AAA vs WPX vs KRN
Aug 26 2013, 09:43
Charles Lemieux
Disclosure: I am long KRLTF.PK. (More...)
What's going on with potash
We all pretty much know the story by now. On July 30, Russian potash supplier Uralkali announced that it wanted out of the BPC (Belarusian Potash Company), a joint-venture created by the latter and Belaruskali to export their potash fertilizers. This had the effect of a bomb in the stock markets. The news created a going concern about future potash prices; and god knows markets hate wavering. On July 30, producers Potash Corp (POT), Intrepid (IPI), Mosaic (MOS) and Agrium (AGU) lost 16.54%, 28.54%, 17.67% and 5.39%. According to Uralkali, the commodity could drop below 300$ per tonne. BPC, along with Canpotex (joint-venture between Potash, Mosaic and Agrium), control nearly 70% of the potash market. By collaborating together, they were able to control the output and, ultimately, influence the price of the commodity. Uralkali said it would increase production from 10 million tonnes per year to 13 million tonnes per year and export the potash itself. Markets fear that future potash offer exceeds demand. This could result into a dramatic price cut into the commodity; high cost producers would struggle to survive. This article has no intention of predicting future. I won't try to convince anyone that Uralkali may join back the BPC or that its decision to exit the cartel doesn't change global potash market fundamentals. The purpose of this article is to demonstrate that Uralkali's announcement on July 30 possibly created an interesting investment opportunity among junior potash plays.
What does that mean for juniors
A lot of potash juniors are sitting on good projects. Most, such as Allana Potash (ALLRF.PK), Western Potash (WPSHF.PK) and Karnalyte Resources (KRLTF.PK), already completed a feasibility study and are almost ready to go into production. Stopping them is the high upfront costs associated with the construction of a mine. Raising capital under good conditions in the pre-collapse potash market was already harsh; we can image how difficult it must be these days. Needless to say, the stock price of all of them pretty much crashed following Uralkali's announcement. Some took a bigger hit than the others. It's the case of Karnalyte Resources, which lost 66.6% of its market cap since July 23 (as of Aug.22). Interestingly, as illustrated in graph #1, Karnalyte was one of the market's favorite potash play among juniors before the crash. Fundamentals about the project haven't changed. Compared to its peers, its current valuation makes no sense at all.
Graph #1 : Look how the drop in Karnalyte on July 30 made no sense since it was a star performer before.
(click to enlarge)
Source : Market data from TMX and Google Finance
All three projects have completed studies confirming very strong economics. As you can see in table #1, Karnalyte's operating costs are higher than its peers. In a wavering potash market, it is normal the market discounts this fact. But keep in mind that potash prices still have a long way to go in order to reach sub 200$ levels.
Table #1 : Economic metrics for Karnalyte, Allana and Western
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Source : Company presentations (Aug.2013 for WPX and AAA, June 2013 for KRN) and Karnalyte's feasibility study, SEDAR, July 19 2012, p.211.
Below are a few reasons why I think that Karnalyte is still one of the most undervalued junior potash play of the moment. Global potash industry may be changing, but I think Karnalyte has the resources needed to survive the transition and one day, become a producer.
1. It has an incredibly strong cash position
Working capital as of July 30th is 55 654 143$ (of which 56 224 956$ is cash, as illustrated in graph #2). On March 7, it closed a non-brokered private placement with Gujarat State Fertilizers & Chemicals (GSFC). GSFC took a 19.98% stake in Karnalyte in exchange for 44.7M$, valuing the company at 223.73M$ (as of Aug.23, it is down about 75.7% on its investment) . This investment also came with an off-take agreement for 20 years, starting with 350 000 tonnes of potash/year when phase 1 rolls out and 600 000 tonnes of potash/year when phase 2 commences. The company is a major player in the fertilizers market in India. This, in my opinion, gives a lot of credibility to Karnalyte's project. It is great that it closed that financing round when potash market fundamentals were good. It issued the shares at a great price (8.15$). The company now has the time to wait for the potash market to recover; let the dust settle.
Graph #2 : Cash on hand as of July 30 for Karnalyte Resources / Western Potash and as April 30 for Allana Potash
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Source : interim financial statements for Karnalyte Resources (June 30 2013), Allana Potash (April 30 2013) and Western Potash (June 30 2013)
2. Grab the project for free… it's trading below cash value
By deducting working capital from the market cap, the market implies a negative project value (-1 800 000$ as of August 23). Project values implied for Allana and Western are both positive at 115 554 139$ and 62 683 243$. As illustrated in graph #3, before Uralkali's announcement, implied market value for Karnalyte's project was about 99 602 263$. Allana's was 141 861 136$ and Western's 75 131 726$. As of August 23, the drop in the implied value of the project has been of 102% for Karnalyte and only of 19%/17% for Allana and Western (graph #4). Those are stunning metrics because as illustrated in graph #1, the company was a star performer before July 30. In a press release dated August 9th 2013, Robin Phinney (Karnalyte's CEO) confirmed that the company is « not aware of any material undisclosed information that may be contributing to the recent decrease in market price and level of trading activity of its shares ».
Graph #3 : Comparing the market cap with the implied value of the project for Karnalyte Resources, Allana Potash and Western Potash (as of July 29, before Uralkali's announcement)
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Source :interim financial statements for Karnalyte Resources (June 30 2013), Allana Potash (April 30 2013) and Western Potash (June 30 2013). Market data from TMX
Graph #4 : Comparing the market cap with the implied value of the project for Karnalyte Resources, Allana Potash and Western Potash (as of August 23, after Uralkali's announcement)
(click to enlarge)
Source :interim financial statements for Karnalyte Resources (June 30 2013), Allana Potash (April 30 2013) and Western Potash (June 30 2013). Market data from TMX
3. CEO has massive skin in the game
Table #2 : CEO ownership for Allana, Karnalyte and Western
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Source : SEDI, as of August 23 2013
On a non-diluted basis, Karnalyte's CEO Robin Phinney owns 14.60% of the outstanding shares of the company. He has massive skin in the game. From January 10 to August 23, the value of his shares went down by 26 120 783$. Believe me; he must have cried his losses just as much as any other shareholder. I am quite confident the company will find a way to maximise shareholder's value in the near future. As people say in the stock market, you lost nothing until you actually sold.
4. It aims to ramp-up production gradually. This means lower initial capex.
Karnalyte's bankable feasibility study considers an initial production of 625 000 tonnes of potash per year. This means lower initial CAPEX than Western, which seem to aim at starting production of massive quantities as soon as possible. The cost of building the mine for phase 1 is estimated at 626M$. This means it could be easier for Karnalyte to raise the funds needed to proceed with the project. Free cash flows generated by phase 1 will then be able to help funding phase 2, and so on. According to their feasibility study, phase 1 (625 000 tonnes/year) could start as soon at 2015, phase 2 (1 375 000 tonnes/year) in 2016 and phase 3 (maximum capacity, 2 125 000 tonnes/year) in 2018. Recently, Karnalyte hired BNP Paribas and Natixis to underwrite a senior secured project finance facility of up to 300M$ US. That means it would only need to raise another 271M$ in order to proceed with phase 1. With the current stock price, it would be surprising the company try to do a public offering in order to raise the additional capital. Dilution would be massive and not in shareholders interest. I think the company will wait for the potash market to calm down and gain back some popularity or try to find a partner. As mentioned, it has the cash to wait for the right moment to proceed with the project.
5. 300$ potash prices won't be a problem
In a market where future potash prices are more than ever uncertain, it is logical for an investor to want to invest into the lowest cost producer/junior possible. Based on my analysis of the numbers contained in the feasibility study published on July 19 2012 (p.230), Karnalyte could be profitable at 300$ potash prices. The break-even point for phase 1 (625 000 tonnes production capacity) could be as low as 184.72$/tonne of potash. At 300$, Karnalyte could generate EBITDA of more than 72 000 000$ in 2015. While Karnalyte is not as low cost as Allana or Western, their cost structure is very reasonable and it would take a massive drop in potash prices to turn their project unprofitable.
Table #3 : EBITDA at different potash prices and prices to break-even
Source : Karnalyte Feasibility Study, July 19 2012, SEDAR, p.230.
6. With a low burn rate and tons of cash, it can wait for better potash market conditions without dilution
Assuming no financing and investing activities, it is possible to estimate how much time a company can survive based on its burn rate and current cash on hand. Note that these are estimates and based on my interpretation of the data, assuming cash flows using in operating activities will be the same as now for the years to come.
Table #4 : Estimated burn rates assuming no financing or investing activities
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Source :Source :interim financial statements for Karnalyte Resources (June 30 2013), Allana Potash (April 30 2013) and Western Potash (June 30 2013)
As you can see, Karnalyte could theoretically stay in « stagnation mode » for 11.13 years. If it wishes, it could wait for better potash market conditions before going ahead with the project. I see no dilution in the short term.
7. It has a tight share structure
Table #5 : Share structure and average trading volume
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Source : Stockwatch and Google Finance
With 27 479 010 shares outstanding, Karnalyte has significantly tighter held than Allana and Western. With an average of 130 539 shares changing hands each day on the TSX, the stock is also less liquid than its peers. It may actually be the reason behind the large drop in the share price occurred recently. When people with big positions want out no matter what and only a few people at once want to buy the shares, a massive drop can happen (because the stock is not very liquid). If that's what happened, I would expect a correction soon.
8. It also has a magnesium compounds project to sweeten the deal
While Karnalyte is focused primarily on potash, they also have plans to market the magnesium salt produced during the mining process. Based on their feasibility study available on SEDAR, CAPEX for this project is estimated at 155 980 000$. NPV of 262M$ (11% discount rate) and IRR of 34.6% (after tax). This means possible additional cash flows.
Conclusion
Want to grab a piece of what could be a future potash producer? In my opinion, Karnalyte Resources is the way to go. The recent drop in share price of more than 66% is, in my opinion, hardly justified. In my opinion, comparing Karnalyte to its peers shows its current situation is superior in various aspects. The project, while starting with fewer production than its peers, has a lower CAPEX. Owning 14.60% of the shares outstanding, it makes no doubt in my mind that the CEO is dedicated to this project and has shareholders interest in mind. With 300$ potash prices, my analysis of the feasibility study indicates they would still be profitable. In fact, if my interpretation of the data is correct, potash prices could fall as low as 200$ and they could still turn in a profit.
Thanks for reading and feel free to comment. Keep in mind data has been transcribed from financial statements into Excel in order to facilitate processing. While I have double checked myself, there may still be mistakes.
https://seekingalpha.com/article/1656652-karnalyte-resources-a-junior-potash-play-trading-below-cash-value