Mosaic (MOS) – (LAM) Lombardo Asset Management

It’s been nearly two years since this website published its first article on Mosaic, of which was also on Seeking Alpha. At that time, the Potash-Fertilizer industry was reeling from the July 31, 2013 event whereby Uralkali pulled-out of the BPC potash cartel. (This article will focus on Mosaic’s vital potash business though the company also sells phosphate.)

At that time, investing in Mosaic (MOS) appealed to me as a contrarian play. Such tactics are best for cyclical industries such as Fertilizers, Steel, and Energy. If one can be disciplined, contrarian views eventually work-out, but they may take years to work themselves through, as the industry and participants rejigger their strategies and Industry Structure realigns. Here is a Harvard Business Review paper from the infamous Michael Porter.

(Note: Those asset managers focusing on socially responsible investing might want to examine the company as a way of diversifying their often heavy portfolio weighting in consumer-oriented companies. In other words, SRI funds are overweighted in tech and retailing and adding Mosaic would be a good diversifier.)

My worst fear at that time (2013) was that there would be a price war in potash. The industry was, and remains, in a global oversupply situation, which isn’t expected to balance for several years. The table below shows the net Supply minus Demand balance for each major fertilizer (numbers are in 000s tonnes). The numbers in brackets represent the percentage that each fertilizer is oversupplied. So (32.8) for Potash in 2018 represents Supply that is 32.8% greater than world Demand.

Source: Food and Agriculture Association of the United Nations

Back in 2013, I expected Mosaic’s share-price to decline from the $40s level towards $30-$35 where the shares have much support including on an asset value (i.e., book value) basis. However, this never occurred. It appears the shares are supported by another factor, let’s call it the “X” factor which I frankly do not know. I believe, however, that the smart-money is expecting Demand to eventually catch-up with Supply and for the Industry Structure to improve. In fact, Potash recently proposed to acquire K+S (a very high-cost potash competitor) and potentially close the high-cost mines and keep its new mines that are coming on-line in Canada.

Mosaic’s shares also seemed overvalued back in 2013, despite several bullish reports from the sell-side as well as Seeking Alpha writers. It’s forward P/E was at least 16-17x. However, this has come-down towards 13x, which is a large discount to the S&P500’s P/E of 17x. Also the PEG ratio has declined as forecast growth is now greater than its forward P/E of 13x (see below). Consequently, I believe Mosaic offers a good return-on-risk versus what appears to be an overvalued stock market.

While fertilizer supplies remain high, and farmer economics (via falling Corn and Soybean prices) have declined, factors are moving positive in Mosaic’s direction. These are summarized below:

A lower Price-to-Earnings ratio compared to historicals and the S&P500
Improving forecasted earnings growth (S&P Capital IQ expects 16% CAGR)
Initiation of another stock-repurchase program ($1.5bn worth)
The potential consolidation of the Potash Industry (via K+S acquisition)
Competitor Uralkali recently stated that its potash volumes reached their historical levels, and that it would now work on increasing its revenues (rather than selling potash at any price). It is also possible that Uralkali may rejoin the BPC marketing “cartel”, however the company denied that it would.
Overall demand is slowly increasing. Despite China’s declining economic growth rate, note that a substantial slice of its population is moving into “meat-eating” middle and upper class. (Note that meat production is quite ag-intensive!)
Declining potash production-costs (new low reached in 1Q’15)
Improving industry and business-segment profile in Phosphate (via the CF Industries asset acquisition)

Corporate Social Responsibility:
Mosaic is followed by my website given its leadership in ESG. In June’15, the company published its sixth Sustainability Report which is in-depth including the usual ESG data as well as self-implied targets. Mosaic has received many awards for its CSR conduct including the prestigious CR 100 Best Corporate Citizens.
Readers may be asking, so what does this have to do with investing in Mosaic? Well it’s been proven that good CSR management is reflective of good overall management and lower corporate risk.

Conclusion:
While the pendulum of supply/demand has yet to balance for the Potash industry, Mosaic’s fundamentals have certainly improved. Since 2013, the S&P500 has risen, yet Mosaic’s share-price remains relatively unchanged. Consequently, any positive catalyst will likely boost Mosaic’s share price.

Full Disclosure: The author is long Mosaic Corporation.

On July 31st, I saw that share prices of Potash nutrient companies (e.g., Agrium (AGU), Potash Corp (POT), Intrepid Potash (IPI)) had taken double-digit falls on news that Uralkali was walking away from the BPC cartel.

Mosaic Corp. (MOS) in particular caught my eye because as a socially responsible investor I had seen the company on several SRI lists (e.g., Corp Responsibility Magazine’s list). And besides, the contrarian-side of me couldn’t wait to jump on MOS shares.

So I set out gathering data on the fertilizer market, feeling very bullish on Mosaic before even having a stab at the documents. Part of any good due-diligence, of course, is reading what SA authors are saying. However, several seem to be looking at MOS with rose-colored glasses. I now feel it necessary to “set things straight” on Mosaic. This article is a rebuttal of their logic.

They say: Several writers noted Mosaic’s low 10x price/earnings ratio.
I say: I believe this number’s deceiving and based on trailing earnings. Going forward, Potash prices could decline as low as $280/metric ton, according to Goldman Sachs. The lower prices are indicative of the constant oversupply condition of the industry and change in industry structure towards higher production. Lower Phosphate prices, in turn, boost the P/E ratio as the earnings denominator declines. I prefer to think of a P/E as expected earnings growth. So a P/E of 10 would infer 10% growth for the next year. I believe a 15% decline is more likely. Several sell-side analysts (who are typically bullish) expect EPS to decline from $4.08 in FY’13 to about $3.50 next year. (Note: EPS may be higher if the company repurchases shares at year-end.)
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They say: Some investors think Mosaic is protected by its large phosphate business.
I say: Over 60% of Mosaic’s earnings are from its smaller Potash business and, secondly, the Law of Substitution will suppress phosphate prices. While the two nutrients are indeed different, farmers tend to buy higher volumes of whatever’s cheapest at the time.

They say: There is a secular upward demand trend for fertilizer from Emerging Markets, especially the BRICs.
I say: This trend is not new and is already baked into prices. Further, weak currencies (attributed to the Fed tapering), falling subsidies and slowing population growth will reduce Emerging Market demand. While anecdotal evidence says that China’s population is growing rapidly, in fact, its population is expected to grow just 1% annually.

Yearly Chart of the Indian Rupee

They Say: One SA writer said, “Uralkali failed to substantiate plans to increase supply.”
I say: Uralkali expects to ship over 10 million tons (MT) of potash in 2013 and their stated capacity is 13mt. Further, it has already secured an agreement with China. In fact, China recently purchased a 12.5% stake in Uralkali to secure supplies.

They say: A SA writer said that Uralkali’s management won’t have time to increase production because it will be distracted with legal battles related to its arrested CEO.
I say: I believe that legal issues will be handled by the company’s legal team. A CEO’s duties are to set a company’s strategy, mission and build its culture.

They say: Another SA writer believes the cartel will resume soon.
I say: I believe this is doubtful because Uralkali’s CEO has been jailed (now under house arrest) and he’s supported by Uralkali’s Board of Directors. There is also the risk that the other side of the cartel, via North America’s Canpotex, could also break up. Further, do you really think the Chinese favor higher potash prices?

What’s working for Mosaic?
I think the best thing going for Mosaic is its management. It’s an offspring from one of the most successful private/family businesses. As such, cash and liquidity are high and I expect a large share-repurchase program. Expect a press release on the share repurchase amount soon as the company will no longer be restricted from buying-back shares after November 26th. What distinguishes the company from other miners is its progress in corporate social responsibility. Though the company’s mines remain a work-in-progress, Mosaic is a leader in governance and reporting. In 2011, Mosaic became a founding member of the Global Reporting Initiative. In 2012, it became a signatory in the United Nations Global Compact (deals with Labor issues).

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Conclusion
A friend once told me that good portfolio management is actually good risk management in disguise. And given that the S&P 500 is so elevated (as well as its P/E) it makes sense to trim your gainers and buy into a small MOS position. Then wait and see how the Potash market unfolds.

Tag: Mosaic (MOS)

Mosaic update: Return on risk has increased since 2013

Investors are Look’n Thru a Rose-Colored Mosaic

On July 31st, I saw that share prices of Potash nutrient companies (e.g., Agrium (AGU), Potash Corp (POT), Intrepid Potash (IPI)) had taken double-digit falls on news that Uralkali was walking away from the BPC cartel.