To say Canadian (and global) investors have been having a bad summer may be an understatement. The TSX has plunged 15% since the beginning of April, effectively wiping out all of 2015’s gains and most of 2014’s.
Shareholders of agricultural company Agrium Inc. (TSX:AGU)(NYSE:AGU), have been mostly immune from the pain. Agrium shares are up 13% year-to-date, and since the beginning of April, Agrium shareholders have only seen their shares drop 4.5%—significantly less than the TSX.
There are many reasons for Agrium’s outperformance. One of the biggest is the fact that the company is expecting free cash flow to grow from an estimated $289 million this year to $1.3 billion by 2018. With this growth, the company has committed to increase its payout ratio from 35% to 50%, which will in turn lead to double-digit dividend growth, along with excess cash to use either for share buybacks, or for making further acquisitions or investments.
This impressive free cash flow growth comes from Agrium’s unique business model—a stable retail agricultural retail business combined with a more volatile and commodity-focused wholesale business. This model allows Agrium to use its stable retail cash flows to expand the wholesale segment and reward shareholders when fertilizer prices from the wholesale segment are weak, and vice-versa when wholesale prices are strong.
While strong and stable free cash flow have helped to support Agrium shares, there are many tailwinds forming that make the current 4.5% pullback in Agrium shares an excellent buying opportunity.
1) The weak Canadian dollar
The weak (and weakening) Canadian dollar presents a solid tailwind for Agrium. The reason for this is because Agrium reports its earnings in U.S. dollars, and has most of its revenues in U.S. dollars as well. This is because the company’s wholesale fertilizer products (potash, nitrogen, and phosphate), are priced in U.S dollars, and a large portion of the company’s retail segment (69%) is in the U.S.
A large portion of the company’s costs, however, are based in Canada. For example, 100% of the company’s potash operations are based in Canada, 65% of its nitrogen production is in Canada, and half of its phosphate production is based in Canada.
This means that when these costs are translated into stronger U.S. dollars, Agrium will see its costs decrease and its margins improve. In this, the weak Canadian dollar should assist Agrium.
2) Agrium is heading into a period of seasonal strength
In addition to the weakening Canadian dollar, Agrium is heading into a period of seasonal strength that will not only support shares, but also likely drive them higher from these levels. Agrium sees solid cash flow in the second half of the year due to the fact that farmers are often completing their harvests, and therefore have more cash to spend on Agrium’s products.
In the fall, farmers typically buy nutrients for the following year’s crop, and also make big-ticket purchases before the year-end for tax optimization purposes. In addition, many farmers also apply crop nutrients in the fall, so they have more time available for the busy spring planting season.
The end result is that over the past 18 years Agrium shares have averaged a 13.8% return between June and January, and Agrium has been profitable 75% of the time during this period.
3) Agrium will also benefit from lower natural gas prices
Commodity prices have been plunging, and natural gas has not been exempt from this. In fact, natural gas prices have plunged from $7.52 per million British Thermal Units (or BTU’s) to $2.67 per million BTU’s. With ample supply available, it is unlikely prices will rise substantially any time soon.
This is a major positive for Agrium, since one of the key costs required to create nitrogen (Agrium’s main fertilizer product) is natural gas. Nitrogen represents 58% of Agrium’s wholesale gross profits, and as natural gas costs decrease, Agrium will see increases to its nitrogen gross profit margins, which in turn, results in increases to Agrium’s earnings per share.
