The Mining Report: The United Nations recently raised population projections based on increased births in industrialized nations, and has said that it expects 8 billion people to be on the planet by 2050. Is this good news for agriculture and fertilizer companies?
Spencer Churchill: Population growth is a positive long-term driver for agriculture and fertilizer companies, and this has been one of the key arguments for many years in favor of investing in these stocks. That said, the market is more concerned with changes in the near-term fundamentals (grain and fertilizer prices, inventories, geo-political events, macro-economic factors etc.) and we believe the long-term argument has lost some weight in the minds of investors, partly because it is repeated so many times and referred to during periods of underperformance.
TMR: Will some types of companies in some places do better than others? What is your litmus test for picking companies?
SC: Our litmus test for picking companies is a combination of financial health (solid balance sheet, track record of profitability in different environments), strong management, positive macro trends and valuation (trading in line or at a discount to peers/historical average).
More people eating more and eating better should lift all boats in the space, but there are definitely times in the cycle when some will outperform others. A good example of this is the current situation in the agricultural equipment market. While sales of big ticket items like tractors and combines have been hit hard with the drop in grain prices and decline in farmer sentiment and spending, some companies in the equipment space have prospered. For example, Ag Growth International Inc. (AFN:TSX) sells lower-ticket equipment that is essential to farm operations and that must be replaced regularly. One of the primary drivers for the company is corn volumes in the U.S., which have reached record levels two years straight. Lower corn prices have resulted, but this is a positive for Ag Growth. Farmers are more reluctant to sell at depressed prices, which increases the need for on-farm storage capacity. Ag Growth is a player in that space as well, and will be a much larger one with the proposed acquisition of Vicwest's Westeel division.
TMR: Could reports of a giant sinkhole under a potash mine in Russia bring potash commodity prices up, at least short term?
SC: While there is still uncertainty around the final outcome of this event, Uralkali (URKA: LSE) recently indicated that the sink hole has increased in size to 50–80 meters (from 30–40 meters) and that there is a high probability the mine could be a complete loss (according to the director of the Mining Institute of the Urals Branch of the Russian Academy of Science). Given the size of the mine (~3.5% of global capacity), the increased likelihood it will be at least shut down for many months and the potential the flooding spreads to the second mine (~1.5% of global capacity), we believe the event should support potash prices in the near term.
TMR: What potash companies could be poised to take advantage of future price increases?
SC: Those with the greatest exposure to potash would benefit most: 50% of PotashCorp.'s (POT:TSX; POT:NYSE) gross margin is generated from potash, Intrepid Potash Inc. (IPI:NYSE) has 100% exposure to potash in the U.S., The Mosaic Co. (MOS:NYSE) revenue is derived from around 40% potash and Agrium Inc. (AGU: NYSE) is the lowest with around 5% potash.
TMR: IC Potash Corp. (ICP:TSX; ICPTF:OTCQX) just announced $10 million ($10M) in funding from Cartesian Capital Group. How has it said it will use that money to add value?
SC: The money raised from Cartesian will be used for general corporate purposes and, to a lesser degree, to advance the Ochoa project. The value was not so much in the amount raised (they will need $1B+ to fully fund the project), but in the nature of the investment and the implied public company valuation. Cartesian invested at the project level, marking the first time we've seen a junior in the space get financing in this manner. All the other strategic investments came at the public company level and were generally highly dilutive and, in some cases, came with warrants. The 7.8% interest Cartesian could own of the project implies a project value of $130M against the market cap at the time of ~$40M. Had IC Potash raised $10M at the public company level (priced at $0.24/share, the previous close) Cartesian would have owned ~20% of the company and project. Hence, IC Potash effectively raised $10M at the public company level priced at about $0.75/share, or a 200% premium. We believe IC Potash is Cartesian's first junior resource, non-operating company investment, which speaks to the strategic value of the project. In addition, given the relatively small size of the investment (for Cartesian), we would expect it should be a further source of funds going forward.
TMR: Funding is always a challenge for juniors. You follow Input Capital Corp. (INP:TSX.V), which is a unique agricultural streaming company. Can you explain the value proposition for investors?
SC: Input Capital is a small cap in the space, but not a junior. The company is not exploring or developing a fertilizer deposit. Input provides capital to canola farmers in Canada in exchange for a stream of canola production, which Input then sells into the market.
"More people eating more and eating better should lift all boats in the space, but there are definitely times in the cycle when some will outperform others."
Like other royalty companies, the attraction is the very high earnings leverage these companies can produce (EBITDA margins of 90%+), given the relatively low headcount required and the growing recurring revenue base generated as capital is deployed. Input is unique in that it generates revenue from its contracts in year one, with no waiting for a mine to be built, concerns about capital expenditure, mineralogy etc. like with the precious metal streamers. There is much less concentration risk; the company already has 20 customers and is growing. And by reinvesting the cash flow from current contracts, Input can grow the business 25–35% a year without having to raise new capital. Input is the first company to attempt this business model in the agricultural space and the founders have a great pedigree. They founded and grew Assiniboia Farmland LP, which sold for $128M in December 2013.
The biggest risks are with the commodity price (the company does not hedge) and Input's ability to continue to deploy more capital to meet the market's expectations for growth. Input is one of our favorite names in the space.
TMR: Thank you, Spencer.
Spencer Churchill has been working in the investment industry for 15 years. Prior to joining Paradigm, Churchill worked as a sellside research analyst at CIBC and Clarus Securities, with coverage areas including agriculture, clean technology, special situations, software and wireless technology. Churchill also spent two years working as an associate portfolio manager at a hedge fund in Toronto.
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1) JT Long conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report, The Life Sciences Report and The Mining Report, and provides services to Streetwise Reports as an independent contractor. She owns, or her family owns, shares of the following companies mentioned in this interview: None.
2) Spencer Churchill: I own, or my family owns, shares of the following companies mentioned in this interview: None. I personally am, or my family is, paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: Input Capital Corp. and Ag Growth International Inc. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I determined and had final say over which companies would be included in the interview based on my research, understanding of the sector and interview theme. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview. Paradigm Capital Inc.'s disclosure policies and research distribution procedures can be found on our website at: http://www.paradigmcapinc.com/documents/show.php/10016
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