Agrium Inc.: Activists at the Gate

Despite record global grain yields Agrium Inc. (TSX: AGU)(NYSE: AGU) delivered quarterly results that at best could be described as mixed with annual profits heading for a 20% decline.

A mixed quarterly result… as expected

Agrium announced adjusted earnings per share from continuing operations of US$0.63 for the third quarter, which was 17% higher than the comparable quarter last year. For the first nine months of the year, earnings per share declined by 23%. On an unadjusted IFRS basis, including discontinued operations, earnings per share declined by 33% for the quarter.

Revenue for the quarter was 4% higher than the year before as a result of the inclusion of the Viterra business acquired in October 2013 and higher nitrogen and phosphate volumes and prices. As a result of higher sales costs, expenses jumped by 17% during the quarter resulting in a compression of the EBIT margin from 5.2% to 3.6%.

The Retail division, with main products crop nutrients and crop protection, had a poor quarter with EBIT declining by 44% mainly as a result in much higher selling costs although the year to date result improved with a 14% EBIT increase.

The Wholesale division had excellent nitrogen and phosphate sales but lower potash sales with a net result of a small EBIT increase. Potash production was impacted by mechanical failure and advanced expansion tie-in at the Vanscoy facility detracting from what otherwise could have been a good quarter for this division. The year-to-date result was rather poor with a 14% decline in sales revenue and a 47% decline in EBIT with profits of all major product lines lower than the year before.

The decline in the profitability of the Agrium business over the past 4 quarters is illustrated by the four-quarter rolling return on capital employed, which declined from 14% at the end of the third quarter 2013 to 8% by the end of the same quarter in 2014.

Poor cash flow but a sound balance sheet

Agrium consumed cash of US$466 million during the quarter mainly as a result of additional working capital requirements. The business only managed to convert 2.5% of sales to operating cash flow (US$332 million) during the first nine months of the year. This was not nearly enough to cover the capital expenditures of US$1.5 billion resulting in a negative free cash flow so far this year and a requirement to raise considerable additional short-term debt of US$1.1 billion. The balance sheet remains in reasonable shape with net debt of US$4.7 billion representing a manageable 40% of total capital.

Agrium’s board also announced a 4% increase in the dividend to US$0.78 per share for a total dividend of US$3.12 per share on an annualized basis. No shares were repurchased from the market so far this year compared to the almost US$500 million spent last year.

Outlook for the full year unchanged

Agrium is providing guidance of adjusted earnings per share of US$0.45-$0.75 per share for the fourth quarter, which would bring the full year profit to US$5.67 per share (based on the midpoint of the fourth quarter estimate) — equating to a 21% decline from last year.

Agrium will have to work hard to improve shareholder value

ValueAct Capital, a San Francisco-based fund manager recently acquired a 5.7% equity interest in Agrium and in the process become the second largest shareholder — clearly with the objective to improve shareholder value.

Based on consensus estimates, Agrium is valued on a 13 times price/earnings ratio and 7.9 times EV/EBITDA, roughly in line with its nutrient producing peers. Whether ValueAct will push for a separate listing of the Retail division is unclear but this possibility was rebuffed by the Agrium Board less than 18 months ago. Agrium is in a weaker position now to convince shareholders that the current strategy is the right one.

Perhaps there is an interesting time ahead for Agrium shareholders but meanwhile, don't miss our TOP PICK for 2014 and beyond

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Fool contributor Deon Vernooy, CFA has no position in any stocks mentioned. Agrium is a recommendation of Stock Advisor Canada.

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