Agrium Inc. (TSX: AGU)(NYSE: AGU) investors have been along for a wild ride recently. In early October, Agrium shares declined sharply to a 2014 low due to the company guiding its Q3 2014 earnings downward to $0.45-$0.55 per share, away from the analyst consensus estimate of $0.64 per share.
On Friday, shares suddenly skyrocketed from around $96 to a high of $105 before pulling back slightly. The reason? Activist investors ValueAct Capital revealed they acquired a 5.7% stake in Agrium, purchasing 8.2 million shares over the past two months.
This is not Agrium’s first experience with activist investors. Here’s what you need to know and how you should react.
Agrium has had a difficult history with activist investors
In 2013, Agrium won a bitter 10-month feud with hedge fund activist investors Jana Partners, who wanted to install board members and make several fundamental changes to Agrium’s business structure and operations, including splitting its fertilizer and wholesale businesses into separate entities to unlock value. Jana suggested Agrium’s retail segment was highly undervalued, and over $28 per share in value could be added by separating retail from the commodity focused wholesale division weighing it down.
Jana’s analysis was widely questioned, and they were ultimately unsuccessful in electing any members to Agrium’s board. It is questionable if ValueAct has such radical ambitions for Agrium.
What is not questionable is that ValueAct taking a large position signals to investors that Agrium has value that can be unlocked. ValueAct focuses largely on taking long-term positions in companies it believes are fundamentally undervalued.
Based on ValueAct’s and Agrium’s statements, as well as on the many constructive changes Agrium made post-Jana, it appears ValueAct may be taking a more conservative role in Agrium, and ValueAct’s interest can be seen as confirmation that Agrium will see excellent growth going forward. The question is: should you buy on this news?
Even at recent prices, Agrium is still a buy
Agrium and ValueAct have had multiple meetings since ValueAct took its position, and according to Agrium, ValueAct made no indication of radical plans, and is interested in Agrium as a long-term investment. It sees Agrium as an undervalued play with strong long-term growth, with a stable retail business that complements the wholesale business.
This was corroborated by ValueAct CEO Jeffrey Ubben, who also stated that he expects Agrium’s free cash flow to explode over the next several years, and expects significant return on capital and improved crop prices in 2016 and beyond.
In other words, ValueAct seems interested in the potential Agrium’s current corporate form offers.
This analysis would be a sound one. Much of Agrium’s recent difficulties, including its Q3 2014 downward earnings guidance, are due to short-term issues influencing earnings. One of these issues is the shutdown of Agrium’s Vanscoy potash mine in order to tie in its $1.8 billion expansion, which is expected to add 40% to Agrium’s potash production, eventually increasing it to 2.8 million tonnes per year.
This turnaround, originally planned for 14 weeks, had to be extended for several weeks due to a prior mechanical failure on the main hoist system. Lower production combined with higher fixed costs is expected to produce a $40 million loss for potash the second half of 2014, influencing total earnings.
Lower earnings due to capital projects are working together with weak macroeconomic conditions, such as poor crop prices and weak fertilizer prices, to produce the poor earnings guidance.
Fortunately, these macroeconomic conditions are expected to improve moving into 2015. In addition, Agrium will have completed all of its major capital projects by 2015, which will result in significant reductions in capital expenditures, increased production, and therefore sharp increases in free cash flow and earnings.
The earnings 10% annual earnings growth that will occur is not adequately reflected in Agrium’s relatively low price-to-earnings ratio of 15.3, and even at a share price of almost $105, buying at these levels or waiting for a slight pullback to the $100 region is a wise choice.
