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Morningstar | Despite Softer Volume Guidance, We Are Encouraged by Higher Salt Prices; Compass Shares Undervalued. See Updated Analyst Note from 07 Aug 2018

Wide-moat Compass Minerals reported second-quarter results that support our outlook for higher near-term prices. As an offset, however, the company issued softer volume guidance than we anticipated. Overall, adjusted EBITDA grew 16% from the prior-year period to $37.5 million. Having updated our valuation model, we maintain our $83 per share fair value estimate for Compass Minerals.

In the earnings release, management provided an update on the deicing salt bid season. With roughly 75% of the bids complete, Compass is set to realize a 15% deicing salt price increase, which includes increased shipping costs. Following the harsh 2017-18 winter, we had previously assumed Compass would be able to realize only a mid-single-digit price increase, so the prospect of larger gains is encouraging. However, Compass' midpoint bid volume will be lower in the upcoming winter as the Goderich mine strike had temporarily reduced the company's bid footprint. Regardless, deicing salt volumes are ultimately driven by winter weather, as the volumes that are actually purchased can range from 80% to 120% of the midpoint contract volumes.

Although we've adjusted our near-term forecasts, our long-term thesis is unchanged. Compass is well positioned to realize material cost savings from the implementation of continuous miners at Goderich. We continue to expect unit production costs to fall in the coming years. Accordingly, the stock is trading at over a 20% discount to our fair value estimate. With the operational issues that have plagued Compass' low-cost Goderich now largely resolved, more typical earnings power has been restored. Assuming normal winter conditions, Compass will benefit from a combination of higher deicing salt prices and lower unit production costs. Although profits have risen only modestly since 2015, we forecast that EBITDA will rise 27% in 2019, boosting returns on invested capital by roughly four-fold.

In the plant nutrition businesses, Compass should benefit from higher volumes. In North America, which primarily sells sulfate of potash, we expect strong farmer demand to result in a 7% volume growth to around 350,000 tons in 2018. Similarly, the South American business, which sells micronutrients primarily for use in Brazilian row crops, should benefit from improving near-term soybean economics in Brazil. This is due to a Brazilian soybean price premium versus U.S. exports stemming from Chinese tariffs targeting U.S. producers. The premium, which reached 21% in July, should ultimately normalize as global crop trade flows adjust. However, in the second half of the year, we expect Brazilian farmers to purchase more micronutrients for the soybean crop. As a result, we forecast a 10% increase in agriculture volumes in the Plant Nutrition South America segment.