Intrepid Potash’s (IPI) share price has been a laggard over the past year, which is all the more frustrating given the clear progress the company has made, not only in diversifying its revenue but towards being increasingly profitable and cash-generative.
In the article that follows I highlight why Intrepid Potash is worth $1 billion market cap (more than 100% upside potential).
Water Sales – Solid Recurring Revenue
Numerous reports have pointed towards strong water demand in the Permian Basin. In fact, some reports point towards a rise of nearly 9 times between 2011 and 2016. Now, the thing with water is that, apart from it being a scarce resource in this key area, it is also prohibitively expensive to freight water long distances for the oil and gas industry.
Now onto some insightful background. Roughly 2 years ago, Intrepid had no water sales. Today, not only is this high growth emerging opportunity evident, but most importantly, from a valuation perspective, it is predominantly an asset-light business with high margins, leading to a cash conversion of roughly 85%.
In more detail, we can see in the 10-Q that Intrepid has a $15 million per year in quarterly installments recurring revenue contract. This right here is the holy grail of investing. However, I strongly contend this is in no way, shape or form being recognized by investors at present.
Is This Meaningful?
You would be correct to be skeptical. Why has such a positive and tangible opportunity not been priced in by the market? Firstly, it has to do with the way that these water sales are recognized. Most investors would appreciate and indeed reward revenue growth. However, right away this poses a problem for Intrepid because Intrepid only recognizes as revenue these water sales once the water has been taken by the key large customer.
Secondly, as I have already noted above, given that this is an extremely high cash conversion revenue, you don’t need a lot of revenue to generate solid cash. However, anyone doing a stock market screen on Intrepid Potash would not pick up this aspect of the story.
Thirdly, Intrepid raised its guidance in Q3 2018 for cash from water sales. As of Q3 2018, Intrepid announced that it would raise the low end of its previous guidance to $28 million to $35 million in cash from water in 2018.
Fourthly, in light of this side of the story, this past Friday night, Intrepid posted an 8-K which detailed that it had purchased water rights in Lea County, New Mexico, for $65 million. The seller will still get 10% royalty on any water revenue from these assets. To put this purchase in context, it approximates 15% of Intrepid’s current market cap.
Potash Outlook Stable
Moving in, highlighted in the graph below, is Nutrien’s (NTR) investor presentation from Nutrien’s Q4 2018 results.
Source: Q4 2018 investor presentation
Immediately, we can see that potash prices appear to have stabilized. Note, I’m not saying growing, but stabilizing.
Back to Intrepid. During the previous earnings call, Intrepid noted that it had succeeded in having its price increase accepted in the spot market. So that starting the beginning of the first quarter of 2019, we should expect the average net realized sales price to reach $283 – implying a 16% YoY growth in pricing.
Separately, if you have followed Intrepid for a while, you will by now have learned to forget about Intrepid’s highly promising story of Trio. As a brief reminder, Trio was highlighted to be a very promising high-value product. However, thus far, Trio has turned out to be a meaningful distractor and unprofitable endeavor.
Management tells us to remain faithful, that in time the market would come to more accurately reprice this high-value fertilizer product, although for now I remain pessimistic and give nil value to this segment.
Nevertheless, we should bear in mind that CEO Robert Jornayvaz did state on Intrepid’s Q3 2018 call that ‘that the price [of Trio] has stopped going down and is reversed and is now going back up;’ so possibly some good news might come from Intrepid’s upcoming Q4 results.
By-Products – Not Large But Important
Finally, included within Intrepid’s potash segments are its by-products sales which include heavy brine, high-speed potassium chloride mixing, salt water disposal, and trucking service lines.
In essence, a diverse set of products and services. However, rather than being recognized as revenue, these by-products are recognized as a contra accountto Intrepid’s cost. What this means is that going forward, these small yet important sales will aid in improving Intrepid’s profitability profile.
Intrepid Potash has described numerous times that it has a modest lithium reserve. After several rounds of bench testing, these lithium reserves have yielded solid positive results.
In reality, this lithium potential is still very early stage, so much so that we are unlikely to hear about any commercial viability prospects backed by tangible numbers during Intrepid’s Q4 2018 results.
Having said that, hopefully towards the end of H1 2019, we will finally hear what kind of ballpark revenue might be derived from this ‘modest’ lithium source. Given the strong demand by the EV industry for lithium, any revenues are likely to carry very satisfactory margins.
On the other hand, without having tangible numbers it is difficult to award this potential more than $100 million valuation.
Starting backward from the article:
– Lithium potential might be worth $100 million market cap.
– Potash, Trio and by-product sales: The more stable outlook for potash, combined with the fact that Intrepid carries net operating losses valuation of more than $200 million, means that Intrepid will not have to pay taxes for a very long time. Also, seeing how Intrepid carries roughly $350 million of depreciated property, plant and equipment, that should certainly be given some consideration. All in all, I’m confident that this segment should return to be worth a minimum of $500 million.
– Finally, onto the story on the Street: water sales. Seen as how water is in such high demand, Intrepid’s geographic competitive advantage, as well as the recurring nature of these contracts, on balance, I continue to assert that this segment should be worth at least 20X its cash flows. In more detail, 20X to Intrepid’s full-year 2018 $30 million of annual and growing cash sales, hence up to $600 million market cap.
Hence, in summary, I struggle to see how Intrepid’s market cap should not reprice closer to at least $1 billion.
Intrepid Potash is a commodity-based product and service company. As such, it is exposed to cyclicality and weather conditions. For example, a challenging wet season of the kind that the U.S. just suffered, with one of the wettest 4thquarter seasons in over 100 years will cause Intrepid’s potash inventory to raise, tying up precious working capital.
Separately, given that Intrepid’s water sales are largely dependent on the fracking industry, when oil prices drop into high-to-mid $40 range (back in December 2018 – January 2019), oil operators might look to hold back from heavy capital-intensive projects, which would have a very strong impact on Intrepid’s water sales ‘story.’
No investment is without risks. That’s the nature of investing in capital markets. While this upcoming quarter might disappoint or positively surprise, I confidently expect Intrepid to reprice closer to $1 billion market cap, hopefully, sooner rather than later.
Disclaimer: Please do your own due diligence to reach your own conclusions.
Disclosure: I am/we are long IPI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.