Take This Stock with a Grain of Salt

03/04/2010 11:57 am EST


Josh Peters

Editor, Morningstar DividendInvestor

Josh Peters, editor of Morningstar DividendInvestor, likes everything about salt producer Compass Minerals except the share price. Wait for a correction.

Salt is a commodity product—there’s little product differentiation, and industry players compete on price. But Compass Minerals International’s (NYSE: CMP) world-class rock salt mines in Goderich, Ontario, Cote Blanche, La., and the United Kingdom, plus access to water transportation systems, give the company the ability to produce and deliver highway deicing salt cost-effectively.

Compass also produces sulfate of potash, or SOP, a specialty fertilizer that improves the yield and quality of high-value crops. Favorable long-term trends point to SOP prices above historical averages.

As world population grows, the amount of arable land per person decreases. Increasing personal income levels in developing countries are driving people to change their diets. Finally, high crude-oil prices and political considerations have motivated countries to encourage biofuel production. Compass’s energy-efficient Great Salt Lake solar evaporation facility gives the firm an edge in the production of SOP.

We believe the geologic advantages of Compass’s facilities endow the firm with a wide economic moat, but there is always the possibility of irrational pricing or substitutes for highway deicing salt. While Compass’s results will fluctuate from year to year on the basis of winter weather, we expect long-run demand for highway deicing salt to reflect normal weather patterns.

We also note that SOP, which accounted for about one-fourth of 2009 profits, has experienced rapid price fluctuations. That said, favorable long-term trends in agriculture globally lead us to believe that SOP prices will continue providing attractive margins and returns on capital for Compass.

Compass’s dividend-paying capacity has improved substantially since 2005: Earnings have more than doubled, total debt has declined, and operating profits now cover interest charges by more than ten times. While weather and commodity price fluctuations will continue affecting Compass’s yearly profits, a 27% payout ratio gives such variations with a wide berth.

Demand for salt typically rises about 1%–2% a year, along with price increases approximating inflation (3%–4%). This gives the company a natural growth rate of 5% while generating free cash flow well in excess of dividend payments. While growth-boosting share buybacks are a long-run option, these resources are currently devoted to expanding capacity for both deicing salt and SOP.

Given these assets’ inherent cost advantages, we expect profitable sales growth as a result. Overall, we think Compass is capable of dividend increases averaging 10% a year, and this year’s hike (after a spell of more modest growth) suggests future dividend growth will reach this range.

Though our dividend forecast and a current yield of 2.2% suggest annual total returns averaging around 12%, the heavy reliance of this total return profile on capital appreciation prompts us to require a good-sized margin of safety when buying for income.

A 9.9% dividend hike put Compass Minerals back in my good graces—but with a yield far short of what I’m seeking these days, I wouldn’t buy above $61. (Compass's shares closed Wednesday at $75.90—Editor.)

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