An Investment Grade Credit at Junk Prices

Jeremy Glaser: For Morningstar.com, I'm Jeremy Glaser.

I'm joining today with Elizabeth Collins and Dan Rohr. They're both basic materials equity analysts, and we're going to talk little bit about Compass Minerals and see if the bonds are attractive for potential investors today.

Elizabeth, Dan, thanks for talking with me today.

Elizabeth Collins: Thanks, Jeremy.

Glaser: So, let's talk about Compass a little bit as a company first. What kind of competitive advantages do we think it has?

Collins: That's a really good question, Jeremy. So Compass produces highway deicing salt and specialty fertilizer, and we think that they have a wide economic moat, because they have two world-class assets that allow them to produce these commodities at a lower cost than most of their competitors.

They have the Goderich rock salt mine in Ontario, which is one of the world's largest, which gives them some scale advantages. They also have some transportation advantages there, which allows them to deliver salt to their customers at a lower cost.

They also have the Great Salt Lake production facility in Utah for the production of sulfate of potash specialty fertilizer. Because they use solar evaporation as opposed to the chemical manufacturing processes that most of their competitors use, they have lower cost there as well.

Glaser: So it sounds like a business that has a lot of competitive advantages, but Dan, I know lot of the rating agencies rate it as junk credit. Why do you think that is?

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Daniel Rohr: Well, I'm not going to go ahead and speculate on what they are thinking over there, but you're right. Do you view Compass as a speculative grade credit, which may be one of the reasons why Compass' bonds trade in the junk territory.

Now we view Compass as a borderline investment-grade credit. We rate the issuer BBB minus. It's that difference of opinion when the agencies and the market perceive a company as speculative grade, and we perceive them as investment grade that you can get an investment opportunity. So getting investment grade quality at junk prices. Not quite finding a Monet at a garage sale, but you get the idea.

We think there's a few factors that make Compass an investment grade issuer. First, leverage and coverage. In contrast to say a few years ago when they were just coming out of whole LBO ordeal, leverage and coverage are pretty good. For 2010, which isn't going to be a very great year for Compass, we expect leverage to be around two times EBITDA, and interest coverage to be over 10 times, so those are pretty good numbers for a BBB minus issuer.

Second and probably most important in supporting our investment-grade rating on these guys is what Elizabeth just talked about, and that's competitive advantage. And this notion of being a low-cost producer in a commodity product is of crucial importance when you're thinking about the credit quality of a bond. Commodity prices can be extremely volatile, but we would expect Compass' enviable position on the industry cost curve is going to dampen some of the ill effects that weak pricing might have on the balance sheet.

Glaser: Does that mean that there is any opportunities in specific bonds right now?

Rohr: Yes, so Compass has one publicly traded issue out there; 8% notes due in 2019. They typically trade around 450 to 500 basis points above comparably-dated Treasuries, which is quite a bit wider than where you typically see the average BBB minus bond trade, for which around I'd say is around 230 basis points. So you're looking at about 250 basis points in additional value so to speak.

Now, that said, there are couple things that are worth noting when we're looking at those spreads. The first is that there is a lot of bank debt in the capital structure that sits ahead of these bonds. So consequently, we demand a little bit more spread in turn for sitting a little bit lower, junior, in the capital structure.

Second, these are fairly illiquid bonds. They don't trade everyday, and as a consequence we'd want to be compensated for that illiquidity.

But even despite those two somewhat negative factors, we still think the bonds look like a compelling opportunity at prevailing prices.

Glaser: That sounds great. Dan, Elizabeth, thank you for taking the time today.

Collins: Thanks, Jeremy.

Rohr: Thanks.

Glaser: For Morningstar.com, I am Jeremy Glaser.