Innophos Holdings (IPHS) Update
This will just be a brief update. However, the price fall of the stock suggests either an incredible buying opportunity, or incredibly bad recommendation on my part. As always, I don’t invest based on short term (meaning under 3 years) price movements, but on long term value.
At the moment of posting, Innophos is trading at $8.84, for a PE of 1.0. That reflects an extraordinary pessimistic view of the long term earnings of Innophos. Innophos had their year end conference call in Febuary, and the transcript is available on their website here: http://ir.innophos.com/
Let’s look at what they had to say. I’m not going through the full thing; I’ll extract a few telling comments. Let’s start with the previous year’s performance:
“Full-year results can only be described as exceptional.”
“Innophos delivered solid results in the fourth quarter despite a selling environment that became significantly more challenging through the quarter. Net sales for the fourth quarter were up 50% over fourth quarter 2007”
But, of course, we buy stocks based on their future potential, not previous glories. And yes, we can’t expect a repeat of 2008. Here’s what Innophos has to say about that:
“Going forward as result of these pressures, we expect to see downward pressure on selling prices which are currently at historically high levels. In response, we are taking a more aggressive stance to retain our leading market position and keep profitable business going forward.”
“We are benefiting from declining sulfur, energy and transportation costs in comparison to 2008 levels”
There is about a 2 page description of all their business segments, with the market’s effects on costs and sales estimated. I can’t summarize all of that. Needless to say, there is pressure on them. They summarize with:
“In expressing an outlook for Innophos financial performance in 2009, we must consider several issues. We cannot now predict how severe the recession will be, nor the associated impact on industrial and agricultural demand. With the uncertainly around Mexican phosphate rock cost and operating levels, and along with greater competitive intensity, we have to conclude that we cannot offer reliable and specific operating income guidance for the year.
We can give you an idea of first quarter outlook. We expect that first quarter 2009 volumes will be up approximately 15% from fourth quarter 2008 levels. For selling prices, with the usual puts and takes from various customer agreements, we expect to increase prices in some areas, primarily in the US, but this will be offset in our less specialized product areas and should result in overall prices that should remain somewhat similar to those of fourth quarter 2008. Lastly, our cost structure should remain relatively flat as well.
Beyond the first quarter, volume impacts are uncertain and we believe are recession dependent. We do expect to see selling prices trending down, while Mexican cost structure increases also start to kick in mid-second quarter, again, to some extent affected by operating levels.”
Okay, not perfect news, but exactly what we would expect from a stellar company selling staples in a recession. In short, they (like everyone else in the world) have no particular insight into when the recession will end, and they will have to tighten their belts a bit until it is over.
Note that all of the uncertainty here is to the extent of the profitibility during the recession, not whether there will be profit, or whether IPHS will survive. Yet stock prices have plummeted. IPHS is currently selling for 40 cents less than last years EPS! They are being priced as if they are a fertilizer business, and as if fertilizer will never go up again. Hoewever, they are primarily a specialty products business, with margins in the 30%+ range, not the under 10% margin of raw products like fertilizer. They do sell raw materials, and lower end materials, and there they are facing significant competition from the Chinese and such.
I feel like typing more, but the situation is uncertain. We can set and weigh the different components of the business, try to estimate the future of the recession, predict prices for raw materials, predict how changes in China will effect competition, etc. I’d be a fool to think I could do that better than the managment of IPHS, and their position is: “I don’t know”.
So is the price fall justified? Well, they are going to be cash flow positive in 2009, they will continue to pay down debt, they will continue to be profitable. They still sell specialty products required for all kinds of staples. A segment of their business is still highly resistant to competition - food additives. They expect to maintain their margins in their specialty products.
Investors confuse uncertainty with risk. We cannot reliably make 2009 EPS predictions. We cannot clearly see what the competitive landscape will be in 2011 and on. What we can see is a company that has been making specialty chemicals for a very long time, remaining highly competitive, with high margins, with a strong balance sheet, cash flows, and the ability to compete and react to the market (something a debt heavy, poor balance sheet company often can’t do).
I don’t know what 2009 will bring IPHS. Read the transcript for some of the possibilities. What I do know is that this company will continue to make money, will continue to be very competitive, will continue to try to increase market share. Nothing is looming to make us think that IPHS is about to disintegrate - the uncertainty about it’s future is no more uncertain than a JNJ, Berkshire, etc. We don’t know next year’s earnings, but we know in the long term the company will continue to make money, and thrive. A PE of 1.0 gives us a huge margin of safety - far beyond the 50% required by value investors.
Tags: IPHS
March 7th, 2009 at 9:31 pm
Good post and an interesting idea. Glancing through the 10K however, I was a little troubled by all the litigation against them. I understand all companies spent their share of time fighting lawsuits but as I know little about the company at this time it worried me a little. I also know that most laundry detergent companies have been forced by the EPA to reduce or eliminate phosphate additivies in their products. I will have to look into how this might affect their business (what portion of sales went to laundry detergent producers) and more about the litigation. Either way interesting find and I look forward to learning more about the company.
March 11th, 2009 at 7:20 am
Okay, on litigation, we have worst case estimates of $43.5MM. The EPA and DOJ actions are still in the investigative phases, so no dollar figure can be assigned.
In comparison, we have $125MM in cash in Q4. Net income for Q4 alone was over 200MM.
Let’s say the EPA and DOJ are huge judgments. We could be looking at wiping out a quarters worth of income. That’s not a company killer.
I don’t have an answer on the use of laundry phosphates other than to read or listen to the most recent conference call. Quite a few states have limited phosphate use in residential laundry detergents (can’t really take it out of commercial detergents because realistically phosphates are the only game in town). Bills have been introduced to limit their use in dishwasher detergents. The conference call addresses demand destruction, and what Innophos is doing in response. One thing they are doing is shutting down factories in Mexico producing STPP, and working with them to start producing food grade STPP (used in food for shelf life, to improve tenderness in meats, etc). Also, they are working on specialty reformulations for detergents.
The beginning of the conference call addresses STPP:
Full-year results can only be described as exceptional. We saw substantial increases in 2008 net sales at $935 million versus $579 million in 2007 or a 61% improvement as our 83% selling price increases positively impacted revenue and income by $480 million across all product lines. These changes outweigh the 22% negative volume and mix impacts on revenue, primarily in STPP and other products.
In short, the business as a whole is improving, offsetting the losses in the STPP business.
Thanks!