We are unconvinced by The Mosaic Company (NYSE:MOS)’s arguments that potash concerns are overblown, but more bullish on phosphate. We didn’t appreciate net closures of Chinese P capacity and therefore, why MOS/CRU is now looking for annual decreases in Chinese P exports. They are calling 2014 peak Chinese exports, which is clearly bullish.
If higher P and lower K prices are a wash, then FCF growth should be huge – exceeding $1.1 billion by 2018 – versus $0.4 billion in 2014, with phosphate providing the bulk of the growth. K3 is a game changer, and has the ability to bring Esterhazy cash costs down to $65/mt. Watch for brine inflow risk to decline in the mid-term. We have tightened our MOS model following its investor day, as well as MOS’ new CRT disclosure, which results in updated 2015 estimate and 2016 estimate EPS of $3.29 and $3.51, correspondingly.
There is more upside to our target if the phosphate market tightens. If we assume no change to feedstock and fertilizer prices, we agree with MOS’ free cash flow growth story, which should see $1.1 billion realized in 2018, up from $0.4B earned previous year. But, is a flat-lined 2014 realized price reasonable? Given a more positive perspective on the P market, and a still-bearish perspective on potash, we could call it a wash. MOS showed a neat chart of its ability to lever price. A $50/mt price boost for both P increased by K, in 2018, would boost FCF by a stunning 70%.
Phosphate supply reductions should tighten up the market. MOS showed some interesting data on the P market that justifies being to some extent more bullish, in our view: (1) beyond Ma’aden @1.9 million mt (all figures in P2O5 mt) and OCP @ 1.5 million mt, there is no more than 1 million mt of “firm and probable” capacity being added to the market over the next four to five years; (2) China should see net closures of 1.9 million mt, given the persevered closure of small, inefficient, and dirty plants, as well as China’s decision to stop developing new phosphate mines – this means lower exports and (3) while the P market has seen consolidation over the past decade, MOS anticipates there is more room to go.
MOS increased its divvy by 10% to $1.10. The market may be disappointed with the surge, as investors we have spoken with were hoping for a larger dividend surge – in the 25% to 50% range. Second, the new (forward) yield of 2.3% yet lags the 3% to 4.7% that AGU and POT offer, correspondingly. International companies like URKA, SQM, ICL, etc. offer much higher yields. While MOS’ yield is better than CF’s 2.1%, we note that N profitability is more volatile than P increased by K, which would warrant CF’s lower yield. MOS will continue to grow its dividend methodically.
MOS is less worried about potash than we are. Why: (1) demand growth is healthy, even though the market may take back a couple million mt this year. We’re not convinced on this, and believe the solid U.S. dollar, poorer farmer economics, and the end of an inventory restocking, should drive to at least 4 million mt of demand destruction; (2) actual operational capacity is lower than what many calculate, as consultant estimates are based on proving runs, and not normal productive capability. In addition, some producers are optimizing production, such as the closure of MOP production at Hersey and Carlsbad by MOS; and (3) while the North American premium may slash, because of greater supply from AGU and FSU producers, the netback to FSU producers suggests that downside may be limited. On BHP’s Jansen project, MOS disclosed mine development is effectively on hold, and therefore production is unlikely to start this decade.
While the K3 expansion continues on time and on budget, there are various points that we believe the market is missing. First, the $1.5 billion of capex to develop the mine is actually a net cash outlay of only $300 million, if there is a complete migration away from K1/K2. This is because $600 million was going to be spent on K1/K2, which drops the accumulative capital outlay to only $900 million. Of this, another $350 million will come from the NPV of savings on brine inflow costs. In addition, tax benefits will total $250 million. In the meantime, MOS has downgraded its potash cash cost profile to $91/mt from $133/mt over two years.
Our $55 target did not change, which warrants a “Sector Outperform”.