Q2 2020 earnings are all-round much better than expectations
- Mosaic’s Phosphates segment has benefited from lower cash costs, which is anticipated to sustainably improve its gross margin.
- Phosphates market guidance is much better on improvement in the demand-supply perspective.
Q2 Non-GAAP EPS of $0.11 beats by $0.12; GAAP EPS of $0.12 beats by $0.17. Revenue at $2.04 billion though down 6.4% YoY beat estimate by $200 million. Further, adjusted EBITDA margin of 18.8% beats consensus of 15.3%.
Chart 1: EBITDA Segment Contributions
Source: Author’s analysis based on Mosaic’s Q2 2020 Performance Data
Chart 1 shows the EBITDA contributions by segment. Q2 adjusted EBITDA has improved from $234 million to $383 million i.e. by $149 million. Out of this, $96 million or 64% has come from Phosphates. Fertilizantes EBITDA (dominated by Phosphates) has soared by $41 million. Therefore, Phosphates is the key story here. Looking into the details, EBITDAs of all the three segments i.e. Phosphates, Potash and Fertilizantes have improved. Higher volume was a common theme in all three segments. Overall Q2 2020 volumes rose 28% QoQ. Phosphates portrayed a 16% surge in sales volumes and 7% higher average price. Potash average price was lower by 7% even though volumes soared 35%. Fertilizantes sales volumes were up 23% while prices decreased 13%.
60% of the margin improvement in the Phosphates segment has come from the cost side
The second key driver for Mosaic’s earnings in Q2 2020 was lower cash costs, which improved margins, even though the product price trend was divergent among segments. The most significant surprise was that Phosphates gross margin has turned positive for the first time since Q1 2019 (see Chart 2).
Mosaic’s Q2 2020 Management Commentary talks about the Phosphates segment:
“Cash conversion costs in the quarter were $59 per tonne, down from $67 per tonne in the first quarter, as the Phosphates segment’s operating rate returned to more normal levels.”
Further, the Q2 2020 Earnings Press Release states:
“Phosphates gross margin per tonne improved to $7 from negative $7 and adjusted gross margin per tonne to $12 from negative $5 in the same period a year ago as strong volumes, lower raw material costs and production cost improvements, overcame finished product price declines.”
On a QoQ basis, Phosphates segment’s gross margin per tonne improved by $52. In our view, this is largely sustainable and very significant. Average phosphates product price was up by $21 per tonne and cash conversion costs were lower by $8 per tonne. Cumulatively this is about $30/tonne. The remaining $22 seems to be coming from the effect of economies of scale, internal efficiencies and ongoing cost rationalization. Cash costs have declined on the back of lower energy prices. US mined rock costs are flat QoQ but down $4/tonne in Q2 2020. Overall, this means that almost 60% ($30 out of $52 per tonne) of the Q2 Phosphates margin improvement has come from the cost side. Potash also saw a $5/tonne reduction in cash costs. As MOP prices were lower, this restricted the decrease in per tonne gross margin to $6. In Fertilizantes the trends were mixed. Though realized prices were lower. Decrease in BRL phosphate cash conversion costs improved gross margin.
Phosphates market will be much tighter with 2020 market deficit estimated to be 1.3 million tonnes
Mosaic has guided that the Phosphates market will be much tighter than previously estimated. Market deficit in 2020 is estimated to be 1.3 million tonnes (Chart 3).
Chart 3: Phosphate Supply/Demand Changes
Source: Mosaic Investor Relations, August 2020 Market Update
This is attributable to three reasons:
- Lower China exports to the tune of 0.6 million tonnes. Yangtze River flooding situation has constrained supply.
- Producer and COVID-19 curtailments cumulatively amounting to 1.4 million tonnes.
- Demand recovery of 0.6 million tonnes. This is coming from India emanating from low domestic inventories.
Phosphates are already seeing a price recovery. DAP recovered strongly from its 2019 lows during Q1 and Q2 2020. This is also reflected in the reversal of NOLA discount to international benchmarks. Nitrogens i.e. Urea have started to see a rebound on lower supply from China and impact of the India tender. The Potash market is projected to be balanced, which is expected to lead to stable industry operating rate. In any case, the Potash price environment is still lackluster. MOP NOLA is down 18% YTD with a fresh wave of weakness during Q3. Mosaic’s management has guided for an improved fertilizer sector outlook. In our view, agricultural commodity prices are selectively improving and upside from here is contingent on Chinese demand and broader global recovery. In the short to medium term and talking specifically about Phosphates, we see a stable to gradual firming-up price trend for both DAP/MAP.
We upgrade Mosaic on the back of structural improvement in the Phosphates segment
Mosaic’s Potash segment was delivering positive margin even in the dull price environment. Fertilizantes was also making money as indigenous market conditions in Brazil lent support to demand and the cost side. We have been bearish on Mosaic because of Phosphates. Our concern was that prevailing average DAP/MAP prices remained 20-25% below 2H 2018/ H1 2019 average levels, thereby precluding meaningful positive cash flows generation for the segment. However, in the aftermath of Q2 results, we upgrade Mosaic. It is just not that earnings were above expected. We see structural improvement in Mosaic’s Phosphates segment that was struggling since Q2 2019. The dramatic shift in Q2 is that almost 60% of the margin improvement has come from the cost side. This means that Phosphates margins are sustainable even in a flat product price environment. The key thing here is that Mosaic’s operating levels across-the-board are elevated. Q2 rates for Phosphates, Potash and Fertilizantes (phosphate) were at 85%, 91% and 88% respectively. We believe these operating rates will persist given an encouraging demand-supply outlook for both Potash and Phosphates. Mosaic’s stock has been outperforming peers since Q2 and has rallied heavily post the results announcement. Having said this, Mosaic is poised to take advantage of favorable market conditions. This is given the tremendous favorable sensitivity of Mosaic’s EBITDA to change in fertilizer prices. Q2 2020 management guidance estimates the annual EBITDA impact for a $10 change in MOP and DAP price at $55 million and $95 million respectively. We believe that Mosaic will be able to generate quarterly EBITDA in the range of $420-460 million range. Mosaic is moderately placed from a relative EV/EBITDA perspective. Though we continue to like Nutrien (NYSE:NTR) and CF Industries (NYSE:CF), we are of the view that the ongoing fundamental improvement in Phosphates will drive Mosaic’s stock to $20 over the next two to three months.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.