Published on 1/8/2016
Compass Minerals (CMP) has increased its dividend every year since going public in 2003 and boasts an operating history dating back to 1844. Its businesses are simple to understand, largely uncorrelated with the economy, and meaningfully advantaged by a unique set of assets that is, in many cases, practically impossible to replicate.
The stock also has an attractive dividend yield of 3.6%, a 10% historical dividend growth rate, a reasonable earnings multiple (14x), and meaningful free cash flow growth potential over the next five years.
Temporary macro headwinds (the mild winter weather in the Midwest and weak agricultural markets) are impacting the business at the moment. In fact, CMP issued a press release yesterday evening that showed the fourth quarter of 2015 recorded 64% fewer “snow events” than the 10-year average, resulting in sales of the company’s highway deicing products to fall by 32% compared to 2014. Softness in agricultural markets is also impacting demand in CMP’s plant nutrition segment, which missed guidance and sold 41% fewer tons in Q4 than it did in 2014.
While these factors could continue weighing on the stock for the next few months or even quarters, we do not expect them to have an impact on CMP’s long-term earnings potential or dividend safety. Let’s take a closer look at why we own this dividend payer in our Conservative Retirees dividend portfolio.
CMP’s operations date back to the 1840s. Today, the company is a leading producer of essential minerals primarily serving markets in North America (75% of sales) and the U.K. The company produces salt (primarily used by cities for deicing roads but has many consumer and industrial uses as well), specialty potash (a premium fertilizer that improves the quality, yield, and shelf life of high-value fruit, vegetable, and tree nut crops), micronutrients (essential minerals that maximize plant yields), and magnesium chloride (used in numerous ways including roadway deicing, dust control, and as plant nutrients for wheat crops).
CMP owns a handful of salt mines (including the largest rock salt mine in the world – located in Canada – and the biggest in the U.K.) and solar evaporation facilities (including the only sulfate of potash production site in North America) that it uses to produce its minerals. The company is the third-largest salt producer in North America and the largest producer of specialty potash and dry dispersible powder micronutrients.
The company’s 2014 revenue mix by division was: Highway Deicing Salt 49%, Consumer & Industrial Salt 30% (water conditioning, table salt, ice control, animal nutrition, plastics, etc.), and Plant Nutrition 21%.
CMP’s primary advantages are its mineral production sites and logistical networks, which create meaningful barriers to entry and pricing power. Before we dive in deeper, it’s worth mentioning the relatively attractive characteristics of salt.
Salt is mostly a non-discretionary purchase that has no economic substitutes or alternatives today. Governments must buy salt to keep their roadways safe, regardless of how well the economy is doing.
According to the latest available data from the U.S. Geological Survey, during the thirty-year period ending 2012, the production of salt used in highway deicing and for consumer and industrial products in the U.S. has increased at an historical average of approximately 1% per year. Over this same period of time, prices for salt in the U.S. have increased at an historical average of 3% per year.
The cost of salt typically represents less than 1% of a government’s budget, helping CMP’s pricing ability because its products are a relatively small burden on the budget.
Governments purchase salt by taking in bids between April and October. They award a 12-month contract to the lowest bidder, and most contracts have a minimum volume clause (typically 80%) and fix pricing over the duration of the deal.
Governments keep only enough rock salt on hand for 2-3 applications because it’s too bulky for them to store in large quantities. They reorder as their supply is used, which can significantly shift the supply-demand dynamic in favor of salt producers during extreme winter weather events – CMP’s average price on awarded highway deicing contracts rose by 25% in 2014 as a result.
With that said, rock salt is a commodity. What makes it an attractive business for CMP?
With CMP’s highway salt fetching an average selling price of $57 per ton in 2014, the weight-to-value ratio is extremely high for salt. It quickly becomes clear that production and shipping costs define a salt company’s service area. In fact, transportation costs typically account for 30-40% of the total delivered cost of salt.
CMP is the lowest cost producer for the Midwest area because it owns the largest and highest-quality grade rock salt mine in the world in Ontario, Canada, and has a network of 85 supply depots along navigable waterways to reach customers affordably and quickly (its mine is located right next to Lake Huron).
Water transportation is about half the cost of rail and one-third the cost of trucking, keeping CMP’s operations very efficient. The company’s presence in the Midwest also protects it against import competition, which is only somewhat effective on the East and West coasts of the U.S.
Rock salt must also be near customers before winter starts because they can only store so much at a time and might need to order some for quick delivery in the event of a severe winter storm. CMP’s network can get salt to customers quickly by rail, truck, barge, or vessel.
Competitors in the market lack CMP’s economies of scale (their mines can’t produce as much salt and have higher costs) and waterway network advantages. CMP’s asset network allows the company to execute a very competitive bidding strategy that significantly protects its market share thanks to its greater efficiencies.
Sulfate of Potash
CMP’s sulfate of potash (SOP) business is also unique. CMP’s solar evaporation pond complex in Utah is one of only four in the world (and the only one in North America) that can produce SOP from a naturally occurring brine source using solar evaporation. This production method has the lowest cost profile in the world.
With limited pond-based feedstocks available in the country due to geological constraints, especially in cost-effective locations for transportation purposes, barriers to entry are extremely high in CMP’s regional markets. SOP’s limited availability contributes to it accounting for just 10% of all potash consumption.
SOP is also primarily used on high-value or chloride-sensitive crops such as citrus fruits, grapes, almonds, and tobacco. Unlike major global crops such as corn, many of these “specialty” crops have demonstrated more stable economics. It’s also worth mentioning that CMP’s SOP is approved for organic food production, which should only see increased demand over the coming years.
While CMP’s SOP business will be sensitive to broader trends in agricultural markets, its barriers to entry, high value provided to growers of specialty crops, and solid pricing power make the business much less volatile and more profitable than traditional potash fertilizer (which, unlike SOP, includes chloride).
Future Growth Investments
CMP is in the process of significantly expanding the production capacity of its salt mine and solar evaporation facility. These actions are part of the company’s plan to nearly double EBITDA from 2014 to 2018 (see below) and will also result in cost savings and better productivity at existing sites.
It’s also worth mentioning that CMP acquired mining rights to about 100 million tons of salt reserves in Chile in 2012 for $6.5 million. While the site would require significant infrastructure costs to develop, it would further diversify the business and result in additional long-term growth opportunities.
On 12/22/15, CMP highlighted one of the main risks it faces. The extremely mild winter weather reduced demand for CMP’s deicing products and caused the company to lower its guidance for the year. Weather during the four quarter of 2015 was the warmest in at least a decade, so it’s no surprise there was less demand for deicing salt.
The minimum purchase clauses in CMP’s contracts help offset this risk to a degree, but it still hurts. Since little inventory is held by the customer, mild winters result in salt producers like CMP holding much of the extra supply. CMP will reduce activity at its mines and hope for better (worse?) weather from January through March, and it’s important to note that about two-thirds of the company’s deicing product sales occur during November through March each year when winter weather is most severe. It’s hard to say how long this headwind will weigh on the stock, but it shouldn’t impact CMP’s long-term earnings growth.
CMP shareholders should be comfortable with weather-related volatility impacting the stock from one year to the next. It’s inevitable, but we believe the long-term earnings trend is up and to the right.
Similar one-off events that could impact the company’s near-term earnings (but would probably be buying opportunities) include a mine failure, accident, or unfavorable regulation that temporarily halts production. CMP’s three largest mines make up 84% of its salt producing capacity and drive the majority of its sales. However, they have long operating histories dating back to the 1800s in some cases which hopefully eliminates most potential surprises.
But what could threaten CMP’s long-term earnings potential? The factors that we can think of all seem to have relatively low probabilities of playing out, but they are worth keeping an eye on.
First, an economical substitute for rock salt would potentially impact almost half of CMP’s business (highway deicing = 49% of sales), which is not very well diversified. As of today, there are no known cost-effective substitutes for most high-volume uses of salt, including deicing.
There has been talk about the threat of calcium chloride, which is less damaging than rock salt. However, this debate has gone on for decades of time. Calcium chloride is simply not nearly as cost effective as rock salt.
Other nature-friendly deicing methods, including cheese brine, garlic salt, and molasses, have been used in several Midwest locations. All of these products still contain salt, but it has helped customer purchase less salt to get the same effect.
Longer-term, solar advancements could find ways to melt snow and ice on roads, denting demand for deicing salt. However, this seems unlikely to make a difference for at least the next 3-5+ years.
Regarding the threat of salt imports, we would note the high weight-to-value ratio of salt. It’s very difficult to be competitive outside of regional markets closest to where a suppliers’ salt mine is located. CMP is especially protected because it has little market presence on the East and West coasts where imports are more competitive.
For the time being, we believe rock salt is here to stay.
Mine depletion is another risk to consider because salt deposits are not growing as quickly as CMP’s annual production. However, CMP estimates that its two largest mines have 120 and 76 years left of production, respectively. We won’t be around the see the end of their useful lives.
Our biggest long-term concern with the stock is its sulfate of potash (SOP) business. While we believe in the demand growth story over time, the agricultural market is very global and unpredictable. With SOP fetching meaningful price premiums over basic potash fertilizers with chloride, capital would suggest that more supply will enter the SOP market, alternatives will become attractive (e.g. substituting higher levels of more basic fertilizers), or something else will reduce the industry’s profitability.
IC Potash is substantially bringing on more SOP supply next year, including in the California market, and CMP is also increasing its capacity. How these changes will impact the SOP market and CMP’s low-cost business is uncertain.
During its most recent earnings call, CMP noted that market pricing for most of the crops it serves has been healthy in 2015, helping keep SOP prices almost flat year-to-date despite volumes that are down 16%. The agricultural market’s broader weakness is impacting the performance of its plant nutrition segment because it has created general hesitation by growers to make purchases.
When combined with the extremely mild winter weather, it’s no surprise why the stock has been a poor performer over the last year. We believe the salt segment’s challenges are truly temporary and will continue watching SOP market dynamic as more supply appears set to appear in the next 1-2 years. For now, we are glad that salt still drives over 70% of the company’s earnings.
Let’s take a look at CMP’s dividend.
We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend. CMP’s long-term dividend and fundamental data charts can all be seen by clicking here.
Dividend Safety Score
Our Safety Score answers the question, “Is the current dividend payment safe?” We look at factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.
CMP’s dividend has an average Safety Score of 53. Over the last four quarters, CMP’s dividend has consumed 49% of its earnings. This is a very reasonable level for a recession-resistant business. As seen below, the company’s payout ratios have been somewhat volatile over the last decade but have averaged around 50-60%, providing reasonable cushion and opportunity for dividend growth.
During the financial crisis, CMP’s sales fell by 18% in fiscal year 2009, driven completely by fertilizer sales, which fell by 44% after nearly doubling in 2008. Salt sales were down just 3% and highlight the recession-resistant nature of CMP’s primary business. The stock also returned 46% in 2008, significantly beating the market as fertilizer prices roared.
Despite being a fairly capital intensive business selling commodity products, CMP’s competitive advantages have helped it maintain a very strong and consistent operating margin profile, which is often the sign of an economic moat:
The company has also generated positive free cash flow in each of the last 10 years. Free cash flow trends are volatile because of the sizeable maintenance and growth capital expenditures occasionally needed at CMP’s production sites. The company’s capex will remain elevated in 2015 and 2016 (around $225 – $250 million per year) as it invests for growth but will drop to less than $100 million per year in 2018 and beyond.
Looking at the balance sheet, CMP’s debt load seems reasonable. The company could repay all of its debt with cash on hand and two years of earnings before interest and taxes (EBIT). CMP’s reliable free cash flow and Ba1 credit rating from Moody’s are also good signs.
CMP’s reasonable payout ratio (49%), strong profitability, consistent cash flow generation, recession-resistant business segments, and reasonable balance sheet support its dividend Safety Score.
Dividend Growth Score
Our Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.
CMP’s dividend Growth Score is 55, suggesting that the company’s dividend growth potential is about average.
CMP has increased its dividend every year since going public in 2003 (12 year growth streak), compounding its dividend at a rate of 10% per year. The company most recently raised its dividend by 10% in 2014.
The company will be incurring substantial capital expenditures through 2016 to fund expansion projects, which should generate significant free cash flow in 2018 and beyond. As this plays out, CMP’s 10%+ dividend growth rate could prove to be sustainable.
Until then, CMP will continue dealing with (temporary) headwinds related to its salt and specialty fertilizer businesses, which could cause its next dividend hike to come in under 10%.
While CMP is far too small and would still require 13 more years of dividend increase to join the S&P Dividend Aristocrats Index, it has many of the characteristics we like to see in consistent dividend growth stocks.
CMP trades at about 14x forward earnings and offers a dividend yield of 3.6%, which is meaningfully higher than its five year average dividend yield of 2.7% and a great starting base for investors living off dividends in retirement.
While there is some uncertainty (e.g. agriculture markets, warm winter weather) around the company’s $500 million EBITDA target in 2018, if CMP is successful, it trades at 6x projected EBTIDA in 2018. For a company with several hard-to-replicate competitive advantages, this appears to be an attractive price.
As long as agriculture markets don’t fall off a cliff, SOP supply remains reasonable, and winter weather normalizes over the coming years, we believe CMP can grow its earnings by at least 5-10% per year going forward. When coupled with its current 3.6% dividend yield, the stock appears to offer total return potential of at least 9-12% per year.
CMP is a stodgy business with a long operating history. While it will never be a fast-growing company, its valuable asset base, logistical network, and recession-resistant products result in a solid cash flow stream and remind us of some of our favorite blue chip dividend stocks.
We generally prefer to avoid small cap stocks for retirement income (especially those that are less diversified like CMP) because they are generally more volatile and less proven businesses, but we believe CMP is an exception. The stock appears to offer reasonable total return potential, safe income, and decent income growth for conservative dividend growth investors.