Compass Minerals: Core Salt Business Can’t Carry The Valuation (NYSE:CMP)

Compass Minerals International (NYSE:CMP) caught my eye still trading near 52-week lows at $22.54 but the company has some rocky challenges ahead. Cash flows and interest coverage indicate tight liquidity leading to equity issuances in the past year. The company has halted further development on their brine lithium project, which is a positive in my opinion as the project has a lot of regulatory uncertainties and a long lead time. The halt will force Compass Minerals to focus on their roots in salt production until the lithium industry and regulations become more clear. This article will discuss Compass Minerals’ latest results and decent salt cash flows as well as the growth initiatives in Lithium production and forest fire prevention products.

A lot has changed since I last wrote about Compass Minerals back in September 2017 questioning the sustainability of the dividend, but some of the core salt business has stayed the same too. Since this last article, the stock has achieved total returns of negative 55.9% compared to positive 87% returns from the S&P 500. Over the period since my last article, Compass Minerals has sold off the South American plant nutrition business and invested heavily in new growth initiatives. The low ROIC makes me worried that the company could be a value trap even at today’s low prices with the high debt load.

Latest Quarterly Results

In the latest fiscal year results, the company restored full-year adjusted EBITDA margins in excess of $20 per ton for the Salt business. Fiscal year revenue may have been flat for the Salt segment, but EBITDA was a solid $230.7 million (+25.9%) driven in part by pricing being up 11% per ton to $89.

Offsetting the pricing gains were salt volume declines of 9.8% to 11,320 thousand of tons from 12,556 in 2022 across Highway Deicing and Consumer & Industrial. These Salt segment figures continue to recover back towards recent highs of $258 million EBITDA back in FY 2021 and continue to make up 84% ($231 million) of Compass Minerals EBITDA with Plant Nutrition contributing the other significant amount with 16% ($45.1 million).

On the other hand, the Plant Nutrition segment had revenue declines of 22.6% to sit at $172 million for FY 2023. Volumes in the segment declined 23.4% to 219,000 tons from 286,000 tons in 2022. EBITDA of $45 million for the fiscal year was down 37.4% with EBITDA margins down 6.3%.

Compass Mineral’s core Salt business remains the cash cow of the company contributing to 85% ($1.0 billion) of revenues and an even more important 94% ($171.1 million) of operating income compared to Plant Nutrition. This operating income goes a long way to covering the $55 million of interest payments in the TTM period.

Unfortunately, across the whole company, net operating income for the TTM period was $79.1 million signifying that other capital resources are being spent on less productive initiatives. For the latest FY 2023, SG&A expenses were $154.8 million (+0.6%) but for the Q4 period they increased 24.1% YoY to $40.2 million.

The company’s growth initiative of the new fire retardant business, Fortress, contributed around $12 million to adjusted EBITDA, but as mentioned in the earnings release, that won’t get booked to earnings until the contract is done in FY 2024. In May 2023, the company signed an agreement for the 2023 fire season with the U.S. Forest Service (USFS) to provide products and services at up to five mobile retardant bases. This business achieved its first commercial sales in June 2023 with the first commercial drops of product in Arizona. In May, the company closed on acquiring the remaining 55% of Fortress not already owned. The final agreement with the USFS is not expected to be finalized until late December 2023 or early January 2024. I will be keeping an eye out for the results of this contract and how meaningful the growth will be from this new business.

The lithium growth initiative is where the trouble begins. Given the uncertain regulatory environment in Utah surrounding the extraction of Lithium from the Great Salt Lake, Compass Minerals suspended indefinitely further investment into the project. The company’s management stated they are committed to avoiding the use of common equity at the enterprise level and are seeking a partner to de-risk the project through the regulatory wait times. Compass Minerals already extracts multiple minerals through brine evaporation methods and lithium would only be another resource they would be extracting in the current process.

The halt of spending will take time as some parts of the project have services set to be delivered already in 2024. The lithium project will add another $25 – $30 million of capital needs in addition to $90 – 100 million of sustaining capital expenditures for the salt and plant nutrition business. Management laid these expectations out clearly in the Q4 earnings release.

Total capital expenditures for the company in fiscal 2024 are expected to be within a range of $125 million to $140 million. This includes between $90 million and $100 million in sustaining capital expenditures related to the core Salt and Plant Nutrition businesses. In addition, $25 million to $30 million of lithium-associated capital, principally related to “in flight” items ordered prior to the recently announced project suspension and scheduled to be delivered and installed in 2024, is expected to be deployed in 2024

– Fiscal Q4 and FY 2023 Results

The company’s core assets remain strong as this article will discuss, but whether they can generate the long-term returns needed for investors at today’s valuation is another question. With Salt doing the heavy lifting in Compass Minerals’ EBITDA let’s look at the remaining lifespan of the company’s most important assets; the main three salt mines in Goderich, Winsford, and Cote Blanche which make up 85% of Compass Minerals’ salt production capacity as of September 30, 2022.

The weighted average amortization period for the probable mineral reserves is 86 years for the leased portion as of September 30, 2022, and 35 years for the owned portion. Looking individually at the 2020 year mine life data when the company last gave the below table, with the production run rate assumption of 6.5 million metric tons, the Goderich mine (largest underground rock salt mine in the world) has a current mine life of approximately 81 years. On the smaller side of reserves, the Winsford mine (the largest dedicated rock salt mine in the U.K. with a 177 year history) only has a current mine life of approximately 26 years, and Cote Blanche has a lifespan of around 99 years.

A Profitable Core Business

Compass Mineral’s core salt assets have allowed the company to achieve an average return on equity and return on invested capital of 14.8% and 10.5%, respectively, since 2008. This average level of profitability is well around my rule of thumb seeking 15% ROE and 9% ROIC, but has significantly declined in recent years since the divestiture of the South American Plant Nutrition business in 2021. ROIC in the latest TTM period was around only 2.5% with the 2022 and 2021 years showing declines from much more acceptable highs of 7.4% in the 2020. The large ROE decline in 2021 is due to the $300 million impairment charge in 2021 which is not picked up in the still positive ROIC figure of 1.26% for that year.

The company lost significant top-line revenues after the 2021 divestiture of the South American plant nutrition business. SG&A expenses have not been cut to the same extent and have chipped away 1.7% in operating margins since. This is significant for a low-margin commodity business with operating margins of 6.6% in the latest year.

The company’s low profitability in recent years makes me wonder if Compass Minerals will be able to maintain its intrinsic value over a business cycle. The recent impairments highlight that question. The long life of the salt mine assets should allow some base in the Compass Minerals’ operations. We may be seeing the strength of this base now with the company spending cash flows from salt operations at a hefty rate on growth initiatives in lithium and the Fortress fire retardant business acquisition.

Cash Flows Going to Investment Spending

Compass Minerals has decent cash flows but the heavy spending has led to dividend cuts in recent years and equity issuances. For fiscal 2023, net cash used in investing activities was $173.0 million compared to $80.0 million in fiscal 2022. This includes the 2022 receipt of an additional $61.2 million in proceeds from the sale of the company’s South American chemicals business. Compass Minerals remains active on the portfolio management side since selling the South American Plant Nutrition business.

With average cash flows from operations of $114.2 million in the past 2 years, Compass Minerals’ spending on capex has been significant with $156.2 million (145% of CFO) spent in the latest 2023 fiscal year and $96.7 million (80% of CFO) in 2022. The average spending over the past 5 years has approximated 76% which would imply a low 3.0% free cash flow yield at the current $929 million market capitalization of Compass Minerals.

Earlier data from the 2019 – 2021 years before the spending spree began show lower capex averaging 51% of CFO. In this scenario, the FCF yield would be around a more reasonable 6.0%. However, I do not see this slowdown in spending coming anytime soon given management’s guidance, so free cash flows from Compass Minerals are not that impressive at today’s valuation.

Valuation Looks Expensive

Running the newly changed Compass Minerals through a discounted cash flow reveals a low-returning business that struggles to justify even a weighted average cost of capital of 7%. In order to get the valuation somewhat reasonable, I had to aggressively build in SG&A expense cuts of $10 million within a couple of years, give a 10% growth over the 5-year forecast period (terminal growth of 3%), and also lower capex spending towards the sustainable $90 – $100 million forecast by management in the latest release. The starting 2024 operating income is conservatively based on the average of the past two years’ operating income ($42.9 and $79.1 million) multiplied by the 10% growth rate. There are a lot of favorable adjustments to only give an intrinsic value of around $21.93 per share at the 7% WACC as can be seen below.

Interest Coverage Looking Slim

The low-returning recent ventures have added to debt capital requirements in the past couple of years. Interest coverage remains at a low 1.4x in the TTM period with operating income of $79.1 million and interest expenses of $55.5 million. Financial leverage is now back down to 3.5x after hitting new highs of 6.4x in 2022. The reduction in leverage is due to equity increasing to $517 million as of the latest Q4 September 30th year-end driven by the $240.7 million equity raise.

The company strengthened its financial position by issuing $240 million of capital last year along with a $75 million expansion of the revolver to $375 million and a $200 million Term Loan A issuance. Compass Minerals ended the fiscal year with $317.0 million of liquidity, comprised of $38.7 million in cash and equivalents and $278.3 million available on the $375 million credit facility. This is ample liquidity with the new share issuance but it needs to be wisely spent to get the ROIC back up to acceptable 9% levels.

In the near term, I would like to see Compass Minerals pivot and tighten up their spendthrift ways on the SG&A side and focus on milking the cash flows of the salt business. The halt in spending on Lithium projects should help force management’s hand in slowing things down and returning more cash to capital providers.

Takeaway for Investors

Compass Minerals has great cash flows from their core salt business but that segment alone cannot support the valuation with all the recent project expansions. A free cash flow analysis shows low expected yields around 3.0% with spending still trailing off with $20-30 million of scheduled lithium expenditures expected. More sustainable capex spending from pre-2021 years could indicate a 6.0% FCF yield.

Looking for a JV partner in the lithium business seems like a wise idea and should help slow the recent spending. The fire retardant business looks synergistic and promising, so I look forward to seeing what contract growth comes out of next season. Compass Minerals core salt business remains in tact with good liquidity but it can’t support the valuation, even today. I would like to see growth initiatives hit the income statement and if not soon, SG&A costs should reflect a smaller business in the near term.