Compass Minerals: Appears Fair Under $80/Share

Compass Minerals is a large producer of salt and specialty fertilizer.

-Seven Year Revenue Growth Rate: 4.0%
-Seven Year EPS Growth Rate is Erratic.
-Seven Year Dividend Growth Rate: 8.9%
-Current Dividend Yield: 2.55%
-Balance Sheet Strength: Leveraged but Stable

At the current price in the high $70′s, Compass appears poised to offer 10% long-term returns, weather-permitting.

Overview

Compass Minerals (NYSE: CMP) produces and sells salt and specialty fertilizers to countries around the world, although a large chunk of the sales occur in the US, Canada, and the UK. Deicing salt is mostly sold in the Great Lakes and Mid West regions of North America, and in the UK. Consumer and industrial salt is sold throughout the US and Canada. Specialty fertilizers are sold in western and southern US, and in Latin America, Japan, Australia, and New Zealand.

Company Brands

Compass Minerals operates under a variety of industrial and consumer brands, including:

North American Salt Company
Sells diversified salt products throughout the United States

Great Salt Lake Minerals Corporation
American producer of Sulfate of Potash

Sifto Canadian Corp.
Provides diversified salt products in Canada

Deepstore Records Management
Long-term storage solutions in their Winsford, England salt mine

Salt Union Ltd.
Provider of rock salt in the UK

Pristiva
Sells products for the salt-water pool industry

Big Quill Resources
Canadian producer of Potassium Sulphate

In 2011, 48% of sales were from highway deicing, 32% were from consumer and industrial use, 19% were from specialty fertilizer, and the last 1% was from records management.

Ratios

Price to Earnings: 25
Price to Free Cash Flow: 60
Price to Book: 5.3
Return on Equity: 22%

Revenue

(Chart Source: DividendMonk.com)

The “2012″ column on these two charts is for the trailing twelve months as of this writing, which includes the last 3 months of 2011 and the first 9 months of 2012.

Compass Minerals grew its revenue at a 4% annualized rate over this seven-year period. This figure was significantly affected by a weak weather year in the past twelve months.

Earnings and Dividends

(Chart Source: DividendMonk.com)

Earnings per share and Free Cash Flow per share were both highly erratic over this period. This is because the bulk of the company’s earnings and cash come from snowy winters, and these can be rather variable.

If you look at the chart, you’ll see that free cash flow has some rather low years in relation to EPS. This is due to two reasons. First, since weather is erratic, their salt sales are erratic. In 2009 (a particularly low year for FCF but a solid year for EPS), they mined a lot of salt but much of it just went on the books as inventory, which counts as earnings but not cash flow. This inventory was realized during next year’s sales. The same is somewhat true over the last year. Second, the company has increased capital expenditure over the last three years for expansion of their Canadian and Utah assets. The capex over the last twelve months was the highest on the record for the company.

The dividend for Compass Minerals has been growing at a steady pace, and the annualized growth rate over the last seven years was 8.9%. The dividend is well-covered by earnings, but during weak years free cash flow can fail to cover the dividend. Over a period of several years, the dividend is well-covered by both earnings and free cash flow, as demonstrated by the above chart. The current dividend yield is on the low side at 2.55%.

Approximate historical dividend yield at beginning of each year:

Year	Yield
Current	2.55%
2012	2.6%
2011	1.8%
2010	2.1%
2009	2.2%
2008	3.2%
2007	3.8%
2006	4.3%

The dividend yield of Compass started out fairly high when the company was new as a publicly traded company (starting in 2004), then hit a low point during the top of the business cycle as the valuation become high, and has since been a at a moderately low level.

Balance Sheet

The balance sheet is a bit of a weak point for Compass relative to the strength of everything else about the company. The business started its public life with quite a bit of debt and has brought its debt levels down to a leveraged but stable position.

Total debt/equity is currently 100%, which is on the higher side. The debt/income ratio varies due to the company’s weather-related variability, but ranges from about 250% to 400%, which is fair.

The interest coverage ratio has recently varied between 6.5x and 8.5x, which is lower than the 10x I like to see but still fair. Overall, the balance sheet is a bit leveraged but is sustainable in the current situation.

Investment Thesis

Compass Minerals makes an excellent case-study in what an economic moat is. Quite often, large brands such as Coca Cola (KO) get thrown around as examples of companies with strong competitive advantages, but there are smaller companies out there with definitive competitive advantages as well.

Since the market is based almost entirely on price, it’s generally difficult to build a moat around a commodity good or service, unless the company has a structural advantage over all of their competitors.

Compass Minerals owns the largest rock salt mine in the world located in Goderich, Ontario. This allows them to mine the salt more economically than anyone else. In addition, since salt is inherently cheap and required in enormous quantities, the cost of transportation plays a key role in a company’s competitiveness. Since the Goderich mine is located right on the coast of Lake Huron, it is perfectly placed for water shipping. They have depots across the Midwest, along the Mississippi River, Ohio River, and along the coast of the Great Lakes. On top of that, the whole region surrounding the Great Lakes is called the “Snowbelt” due to the enormous snow volumes that the region gets from the lakes.

So, Compass has the largest rock salt mine in the world, located right on the coast of a water system that allows them optimized transportation throughout the region, and it’s all centered right in the middle of the Snowbelt. This is not an asset that can be reproduced by any competitor, and it gives Compass a permanent structural advantage in salt mining and distribution.

In addition, the company owns Britain’s largest rock salt mine, and North America’s largest naturally occurring source of Sulfate of Potash and Magnesium Chloride in Utah.

These assets, with decades of reserves, give Compass a very sturdy business position.

Risks

A particular way that Compass can be helpful to your portfolio is that it diversifies your equity risk in a different way than most other stocks. For the most part, Compass is recession-resistant. Their salt products, especially for deicing purposes, will not be greatly affected by economic downturns, and the pricing of salt is not particularly volatile. Their SOP business is more vulnerable to economic weakness and changes in commodity pricing, but this is a smaller portion of the business, and quite profitable.

Instead, the main risk for Compass is weather. Warm winters reduce the profitability of the company for that year, while particularly snowy winters are helpful to the company. Long-term changes in climate that increase or decrease snow in their target markets (around the Great Lakes in North America, and in the UK) can have a large impact on the company. One of the company’s major sources of free cash flow can be erratic and is based on snowfall.

A completely different weather risk materially set the company back in the last year. A rare F3 tornado struck their Goderich mine, causing damage and a fatality. Increased rainfall in Utah decreased their evaporation rate and therefore their productivity in that area. These were statistically odd occurrences.

Conclusion and Valuation

I previously analyzed Compass back in October 2011 when the stock price was in the low $70′s. I labeled it to be a fair buy, but not particularly appealing at that price. Thirteen months later, the stock is at a bit under $78 and has paid modest dividends, so the return was fair but not strong, which is basically what was expected. The current P/E of 25 and the P/FCF of around 60 are not particularly valid or concerning figures because the company’s results are currently around the bottom of a bad weather year.

Using the Dividend Discount Model (DDM), based on the inputs of $1.93 in dividends over the last 12 months, 8% dividend growth, and a 10% discount rate, the stock would be a fair value at $104. If the dividend growth variable is reduced to 7% in the model, then the stock would be fair at only $69.

The current stock price of around $78/share therefore seems fair for 10% annualized returns if the company can grow the dividend at a rate a bit over 7% per year. If the dividend growth rate is larger than this over the long-term like it has been over the last seven years, then the stock should provide returns in the low double digits over time.

Overall, the qualitative aspects of the company are quite attractive, while the sum of dividend growth and dividend yield, and the total return potential in general, leave a bit to be desired, and don’t offer a large margin of safety. The stock appears to be fairly priced under $80 for a 10% rate of return assuming an approximately 7.5% long-term dividend growth rate. These are pretty solid potential returns for such an advantaged business position.

Full Disclosure: As of this writing, I have no position in CMP.
You can see my dividend portfolio here.

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