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Morningstar | Nutrien Continues Strong 2018; Raising Our FVE on Higher Potash Production and Lower Costs. See Updated Analyst Note from 06 Nov 2018

Nutrien reported strong third-quarter results, as adjusted EBITDA grew roughly 77% year on year to $839 million. This was supported by higher fertilizer prices that led to greater profits across the three wholesale fertilizer segments. We've increased our near-term potash production forecast based on management's revised guidance. Additionally, we've lowered our long-term potash unit production cost forecast to include the cost savings from Nutrien's permanent closure of the New Brunswick potash mine. We've also raised our 2019 nitrogen price forecast to reflect higher natural gas prices.

Having updated our model to reflect these changes, as well as the time value of money, we've increased our fair value estimates to USD 68 and CAD 89 per share from USD 65 and CAD 85 for narrow-moat Nutrien. At current prices, we view Nutrien as modestly undervalued.

In potash, management raised 2018 production guidance by 200 thousand metric tons to a midpoint of 12.75 million metric tons. Because Nutrien typically produces potash at capacity utilization rates well below 100%, the company can increase production to take advantage of higher prices when demand exceeds supply.

With potash gross margins in the mid-50% range at current prices, Nutrien is well positioned to grow profits into 2019. Potash prices continue to be supported by lower production from SQM, K+S, and Israel Chemicals, combined with a slower than expected production ramp from EuroChem. We continue to forecast $300 per metric ton potash price in 2019, with a long-term potash price forecast of $310 per metric ton.

In addition to the earnings release, the company announced the permanent closure of the New Brunswick potash mine, which had ceased production in 2016. The closure is estimated to reduce annual potash operating costs by $25 million. As Nutrien continues to reduce potash unit production costs, we forecast that potash gross margins will grow above 60% over our 10-year explicit forecast period.

We've updated our 2019 nitrogen price forecast to reflect our higher European natural gas price forecast. European nitrogen producers, who produce fertilizers from natural gas-based inputs, set the marginal cost of production that informs our price forecast. Due to higher natural gas prices, we've raised our 2019 urea nitrogen fertilizer price to $260 per metric ton from $245. However, as we forecast European natural gas prices will fall roughly 8% from $7.61 per mmBtu in 2019 to $7.01 by 2022, we maintain our long-term urea nitrogen price forecast of $240 per metric ton in 2018 real terms.

In addition to higher prices, Nutrien should benefit from a greater proportion of its nitrogen being produced via lower-cost U.S. and Canadian natural gas feedstock. As such, we continue to forecast that Nutrien will generate gross profit margins over 30% in a midcycle environment. This is well above the 21% generated in 2017.