The globally booming demand for potash fertiliser continues. K+S is operating at its capacity limit within the Potash and Magnesium Products segment with a unit sales volume of 8 m t. The offering covers the strong demand around the globe without (allowing) the scarce stocks of producers to be increased. The drivers behind the pleasing demand situation are not only the increase in the world’s population and the growing need for high-quality food (particularly in emerging markets), but increasingly the growing significance of bio-fuels around the globe as well. This effect will become even more significant. In global terms, the earnings of farmers are growing at the same time. In this environment, suppliers of potash fertiliser can significantly lift prices. Overall it is becoming apparent that these advantageous general conditions are at least provided through to the year 2011.
We have increased our forecasts for the Potash and Magnesium Products segment significantly with regards to sales and operating profit, particularly for the years as of 2008. In light of the prominent significance of this segment for the Group (2007e: sales share 42%, EBIT I-share before reconciliation 61%), this pushes through to the cash flow and earnings per share. We are increasing our EPS estimate for 2007 by 11%, for 2008 by 17% and for 2009 by 20%. We see two catalysts for further rising share prices in the short to medium term:
Q2 should underpin the very good market conditions for potash fertilisers. K+S continues to increase prices. In addition, SPL is expected to have made up for a part of the dent of Q1 with better de-icing salt deliveries to the US as a result of a cold month of April. However, Salt will fall short of the previous year’s figures for the full year. On the other hand, this should be sufficiently taken into account on the market. We anticipate a lift of the yearly guidance in the scope of the Q2 report on the basis of the booming potash business.
K+S is currently in negotiations with potential partners for the joint development of new potash-mine/production locations overseas (green field). Because K+S already operates at its limit in terms of quantity, such a step is necessary to also participate in the market growth within this core business in the long term.
New price target € 130 – upgrade to Buy
We are increasing the fundamental price target to € 130 on the basis of the new forecasts (previously: € 95.50). We are again upgrading the share to Buy.
We have determined the price target on the basis of three separate approaches (DCF, EVA and SOP), the fair values of which we have weighted. As such, we have given the DCF approach the most importance with a weight of 50% (highest longer-term explanatory value, greatest acceptance). The other weighting factors are each 25%.
In the DCF model and the EVA model we have shown the estimated long-term performance of the Group (detailed forecast through 2009, 10-year transition phase, perpetual rate). We are discounting the respective operating free cash flows (DCF model) and the value contributions (ROCE > WACC in the EVA model) per year with the average cost of capital. The sum of the net present values equals the enterprise value. After deduction of net debt (incl. pension and mining provisions) and the minority shares of equity, the “fair” value of equity results.
We have calculated a fair value (FV) of € 140 from the DCF model and a FV of € 119.50 from the EVA approach. Compared to our previous valuation, the following factors have proven positive: the higher sales estimates and, on top of this, the expectation of a higher operating margin. We now assume that K+S will be able to bring in an adjusted EBITDA margin of 16.5% in the medium to long term (peak figures 2009 to 2012 with each 17.1%).
The SOP approach (sum of the parts) delivers a FV of € 119.40. We have thus lifted the multiples for Potash and Magnesium Products to 2.95x sales and 13.0x EBITDA (each on a 2007e basis). With this approach, we have determined fair multiples of 1.76x sales and 11.9x EBITDA for the Group. This allows for a very good market position, the pleasing growth and, above all, earnings prospects, and the robust balance sheet.
Ideal market environment will last at least 5 years K+S is profiting from a booming demand for potash fertiliser. The demand is increasing heavily around the world, while at the same time, stocks of producers are low. The drivers behind the sustainably positive demand increase are the growing world population and the increasing demand for high-quality food and food supply, which is increasingly supported and intensified by the emerging markets. In addition, the trend towards more use of bio-fuels is also having a stronger effect. We expect this influencing factor, supported by state aid programmes, to gain importance in the future. The global demand for potash fertiliser will reach a level of nearly 57 m t in 2007. This equals the production possibilities available world-wide. Supply and demand are balanced, meaning that the output suffices at the moment for meeting the existing demand. A noteworthy expansion of stocks is not taking place in this environment. At the same time, farmers’ earnings have risen sharply in a historical comparison and are at a comfortable level. This is an ideal environment for fertiliser producers to implement price increases on the market.
Moreover, the following aspect is significant: with the exception of the temporary market shifts in the last year, as drawn-out price negotiations with China had temporarily created an oversupply (the problems have been eliminated, commodity flows are intact and prices have recovered significantly), every potash fertiliser producer is profiting from the strong demand and is able to sell its complete production. Every producer is serving its market as well as its customers. Under such conditions, there is no fight for market shares. This is also an important factor allowing for price increases around the globe.
An average growth in demand of +3% p.a. is expected in the market overall for the coming years (through 2011). The forecast market volume for the year 2011 thus comes out to just under 64 m t. On consideration of the plans made public by all potash producers around the world to expand their production by 2011, the expected demand will also be met in the future with this expansion. The market remains balanced. These capacity expansions to be realised by 2011 are measures aimed at a higher output from the existing mines/ plants. In this timeframe, no more can technically be implemented according to industry statements. In addition, some potash producers – including K+S – plan to open up new mines (green field). K+S is in concrete talks with partners on investing in a green field project. These negotiations are expected to come to an end this year. However, the company has also signalled that, after a positive investment decision – even on the basis of well-founded geological data on a corresponding potash deposit – it will take some 5 years before a green field plant is on the market. This means that the market will very likely remain characterised by the very positive underlying data up to and including 2011 at the least, and this regardless of which suppliers will put green field projects into motion and to what extent in the short to medium term.
Against this background, we have revised our sales and earnings estimates for K+S’s Potash and Magnesium Products segment and lifted the forecasts significantly.
K+S: volume sales at the capacity limit, price increases pushing sales...
The volume sales of the Potash and Magnesium Products segment comes out to 8 m t. With this, K+S is operating at its capacity limit. The growth driver is thus the price component. However, this also means that, with a stable output of 8 m t, therefore with c.p. stable production costs, every price increase is directly pushed through to operating profit. However, the costs should actually rise slightly. In addition to moderately higher personnel costs, depreciation is on the rise as a result of increased capital expenditures. Furthermore, the increases in energy costs, as well as the rises in freight prices are proving a burden. However, here K+S is applying targeted measures to keep a lid on the cost increase overall. In light of share price increases, the operating margin will improve significantly and, given the continuously advantageous market conditions in the medium term, sustainably as well.
For Q1 2007 K+S has implemented average effective prices of € 164.4/t in the Potash and Magnesium Products segment for deliveries in Europe. This is a good 5% more than in the same quarter of the previous year, though this represents the highest basis from 2006. The basis of the subsequent quarters is lower (due to the price negotiations of other suppliers with China, which had temporarily burdened the market on its part), thus resulting in rises of 7-9% in the coming quarters, even with unchanged prices of € 164.4/t. However, K+S actually implemented additional price increases on the market, which will have an effect on deliveries in H2.
A similar picture can be seen for overseas markets, whereby the freight costs and currency effects should be considered here. On the other hand, the consequent currency hedging allowes K+S to cushion the earnings influences of currency fluctuations. In US dollars, the market prices for deliveries to Thailand/Taiwan or Brazil exceed the previous highs of 2005 by more than 13% with currently around US$ 250/t. They are also some 20-30% above the prices in mid-2006.
... and operating profit
We are lifting our forecast for segment sales considerably. For 2007 we now anticipate a rise in Potash and Magnesium Products sales of 10% (previously: +6%) to € 1,363 m. As such, we assume that the quantities will remain stable, prices will rise on a yearly basis by an average of 12-13% and negative currency effects will thereby be significantly overcompensated. For the operating profit before non-cash market value amendments of the US Dollar hedging (EBIT I) we are likewise considerably more optimistic than before on the basis of this raised sales estimate. We anticipate a further lift of the company’s guidance after the release of the Q2 report. At the start of the year it was still being announced that the segment result for 2007 would “increase”. After the Q1 report, a “significant” rise was announced. We now assume that EBIT I of the segment will be able to expand by more than 40% in 2007 to € 232 m (previously: +26% to € 200 m). The operating margin would then improve to 17.0% from 12.8%. The consensus estimate is presently at a good 16%.
For the coming years we continue to assume a unit sales volume of 8 m t and a price-driven sales increase for the Potash and Magnesium Products segment. For 2008 we anticipate a 9% sales plus and an 8% sales plus for 2009. Previously we had assumed a mere +4% for each year. In addition, we now calculate a margin improvement to 20.0% by 2009 (2008: 18.5%).
Overseas cooperation for additional unit sales volumes targeted
As K+S has already realised the optimum amount from the existing mines with the aforementioned 8 m t of unit sales, the company is planning to position itself overseas for further growth through the opening up of a new green field site in light of the quantitatively growing world markets. In addition, talks with potential partners are presently being held. The management is optimistic about being able to realise a positive outcome with these negotiations during the further course of the year. Regionally, commitments in South America, Asia or in Eastern Europe are possible. As outlined above, K+S could benefit from additional unit sales volumes in the market from such a project as early as in 5 years time. Forasmuch we have still not considered this in our model. In light of the strong balance sheet ratios (see Fig. 2) and an estimated operating free cash flow in 2008 of just under 7% and 8% of sales in 2009, the Group has a large amount of financial resources available to be able to tackle a comprehensive project.
Higher potash forecasts push through to EPS
The Potash and Magnesium Products segment dominates Group figures and prospects. The sales share should be 42% in 2007. As measured by EBIT I before reconciliation, the segment should produce 61% of operating earnings in the current year. Insofar, our upwardly revised estimates for this segment have visible effects on the Group figures. We now assume that the Group sales for 2007 will climb by 9.1% to € 3,227.2 m. EBIT I should improve to € 345.5 m, resulting in a Group margin of 10.7% (2006: 9.4%, see. Fig. 1 + 3). Until now we had assumed a figure of 9.9%. The consensus expects 10.3%.
Through 2009 we from now on expect the margin to improve to 12.7% (previously: 11.3%). On average, analyst estimates for 2009 calculate an EBIT I margin of 12.2%. Driven by this more optimistic, but from our current view fundamentally underpinned operating profit, significantly higher EPS estimates result. We are lifting our estimates by 11% for 2007, by 17% for 2008 and by 20% for 2009. In addition, we are correcting our dividend expectations on this basis. K+S is following an earnings-orientated payout policy. The dividend should (without one-off effects) thus be in the scope of a payout ratio of 40-50%. For 2006 the payout was just under 47% of net profits adjusted for oneoff tax-related income from SPL. For the coming dividend payment we assume a payout ratio of just under 43% to a good 40%. We are consciously opting for the lower end of the range, in order to have a buffer in the forecast in view of the additional cash requirements in connection with the targeted co-operation overseas. Under these premises we derive a dividend of € 2.20 per share for 2007. For 2009 a payment of € 2.90 is conceivable in our view.
RWD Price at posting:
0.0¢ Sentiment: Buy Disclosure: Held
