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No Salt in Compass' Wounds

Jeremy Glaser
Elizabeth Collins, CFA

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. Despite some near-term headwinds, we still think that Compass Minerals represents a good long-term value for investors. I'm here with Elizabeth Collins, director of basic materials research, to take a closer look.

Elizabeth, thanks so much for talking with me.

Elizabeth Collins: Thanks for having me, Jeremy.

Glaser: So let’s take a look at Compass first. I know that there have been some weather events that have had a big impact on the stock recently. Can you walk through what those are and why investors are concerned?

Collins: Sure. So a small part of Compass Minerals’ business is the production of sulfate of potash specialty fertilizer from the Great Salt Lake in Utah. And the firm uses a solar evaporation process there. And last spring, there was more rainfall than was typical. It was extraordinarily too much rainfall, and that impacted Compass' harvest of brine from the Great Salt Lake. And that's depressing production volumes and increasing operating costs for the next several years because of how long that production process is. That's one hit to earnings.

The second thing that happened last year was that a tornado hit the firm's Goderich mine in Ontario, and that's hurting production and costs this year. That mine produces highway deicing salt, which is the bigger part of Compass' business.

The third thing that happened last year and early in 2012 was that we had extremely mild winter weather. Anybody who lives in the Midwest can tell you that they didn't shovel their driveway that much last year, and they didn't see too many salt trucks deicing roads. Although it was good for consumers because they didn't have to shovel their driveways, that's bad news for Compass, which sells highway deicing salt. The risk there is that the high inventories in the system for producers of highway deicing salt will lead to lower prices next season, and that's the key uncertainty that we're looking at for Compass in the near term.

Glaser: Have these near-term events, however, affected the competitive advantages of the firm in any way?

Collins: I don't think so. I think that long term, we should think about how the business should perform under normal weather conditions, and in that case, if we have normal rainfall at the Great Salt Lake then the harvest should be good and Compass should be able to leverage that low-cost asset. In the Great Salt Lake, the firm is using solar-evaporation process, which is the lowest-cost method of producing sulfate of potash in the world. That's a really strong competitive advantage for Compass going forward.

At the Goderich mine, the tornado damage is behind the firm, and Compass is wrapping up the repairs from that. And longer term, the firm has expanded capacity there and will be able to grow into that expanded capacity and really see the benefits of that low-cost production that it has because the Goderich mine is the largest rock-salt mine in the world. So while there is near-term concern, I don't think that its business is impaired long term.

Glaser: It sounds like that wide moat is very much intact. Let's take a look at valuation then. You know it's not very usual to get a big discount on a wide-moat company. What do you think about the stock at the levels today?

Collins: I think it's trading at roughly a 20% discount to my fair value estimate, and I think that, like you said, it's a wide-moat company, so it's hard to find it on sale very often. It could get cheaper in the near term as the full effects of last year’s winter weather play out, but I think for long-term investors, this is a good opportunity to buy a high-quality company at a discount to our fair value estimate.

Glaser: Other than weather, are there other risks that people should keep in mind before jumping in?

Collins: I think that one of the main uncertainties is the long-term outlook for sulfate of potash specialty fertilizer. While highway deicing salt prices don't vary too much from year to year or over the long term because of favorable contract negotiations and the oligopolistic nature of the markets that Compass serves, sulfate of potash is much more of a commodity where there can be wild swings in prices. So longer term, that is one of the key uncertainties, but we think that Compass’ low-cost advantage should help it weather any downturn in prices more than its competitors.

Glaser: Elizabeth, thanks so much for the update today.

Collins: Thank you.

Glaser: For Morningstar, I'm Jeremy Glaser.