While the global fertilizer industry continues to struggle with imbalanced markets, efforts hyper-focused on operational efficiency have begun to pay off for several producers. Investors can count small cap Intrepid Potash (NYSE: IPI) among them.
In the first quarter of 2018, the business squeaked out EPS of $0.01 after managing to lower cost of goods sold while increasing sales, lowering selling and administrative expenses, and reducing interest expense 80% compared to the year-ago period. It took one heck of an effort, but Intrepid Potash achieved a profitable quarter without much help from fertilizer selling prices.
It was an encouraging period of progress, but it also was only a single quarter. Can investors be sure Intrepid Potash's turnaround is succeeding?
By the numbers
The business is primarily built on two fertilizer segments: potash and a niche fertilizer compound called langbeinite, sold under the Trio brand name. In recent years the company has transitioned all of its potash production to low-cost solar evaporation ponds. Although total sales levels have dropped , the segment is profitable even at the current market's lowly selling prices.
In addition to selling fertilizers, Intrepid Potash has also begun leveraging one of its best-untapped assets: water. Due to the nature of the business, there was always a need to secure water supplies, especially considering all of its production assets are in the arid landscapes of New Mexico and Utah. But with the Permian Basin, the world's most important energy-producing region next door (and even directly underneath its fertilizer reserves, in some cases), the company has been able to sell its excess water to energy companies for quick and easy profits.
In fact, water sales accounted for 60% of total gross profit in the most recent period. Consider how the headline metrics stack up compared to the same quarter in 2017.
Total gross profit
Total operating income
Diluted shares outstanding
Operating cash flow
Data source: First-quarter 2018 press release. YOY = year over year.
It's also worthwhile to go a level deeper and consider the segment-by-segment breakdown for the same periods.
Potash gross profit
Potash price per ton
Trio gross profit
Trio price per ton
Water gross profit
Data source: SEC filings. *Note: Percent increase omitted due to most recent quarterly performance being significantly higher than year-ago period. YOY = year over year.
Trio is still struggling to turn a profit, but potash and water more than made up the difference. This is exactly what management told investors would happen when it began the turnaround strategy years ago. That is, that low-cost solar evaporation would deliver sustainable profits from potash production and that there was a sizable opportunity in water sales. Can the business continue to improve?
Well, Intrepid Potash hasn't provided full-year 2018 guidance, owing to the fact that the fertilizer market remains volatile and uncertain. But management says starting off the year with $4.8 million in water sales puts the company on track to deliver $20 million to $30 million in revenue from the high-margin segment for the year.
Considering it took in another $3.7 million from a separate water commitment during the first three months of 2018 -- recorded as a liability since deliveries haven't begun yet -- investors should be cautiously optimistic the business will hit the mark. In fact, it could deliver $17 million to $25 million in gross profit in 2018, which should go a long way toward keeping the company close to breakeven operations.
Potash production in the desert.
Of course, while water sales are proving lucrative, Intrepid Potash's success will ultimately be determined by the health of its fertilizer segments. A slow and steady recovery in selling prices should keep the potash segment profitable for the remainder of the year. That would be a hugely important development for investors for two reasons.
First, the potash segment is profitable despite selling prices near all-time lows. All gains from here on out would result in significant incremental profits. Second, the Trio segment is not profitable, but its selling prices are largely influenced by potash selling prices. By the time it reaches profitable sales, the business would likely be much more profitable on the whole.
In other words, Intrepid Potash appears to be well-positioned to capitalize on a prolonged recovery in the fertilizer industry. Whether or not selling prices continue to climb higher is largely dependent upon the actions of the industry's largest producers. That's especially true considering 60% of global production comes from just three companies -- and they haven't proven very good at balancing supply and demand in the last decade.
The turnaround could succeed, but...
Intrepid Potash has done pretty much everything it can to position itself for success. It has transitioned to low-cost solar evaporation ponds for all potash production, which has enabled profitable output even at today's depressed selling prices. It has reduced corporate overhead and paid off debt (albeit through share offerings) to greatly lower operating expenses. And it has managed to monetize its highly coveted water assets near the Permian Basin.
By all accounts, it appears as if the turnaround is succeeding and should deliver sustainably profitable operations. There's just one caveat: The remaining potential improvements to the business are largely out of management's control. In order for shareholders to realize the potential upside Intrepid Potash stock has to offer, the industry's major players have to demonstrate continued supply discipline. Unfortunately, that's far from certain.
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