K+S: A European potash game trading at a yield of 20% FCF

Introduction

Fertilizer markets are on fire these days and while most of the attention is on the North American fertilizer games, one would almost forget that there are a few very interesting European companies as well. In a previous post I discussed OCI (OTC:OCINF) but very few people outside of Canada and Europe are aware of K+S (OTCQX:KPLUY) (OTCQX:KPLUF) a German potash and salt producer. And it’s a shame, because this company is doing exceptionally well thanks to the very strong potash market. And since it flies under the radar, it could potentially be an investment opportunity to gain exposure to potash markets.

K+S has its primary listing in Germany where it trades with SDF as its ticker symbol. Considering that the average daily volume in Germany exceeds 1.5 million shares per day, this is clearly the best quote to trade the company’s shares. There are also options available in Germany.

K+S takes full advantage of favorable winds in the fertilizer sector

While this article focuses on K+S’s fertilizer division, as this will be the primary driver of earnings and free cash flow, it should be remembered that the company’s industrial division generated approximately 30% of revenue in 2021. As I expect the potash division to grow revenue at an exceptional rate this year, the agriculture segment’s contribution to total revenue will likely increase beyond the 70% level achieved last year. last.

The impact of the high potash price is very clearly visible in the company’s first quarter summary. It produced 11% fewer tons of fertilizer (1.79 million tons compared to 2.01 million tons in the first quarter of 2021), but revenues more than doubled, with average revenue per ton falling from less than 240 EUR/t to just over EUR 520 per ton of fertiliser. (of which potash represents approximately 60% of the total quantity of tonnes sold). And thanks to this massive increase, the consolidated EBITDA margin more than doubled and the company quadrupled its EBITDA to 524 million euros, representing a margin of 43.2% compared to only 17.2% in the first quarter of the year. ‘last year.

Total revenue in the first quarter of this year was just over €1.2 billion, resulting in gross profit of €505 million (an increase from just over 294 million euros in the first quarter of last year). Gross profit already includes depreciation and amortization charges of just over 100 million euros per quarter.

As the company cleaned up its balance sheet and reduced its gross debt and net debt, interest expense fell very quickly, giving a nice additional boost to pre-tax profit which nearly doubled to $441 million. euros, while net profit reached 441 million euros. just under EUR 311 million for EPS of EUR 1.62 per share. So, on an annualized basis, K+S appears to be on track to generate north of EUR 6 per share in earnings, especially as fertilizer prices continue their upward trajectory.

And it’s not just a paper profit or an accounting profit. The statement of cash flows confirms that K+S could have a banner year. Reported operating cash flow was €253 million, but this includes a strong increase in working capital position (mainly an increase in receivables) of €248 million. On the other hand, the difference of 113 million euros between taxes due and taxes paid must also be deducted and after making these adjustments, the adjusted operating cash flow was 388 million euros.

Total capex in the first quarter was relatively high at €150 million as the total amount spent on intangibles was high, but this includes some non-recurring items such as factoring and the purchase of emission rights. It was intangibles that weighed on capital expenditure in the first quarter, but it also means that capital expenditure for 2022 has been very concentrated. And despite the high capital expenditure, the free cash flow result in the first quarter of the year was around 238 million euros. Spread over the 191.4 million shares outstanding, free cash flow in the first quarter of the year was approximately EUR 1.24 per share.

The 2022 objectives have been raised again

Before diving into near-term expectations, investors should realize that K+S has done a phenomenal job of restoring the health of its balance sheet. In 2020, the company signed an agreement to sell the Americas business unit for a total enterprise value of $3.2 billion, including €2.6 billion in cash. This immediately helped to strengthen the balance sheet which is now healthy thanks to the combination of lower net debt and a much higher EBITDA.

This now means K+S has more flexibility in how it can invest its incoming cash flow rather than worrying about how it can repay debt, and the company will soon have a luxury problem.

While K+S’ initial guidance provided in the annual report was already quite positive with an expected 70% increase in EBITDA and a 600% increase in adjusted free cash flow, K+S was able to raise this guidance after the exceptionally strong performance in the first quarter of the year.

It now expects its EBITDA to be between 2.3 and 2.6 billion euros, while adjusted free cash flow will be around 1 and 1.2 billion euros. If the cost related to the purchase of additional emission rights were deducted from this amount (this is in addition to the expected capital expenditure of 400 million euros), the underlying free cash flow would be 770 to 970 million euros. Given the current strength in the fertilizer markets and the current EUR/USD exchange rate which is much stronger than the 1.16 used in the forecast, I now think it is likely that K+S will reach and even exceed these forecasts. An underlying free cash flow result of €970 million (including €230 million spent on emission rights for the period beyond 2026) translates to free cash flow per share greater than EUR 5 per share. And if we exclude CO2-related expenses, the underlying free cash flow per share will exceed EUR 6.

Of course, the current tailwinds in the fertilizer business won’t last forever, so I won’t argue that K+S should be trading at 12 times its 2022 free cash flow result. But this windfall of profits and cash will allow K+S to immediately convert its net debt into net cash.

At the end of the first quarter, the company had €630 million in cash and financial investments and less than €1.2 billion in financial liabilities for total net debt of just over €500 million. euros. This is based on net financial debt and excludes lease debt and provisions for mining obligations.

The debt ratio (based on EBITDA LTM) has fallen to just 0.4x, but given that the EBITDA forecast for this year has been raised to around 2.5 billion euros, the debt ratio indebtedness based on expected EBITDA is less than 0.2. And if free cash flow projections hold true, net debt will likely convert to net cash by the end of this year.

Investment thesis

If we assume that net debt is effectively converted into a small net cash position by the end of this year, K+S’s current market capitalization of less than 6 billion euros essentially means that the company is trading at just over twice EBITDA. While the fertilizer market is a highly cyclical industry, the current tailwinds will position K+S into a future down cycle as a stronger company. If the current high price environment lasts until 2024 (which competitor OCI was aiming for), K+S could easily have over €1 billion of net cash on the balance sheet, which will be a big help. in the event of a slowdown.

Additionally, the company is spending money to improve its existing operations to ensure they can withstand falling fertilizer prices.

Although it is difficult to predict future supply volumes for fertilizers and potash products given the issues with Russia and Belarus, K+S is in an enviable position and with an EV/EBITDA ratio of just a little more than 2, it trades slightly cheaper than CF Industries (CF), Nutrien (NTR) and Mosaic (MOS) which trade at consensus estimates of 3, 3.8 and 3 EV/EBITDA respectively.