +$80 million per year. I assume a return to trend in 2023/2024, which would imply ‘on-trend’ EBITDA of $1.7 to $1.8 billion in 2024 (NTR’s internal target is $1.9-$2.1 in 2025). I model this to grow to $2.5 billion over the next four to five years, given compounding.

Potash

Potash is a global oligopoly, with most production coming from Canada, Russia and Belarus. While crops need potassium to achieve satisfactory yields, fertilization can be intermittent, with crops retaining nutrients for more than one season – however nutrient deferral means crops will need greater fertilization in future years.

Russian and Belarus exports have been disrupted by the Ukraine war with exports falling more than 30% in 2022. Since 2001, Potash demand growth has been concentrated in China and Latin America (4.8% CAGR), with rest of world growing roughly 1% annually.

Nutrien sells in partnership with Mosaic (Canpotex), and together they represent 40% of global capacity (MOS has 11 mil tons production capacity). Potash mines are long life and offer potential for expansions – the cost economics of the business are relatively predictable as compared with other commodity businesses such as gas and oil.

Cash costs of production of roughly $100 million, including depreciation (included as estimate of maintenance capital).

Current production roughly 15 million metric tons rising to a target of 18 million by 2025 (or maybe 2026 in scenario where demand growth lags).

Since late 2007 Potash prices have ranged from $200 per metric ton to $1100 last year. Current prices are north of $400 per ton. Most industry observers think it will take years for Russian and Belarus to fully replace lost capacity, suggesting a continued tight market and pricing above historical lows.

Conservatively assuming a near cycle low price of $250/ton, less cash costs of $100, on production of 16 million tons (cycle low won’t happen this year), cycle low EBITDA would be roughly $2.4 billion.

Nitrogen

Nitrogen, which must be applied every year, is the most globally abundant and commoditized of the major fertilizers. There is substantial new capacity in development in the middle east, suggesting prices will fall over the next one to two years. Longer term there are interesting opportunities in plants that are upgraded to produce low carbon ammonia (hydrogen based ‘blue ammonia’), which could potentially be used as a low carbon feedstock for coal fired utilities. Nutrien is considering upgrading one of its plants for low carbon.

NTR produces both Ammonium and Urea. Ammonium is an intermediate product used in the production of Urea, the most commonly used nitrogen fertilizer. NTR has 11 million tons of nitrogen production capacity, split between ammonia and Urea.

Urea production and transport costs are roughly $100/ton excluding natural gas costs. Nutrien’s guidance is that each dollar of natural gas cost equates to roughly $180 million of EBITDA.

Urea price over the last two decades have ranged from $200/ton to $600/ton with a $1,000+ recent outlier due to the Ukraine war and its impact on European natural gas supply. Price is currently around $800 per ton for ammonia while urea price is sharply lower at roughly $400/ton. Note that ammonia is typically used locally while Urea is exported.  

Nitrogen prices are correlated to natural gas prices, with high gas prices lifting the breakeven price for marginal producers. That has led to significant shutdowns in higher cost natural gas sourcing areas, notably Europe. It also makes a return to prior low ammonia and urea prices less likely. Nutrien estimates that more than a third of global Urea production has cost breakeven at $300/ton FOB or higher, although presumably that will fall as newer capacity comes online. Note that much of the higher cost production is from China where the feedstock is coal, with European production on the very high end of the cost curve due to high natural gas prices.

Assuming prices bottom near $250/ton (slightly above 20 year low and below current marginal production cost), implies revenue of roughly $2.8 billion. Less $100/ton pre-gas production cost, or $1.1 billion. Less (180*nat gas price), assume natural gas cost of $3/mmbtu, or $540 million, implies cycle low nitrogen EBITDA of $1.2 billion ($2.8 billion rev - $1.6 billion costs).

Phospate and corporate costs

Phosphate is Nutrien’s Smallest EBIDTA contributor ranging from $500 million to $1 billion EBITDA, largely offsetting recurring corporate costs of roughly $500 million. China is the largest swing producer on phosphate, and recent reductions in China exports have been supportive of phosphate pricing.

Risks

1. Fertilizers are commodities and prices may go below my cycle low estimates. Cash costs may also rise, particularly for nitrogen given the high natural gas component. Nitrogen gross margins have gone modestly lower than my current cycle low assumptions for short time periods and that could recur given planned middle east capacity additions. Potash benefits from supply constraints for Russia and Belarus, and as that supply comes back on-line it may hurt prices, although it will take time for supply to normalize.
2. While I believe retail is a good business, it does correlate in the near term with crop prices, as well as the prices of fertilizers and crop chemicals. Retail is earning above historical trend and in a down cycle will likely see a decline in earnings, although typically those declines have corrected within a year.
3. Regardless of longer-term trends, the stock is highly correlated to prices of potash and nitrogen, and those prices are probably still at mid to high cycle levels. I would not be shocked to see the stock trade below $60 if commodity pricing weakens substantially.

Catalyst

Growth in retail business, earnings stabilization around 'normal' base.