Merger Complete, Is Nutrien Ltd. (NTR) a Buy?

Several years into the fertilizer industry downturn, Agrium and Potash Corporation had had enough. Major producers brought too much production online too quickly. At the same time, large international markets that supported healthy export volumes found supplies closer to home. As a result, selling prices for the big three fertilizer ingredients -- nitrogen, potash, and phosphate -- were sitting at multiyear lows.

That's why Agrium and Potash Corporation decided to combine in a "merger of equals" (Canadians are so polite). And that's how Nutrien (NTR 0.17%) came to be. However, the dismal market environment for fertilizers, and the fact the new company has only been publicly traded since January 2018, might have nudged the global leader off many investor radars. But that could be a mistake. Here's what do you need to know about this fertilizer stock.

Image source: Getty Images.

The business

Nutrien is now the world's largest fertilizer producer with over 26 million metric tons per year of combined nitrogen, potash, phosphate, and sulfate capacity. While most of its geographic footprint resides in North America, it also owns production assets in South America and Australia. To go along with a robust production portfolio, the company is the world's largest distributor of agricultural nutrient products with retail locations in seven countries. 

Management believes the retail business is the key to long-term, profitable growth. It also thinks there are ample opportunities to expand in existing markets. That's why the current growth strategy is relatively straightforward: Nutrien wants to grow its legacy retail operations in North America and Australia, continue expanding its new retail operations in Brazil, and increase investments in digital agriculture products and services across its global footprint.

However, in order to maximize success and wring out all the benefits its size can provide in the long term, the $34 billion fertilizer company must first execute on its near-term financial strategy.

By the numbers

In the near term, Nutrien is focused on three major initiatives that will position the business to capitalize on growth opportunities beyond 2019 and maximize any windfall from a recovery in the fertilizer market.

First, management is working on slashing $500 million in annual run-rate expenses by the end of 2019. While "cost synergies" are highly touted for big mergers, investors shouldn't forget they rarely work out quite as expected. Could this time be different? Well, Nutrien is off to a great start, having achieved $150 million in the first three months of existence. Here's where the remaining savings are expected to come from between now and the end of next year: 

Data source: Nutrien investor presentation.

Second, Nutrien wants to sell its equity investments in Chilean lithium miner Sociedad Quimica y Minera de Chile (SQM) to generate $4 billion to $5 billion in net proceeds. The investment was originally made by Potash Corporation -- and it's not as strange as it sounds. When lithium is produced from brine, it also creates a lot of potash. In fact, it makes more potash than lithium.

Swift progress has been made on this initiative. In early June, Nutrien sold all of its Series B common shares in SQM in a regulated auction on the Santiago Stock Exchange. That provided $1 billion in gross proceeds, while the Series A common shares are expected to provide $4.1 billion in gross proceeds when they're sold. The cash infusion will be used to reduce the $8.1 billion in long-term debt and for growth capital. 

The third and final near-term initiative will double as the core long-term focus, too: growing the retail business. It's already more important than investors might realize. In 2017 retail provided 35% of adjusted EBITDA, compared to a 33% share for potash and 25% share for nitrogen. Nutrien expects to grow retail's adjusted EBITDA by $50 million to $140 million per year going forward, which would help to insulate the business from future volatility in fertilizer markets. 

Business outlook

Nutrien has issued relatively bullish guidance for full-year 2018. It even increased its adjusted EPS expectations after the first quarter of 2018. Here are several highlights: 

Data source: Nutrien investor presentation.

By comparison, full-year 2017 EBITDA was $2.9 billion. Yet, while the business is moving in the right direction, there's a considerable amount of upside potential. That's something to keep an eye on as major crop harvests are increasing in volume.

The fertilizer company thinks a $25-per-metric-ton increase in selling prices could boost annual adjusted EBITDA by $650 million. However, fertilizer prices are more than $100 per metric ton below the mid-cycle average. If the market returned to those pricing levels, then Nutrien says it would generate $6.5 billion to $7 billion in annual adjusted EBITDA and over $7.50 in free cash flow per share. 

That's no minor detail considering the company intends to distribute 40% to 60% of free cash flow after sustaining capital to shareholders or that the fertilizer stock currently sports a 3% dividend yield.

Image source: Getty Images.

Is this fertilizer stock a buy?

There's an incredible amount of upside for this fertilizer business if selling prices begin to return to historical averages. Of course, the long-awaited recovery in fertilizer markets has been elusive for the last four or so years and remains squarely outside of Nutrien's control. But that's what makes management's three-pronged near-term strategy so intriguing.

If Nutrien succeeds in achieving $500 in cost synergies by the end of 2019, wisely deploys the $4-plus billion in net proceeds from selling its stake in SQM, and steadily grows its retail business; then it will be better positioned to capitalize on opportunities presented by an eventual recovery in fertilizer markets. With the stock trading at just 17.2 times future earnings and yielding 3%, investors should feel comfortable buying the stock today -- so long as they closely monitor progress in the strategic initiatives.

However, given the painful recent history of the fertilizer market, I wouldn't recommend getting too carried away with possible price recovery scenarios just yet. Rather, think about this as a long-term investment.