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Morningstar | Maintaining $81 FVE as Compass Reports Detailed 3Q Earnings; Shares Undervalued

Compass Minerals reported detailed third-quarter earnings and management confirmed our thesis that the production issues at the low-cost Goderich mine are temporary.  On Oct. 23, management announced the production issues and reduced 2018 EPS guidance. With no details in the third-quarter earnings that significantly alter our outlook for the company, we maintain Compass' $81 per share fair value estimate and wide moat rating.

The market reacted favorably to the earnings report, sending shares up nearly 6% at the time of writing. However, with Compass trading at roughly 37% below our $81 per share fair value estimate, we continue to view Compass as materially undervalued, trading in 5-star territory.

This production season, Compass Minerals switched to the use of continuous miners throughout the entire Goderich mine to lower costs. Previously, Compass had used drill and blast mining in addition to continuous miners. With no issues related to geology or the equipment at the Goderich mine, we liken this transition to starting up a new mine, as Compass faces a learning curve making a full transition to continuous miners. While the lower production this year will affect 2018 and 2019 earnings, we see no long-term issues related to low-cost salt production at Goderich. As such, we continue to forecast that Compass' salt unit production expenses will fall nearly 10% by 2020 from 2017 levels as the mine is fully ramped up and Compass' cost savings measures are fully implemented.

On the earnings call, management noted that deicing salt prices for the upcoming winter will rise an average of 18%. The price increases will go into effect beginning in the fourth quarter of 2018, and we expect salt segment profits to benefit as a result. Although contractual deicing salt volumes are down 15% for the upcoming winter, we note that volumes will ultimately be determined by winter weather as contracts allow municipalities to purchase between 80% and 120% of the midpoint volume.

In Compass' Plant Nutrition North America segment, EBITDA grew 31% year on year to $15.1 million. The growth was million driven by higher prices and lower unit production costs, partially offset by lower volumes. During the quarter, Compass' production costs fell primarily from the company's new crystallizer, which is a part of management's long-term plan to reduce sulfate of potash, or SOP, unit production costs. The cost reduction will help the PNSA segment maintain higher profits even as we forecast SOP prices to fall to standard potash, or MOP, prices plus the cost of conversion, which is typically the marginal cost of SOP production.