There's a long way to go yet, but 2017 marked a major turning point for fertilizer producer Intrepid Potash (IPI 2.19%). It's been mostly helpless against the prolonged market downturn that has embroiled the global potash industry in recent years. That was brought on by poor supply discipline from the world's leading producers and made worse by the extreme concentration of power in the industry. Nearly all of the planet's potash comes from just 19 deposits, with just three companies supplying 60% of production.
Management did its best to control the factors it could. It nearly doubled the number of shares outstanding in an offering that raised funds used to greatly reduce debt on the balance sheet. Despite the dilution, it could be considered a successful move. The company also transitioned to a new low-cost production method for all of its potash output and increased its focus on langbeinite, a niche fertilizer that Intrepid Potash sells under its Trio brand.
While the business still lost money in 2017, there were signs in the recent fourth-quarter and full-year 2017 earnings report that the company is on the right path. It even recently earned a small analyst upgrade. What should investors think about the stock given all of the recent moving parts? Here are three things Intrepid Potash management wants you to know.
1. Solar evaporation ponds are a success
Intrepid Potash is nearly out of the red thanks to steadily improving operating and net margins. For example, a fourth-quarter 2016 operating loss of $16 million shrank to less than $3 million in the final quarter of 2017. While expenses increased in the fourth quarter of last year compared to the prior period, the increase was temporary.
Most of the improvement was derived from the potash segment, which is now fully utilizing solar evaporation ponds. They are exactly what they sound like: Mineral-containing brine is pumped into large, above-ground ponds, energy from the sun slowly evaporates the water (for free), and the resulting slurry is concentrated and purified into several product streams, namely potash and a handful of byproducts.
The results have been amazing. The potash segment's gross profit improved from a loss of $28.6 million in 2016 to income of $15.6 million in 2017. Things should continue to improve, especially with a significant inventory build in the final quarter of last year, partly due to the seasonality of production (higher in the first and last quarterly periods of each year), and partly due to market fundamentals.
President and CEO Robert Jornayvaz commented on the fourth-quarter 2017 earnings conference call:
Our potash segment realized another quarter of strong margins due to a lower-cost production profile, an increased focus on the byproducts and more selective selling in the markets with higher net realized sales prices. We have solid volumes committed for the first quarter. Our decision to build inventory during the fourth quarter is clearly paying off, as we see good market fundamentals entering the spring season with solid demand and higher price levels as the $20 price increase is now in effect.
That $20 increase may not seem like much, but it's about an 8% increase from 2017 prices. Good news: Potash isn't the only business eyeing improvements this year.
2. Exports providing upside for Trio in 2018
In 2017, Intrepid Potash generated 65% of its revenue from potash and the balance from Trio, which was down from 76% of sales derived from potash in 2016. Unfortunately, the increased focus on Trio last year didn't work out quite like the company had hoped, as selling prices declined 32% year over year for the product. Meanwhile, potash prices rose 22% in that span.
Management is hardly deterred, though. It sees significant upside for selling prices -- especially considering selling prices for the individual components of Trio add up to vastly more than the product itself -- and it has realized an 8% increase in early 2018. That's occurring just as the company's production capability has been optimized.
But there's another major opportunity for the Trio brand: exports. Intrepid Potash ramped up activity in international markets throughout 2017, and it expects to reap the benefits this year. In response to a question about production and inventory management in 2018, Jornayvaz responded:
We've just done a great job of growing our volumes. And when we have certain international customers that are placing their third and fourth orders and those orders are going up significantly -- we have one customer in the South American region that has literally gone from zero to tens of thousands of tons. And so we are now beginning to focus on what are the proper run rates for the plant, because as you know, as we run that plant, it has significant excess capacity. So 2018 is an exciting year for us as we look at our ability to manage our transportation costs on a much higher volume basis and having customers that are now providing warehouse space and placing larger orders that allow us to negotiate freight contracts at larger levels, larger volumes and with more advanced notice.
Management added that larger order volumes lower the per-unit transportation costs of international shipments. Meanwhile, for smaller orders, Intrepid Potash has partnered with other fertilizer companies shipping product abroad to lower freight costs. If selling prices lift off their 2017 bottom, then the company could see positive gross margin for the segment once again.
3. Diversification efforts are ramping up
While Intrepid Potash will continue to generate the bulk of its business from fertilizer production and sales, management has been actively developing alternative business opportunities. The biggest comes from the company's significant water assets strategically located within shouting distance of the Permian Basin, the most important oil and gas-producing region on the planet at the moment. Producers in the shale formation utilize fracking, which requires copious amounts of water, which creates an unusual opportunity to sell water to energy producers.
Water sales may not sound very important, but the fertilizer producer recorded $7 million in water transaction revenue in 2017. Intrepid Potash expects to increase that significantly in 2018 thanks to a combination of long-term contracts and spot market selling. Considering water sales are accompanied by up to 90% gross margin, they represent an important source of income and cash flow for shareholders. Jornayvaz expects water to be an important part of the business in 2018 and beyond:
Water sales of $3.5 million in the fourth quarter were in line with our expectations of $3 million to $4 million and increased our full year sales to $7 million. Fourth quarter sales were a significant increase over the $2.1 million sales during the third quarter of 2017. Increasing demand, combined with several commitments in place for 2018, give us great confidence in our expectation of $20 million to $30 million in sales during 2018. We continue to work on, negotiate, and execute on opportunities that should increase this run rate in future years.
Water sales may be the most significant source of diversification, and could represent over 10% of total sales in 2018, but they aren't the sole source. Intrepid Potash is also expecting between $0.5 million and $1 million in brine sales (for use as a fracking fluid additive) this year, in addition to expanding new business in oilfield services.
What a Fool believes
It sure hasn't been a fun few years for Intrepid Potash, but the company's management has done a great job executing a strategy designed to return the business to profitable operations. Those efforts have delivered a healthier fertilizer business through more efficient potash production and a diversified customer base for Trio sales. If those core segments can thrive in the current down cycle for fertilizers, and revenue diversification efforts take off, then the company could be able to excel in almost any market environment. I would feel more comfortable with a few more quarters of progress and sustainable profits, but I have to admit that the company is oh-so-close to putting its struggles behind it.