RBC RBC Dominion Securities analyst Andrew Wong is anticipating “mixed” second-quarter results from North American fertilizer producers, noting “nitrogen and phosphate prices that performed better than expected, but producers likely only partially benefited given forward sales (mainly nitrogen) and production issues (mainly phosphates), while potash prices drifted lower.”
“Crop prices also declined, pressuring farmer profitability and fertilizer affordability,” he added. “We think the sector will likely need positive catalysts to move equities higher in the near-term. Key factors to watch over the next 3 months — crop prices (U.S. crop conditions, yields, acreage), potash market reaction to India/China contracts, European natural gas (which sets nitrogen marginal cost), and Chinese phosphate export pace.”
In a report released Monday, Mr. Wong said he sees a “favourable upside/downside” for Saskatoon-based Nutrien Ltd. , citing a retail recovery and limited downside. However, he reduced his valuation multiple to reflect lower free cash conversion.
“We think Q2 should be in-line with consensus given a solid North American Spring season, while the Retail segment is on-track for margin improvements and potash prices have bottomed,” the analyst said. “However, softening ag fundamentals may weigh on sentiment and limit upside. Going forward, we see a favourable upside/downside return profile while the company generates solid cash flows that support the dividend with excess cash available for moderate growth and buybacks.”
His lower valuation for Nutrien stems from lower cash conversion, which he thinks is weighing on its valuation.
“We think cash conversion has declined due to several factors – higher sustaining capex due to inflation, higher finance costs resulting from higher interest rates, and rising working capital,” he said. “At the recent investor day (note), Nutrien highlighted plans to raise operating cash flow and optimize working capital, which we think will help, but inflationary pressures and higher rates remain a drag. As such, we have lowered our SOTP [sum-of-the-parts] valuation multiple to 6.6 times, from 7.2 times.”
Maintaining his “outperform” recommendation for its shares, he cut his target to US$60 from US$70. The average target is US$66.03.
“We believe the company has built the most diverse, vertically integrated agricultural input business with an attractive earnings profile, growing free cash flows, and solid balance sheet,” said Mr. Wong.