Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking two high-profile Wall Street picks and putting them under the microscope...
It's been more than a year now since Potash Corporation of Saskatchewan (NYSE:POT) announced plans to buy one of its biggest rivals, fertilizer producer, wholesaler, and retailer Agrium (NYSE: AGU). Now, at long last, the merger process is drawing toward a close. It's likely that any day now, we could see the birth of a true giant of agriculture, as both companies merge to form a new fertilizer company to be known as Nutrien.
TD Securities thinks you should buy in before that happens. Here's why.
Buy Potash or Agrium... or buy Potash and Agrium?
In twin upgrades this morning, Canadian investment banker TD Securities suggested investors interested in owning Nutrien stock once this merger closes should do equally well buying either Potash or Agrium stock.
One year after this merger was first announced, TD Securities advises that we're entering the homestretch now, with Potash and Agrium cooperating with the U.S. Federal Trade Commission to iron out the last few details of the merger, aiming to preserve competition in the fertilizer sector. As TD explains in a note covered by StreetInsider.com (requires subscription), to get the merger done, Potash and Agrium will probably have to divest "two Agrium U.S.-based plants with capacities of ~170,000" tons per year of fertilizer production. Additionally, the analyst notes that Chinese and Indian regulators will probably want Potash to sell off "certain ... minority ownership interests" in their own companies before they sign off on the merger.
What will investors end up owning?
Once the merger is finalized late in Q4 of this year, it should leave Nutrien as a somewhat smaller business than the one investors were promised in the merger announcement last year. Instead of a business generating $20.6 billion in annual sales, and producing annual earnings before interest, taxes, depreciation, and amortization (EBITDA) of $4.7 billion, Nutrien will both sell, and earn, something less.
Regardless, TD sees the merger as still positive for investors. For one thing, divesting businesses will raise cash (perhaps $6 billion from selling the Indian and Chinese minority interests alone), resulting in a Nutrien carrying less debt than it would otherwise have. Also, a combined Potash and Agrium should be able to produce "steady" free cash flow "at current nutrient prices" -- perhaps as much as $3.17 per share -- says the analyst.
The big questions -- and answers
Of course, this immediately raises the questions of how many shares are we talking about here, and how much cash will the whole company be churning out?
Here's my best guess: At last report, Potash had 840.2 million shares outstanding (per data from S&P Global Market Intelligence), and Agrium had 138.2 million. According to the companies' merger plan, Potash is to convert its shares into Nutrien shares at a 0.4:1 ratio, while Agrium stock will convert at a ratio of 2.23:1.
A bit of quick calculator work thus provides our first answer: Nutrien will emerge from this merger with approximately (336.1 million shares from Potash plus 308.2 million shares from Agrium equals) 644.3 million shares outstanding.
And accordingly, our second answer is that, at TD Securities' estimated $3.17 per share in free cash flow, a combined Nutrien will be generating cash profits of roughly $2.04 billion annually.
How much should you pay for that today?
Now, assuming my math is right, that's actually quite a bit less than the $2.5 billion in free cash flow that Agrium ($641 million) and Potash ($1.896 billion), combined, produced over the past 12 months. What's more, TD Securities argues that achieving even this diminished level of cash profitability will require Potash and Agrium to successfully extract $500 million worth of "synergies" from their combination.
Should these "synergies" fail to appear, it would imply that Nutrien will earn even less money than TD is promising it will earn today. Yet despite this, TD Securities is arguing that Potash and Agrium should both sell for more than their stocks sell for today. In recommending the shares, the analyst is arguing that Agrium stock should sell for $134 a share, and Potash should sell for $24 per share.
Higher prices for less profit? That's just crazy -- and TD Securities is wrong to recommend these stocks.