Value Investors Club / The Mosaic Company (MOS)

Description

Finding value in today’s market is difficult. Most stocks fall into stock down significantly

but Massively COVID affected and uncertainty not well discounted, or COVID unaffected

and price inexplicably at new highs despite a concerning macro backdrop.

Seeking businesses where the COVID impact is small and/or is overestimated combined

with significant negative stock price action that persists despite the recent market rally, we

present The Mosaic Company (NYSE: MOS) which we believe is a business with an

improving outlook with a stock still near the lows.

Mosaic is one of the world's largest producers and marketers of concentrated

phosphate and potash nutrients. Globally, Mosaic is the #2 in phosphate, #4 in

potash, and #1 in premium fertilizers. Mosaic mines phosphate in Florida, Brazil, Peru

(JV) and Saudi Arabia (JV). They process phosphate rock into finished phosphate products

in Florida, Louisiana and Brazil. One of the four largest potash producers in the world, they

mine potash in Saskatchewan, New Mexico, and Brazil with production and blending and

distribution operations in Brazil, China, India, and Paraguay.

Pessimism around agricultural commodities in general and Mosaic in particular are at

extremes and were pessimistic prior to COVID-19. Ignoring some liquidity driven March

2020 all-time price lows, Mosaic remains -44% for the year and -67% from late 2018 highs.

Agricultural commodity fundamentals had been weak in 2019 as fertilizer prices fell due to

weak supply and demand dynamics, but the Mosaic’s stock had some support from

expectations that demand trends would reverse, inventories would draw down, resulting in

improved pricing and profitability.

However, investor hopes deflated as COVID-19 drove a general liquidation of commodity

names and as concerns arose around some real and some perceived impacts COVID-19

impacts on agricultural economics. The falling price of oil has had a real impact on demand

and pricing for biofuel additives such as palm oil in Asia and corn for ethanol in the U.S.

collapsed. With 40% of the corn crop slated for ethanol production, the sharp gasoline

demand destruction has deflated expectations for corn demand for next year’s planting

season. However this is more perception than reality, as COVID-19 related farmer

subsidies should support farmer economics, and Mosaic is actually indifferent between the

planting of corn or soybeans.

Contrary to recent price action, we see Mosaic as a well-run company, with a manageable

capital structure (both we and management would like to see debt reduced by 25%, debt

trades above par) with significant self-help opportunities (acquisition synergies,

technology and process improvement can drive EBITDA 50%) and an improving

fundamental outlook.

Phosphate Market at Bottom

(36% of Sales, 10% of EBITDA)

The challenging price environment in the last year has been driven by a pre-COVID

demand shock much of which was circumstantial. 2019 saw particularly wet

weather which delayed planting twice, China’s pig herd was culled due to African

swine flu. These demand shocks combined with production capacity increases from

Ma’aden (a 2 million tonne Saudi Arabian project of which Mosaic has right to 25%

of production), OCP (Morocco’s state phosphate company), and Russia’s Phosagro.

As a result, DAP (the primary fertilizer product derived from phosphate) has been

selling below the marginal cost of production. Demand was expected to rebound

this year with a strong spring planting season in North America and an associated

drawdown in inventories. However, while the spring planting season and inventory

drawdowns proceeded as expected concern about the health of the corn market (see

above) prevented inventories being rebuilt, limiting any rebound in pricing. A more

normalized S&D environment should emerge in the near term as the market comes

to understand farmers will be able to invest in fertilizers next year (due to

subsidies) and will want to invest in fertilizers to drive yield as they look forward to

a resumption in demand for ethanol. Should this not manifest itself, the alternative

to corn (soybeans) is neutral to phosphate demand and as such, Mosaic’s economics.

Longer term, high cost non-integrated producers (India) will not be able to operate

at negative margins for a sustained time frame and supply increases globally are

limited without significant capital investments (which we view as unlikely for

sometime). While Ma’aden and OCP each have planned phosphate production

increases of 1 million tonnes annually (in a 72 million tonne global market) over the

next couple of years, increases beyond that would require significant capital

projects. DAP and MAP margins should recover from breakeven at year end 2019 to

prices at or above 2019 averages of $60.

Potash Market at Bottom

(21% of Sales, 53% of EBITDA

Like Phosphate, circumstantial drivers (such as the aforementioned wet weather in

North America, the trade war with China, Swine flu, and weak palm oil prices) cut

global demand in 2019, resulting in inventory builds, steep price declines and

eventually production cuts on the order of 3mt by all the major potash producers.

With prices already close to 10 year lows ($240/mt versus $350/mt in mid 2019),

China recently agreeing to a new benchmark contract at $220 at the end of April

(prices apparently jumped >$20 the next week),and producer inventories having

drawn down elevated inventories (Canpotex, the Canadian export monopoly, is sold

out through July), we expect a more balanced market going and eventually price

increases. Following price declines in 2015, it took potash ~ 2 years to rise above

$300 again, which Mosaic CEO Joc O’Rouke, called out as a sweet spot price at which

producers would earn cash margins in excess of their maintenance capex without

attracting new capacity. He thought it would take 3 years to rise above $300 again. I

don’t think anyone knows as I find commodity industry insiders are often the most

bullish at the tops and most pessimistic at the bottoms.

Mosaic Fertilizantes, Brazil Farmer Economics Very Strong

(45% of Sales, 40% of EBITDA)

Currently, farmers in Brazil are enjoying very strong economics as demand for Soybeans

from China has skyrocketed. This should support pricing and volume growth for Mosaic’s

fertilizer distribution business in Brazil.

Benefit from Significant Efficiency Gains

With the prices of phosphate, phosphate products and potash weak the past five years,

Mosaic’s significant cost reduction focus has gone unappreciated. Since 2015, Mosaic has

reduced phosphate cash costs per tonne by 8%, potash costs per tonne by 7%, and SG&A

per tonne by 20%. Significant additional potash cost savings will be achieved as Mosaic’s

Esterhazy mine shifts productions from Esterhazy’s K1 and K2 shafts to the automated

Esterhazy K3.

Including Mosaic’s Vale acquisition synergies, initial impacts from Esterhazy K3, and other

operational changes, MOS expects EBITDA benefits to be $225 million in 2020. In total

EBITDA should grow by $600-$700 million over the next five years as Esterhazy K3 comes

into full production, and Vale transformation savings are achieved. This would imply a

50% increase in EBITDA from 2019 levels without any improvements in commodity

pricing and volumes for both DAP and MOP which are both near all-time lows.

Valuation

$4.6b market cap

$1.07b in cash (3/31/2020 BS)

0.74b in investments in non-consolidated companies

$5.58b in debt

$8.4b Enterprise Value

$1.2b LTM trailing EBITDA

$1.1b-1.4b consensus estimates for 2020 EBITDA

$1.6b-2.2b consensus estimates for 2021 EBITDA

6.5-7x 2020 EV/EBITDA

4.4x midpoint of estimates of 2021 EBITDA

Target

With a return to 2018 price levels + $700m of EBITDA improvements due to Esterhazy K3

and Vale synergies would imply $2.7 in EBITDA. At a historical average 8x multiple

(Ma’aden stake valued at cost), $2.7b in EBITDA would imply $47 or a 4 bagger over 4 years.

A 6x multiple on $2.05b of EBITDA, (2019 profitability + costs saves) would imply $22.50 or an 85% return over 4 years.

Liquidity

>$1 billion in cash

$1.5 billion unused line of credit

No Long term debt payments until Nov 2021

Capital Allocation

$700m main cap ex guidance

$75m in one-time 2020 cap ex

$400m in growth cap ex

"Ability to scale down growth cap ex rapidly"

Management has a target to reduce debt by $1 billion over time.

MOS has been an active purchaser of its own shares in the past. A return to repurchases after debt reduction is more likely than a significant increase in the dividend under current management.

Risks

-Significant depopulation due to recurring pandemics

-Demand destruction to meat consumption due to mass poverty which would have a knock-

on effect on grain consumption by cattle, etc.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Catalysts

Esterhazy K3 mine ramp up

Increases in corn prices due to increases ethanol demand

Summer 2020 planting season in Brazil

Inventory restocking in North America

show sort by

			2020	2021
Price:	12.09	EPS	0.14	0.821
Shares Out. (in M):	379	P/E	82	14.726
Market Cap (in $M):	4,582	P/FCF	NA	29
Net Debt (in $M):	4,500	EBIT	330	705
TEV (in $M):	8,400	TEV/EBIT	25.5	12