Intrepid Potash Stock: Deep Value With Favourable Demand-Supply Dynamics (NYSE:IPI)

Colorful potash settling ponds in the Utah desert

knowlesgallery/iStock via Getty Images

Identifying deep-value opportunities that are underappreciated by the market has always been at the core of our approach to investing at Stratos Capital Partners. We think Intrepid Potash (NYSE:IPI) certainly satisfies our criteria for a deep-value stock, and we highlight the favourable demand-supply dynamics that should further stack the odds in IPI’s favour to outperform in the next one to three years.

Although there are valid concerns surrounding industry giant Nutrien’s (NTR) decision to raise potash production despite a recent pullback in demand, the sharp decline in IPI’s share price seems largely unjustified from our point of view. Instead, we see a compelling opportunity to take advantage of the market’s short-sighted focus on quarter-to-quarter performance to initiate our bullish view on IPI.

Fears Over Supply Glut Keeping Investors Away

Let’s jump straight to addressing the key factor that we think is feeding the pessimism surrounding IPI’s weak share price performance.

November earnings call transcripts from both NTR and IPI highlighted concerns that farmers are holding back on replenishing fertilizer inventories and deferring purchases in anticipation of lower prices. This wait-and-see approach from farmers is a self-fulfilling prophecy as holding back on purchases in the short term has driven up wholesale inventories and dragged down prices. What makes matters worse is that NTR has also committed to expanding potash production aggressively in the next few years, stoking fears that a supply glut could be in the making. This pretty much sums up the industry’s disappointing performance in the most recent quarter and the prevailing pessimism heading into 2023.

Due to the sheer scale of NTR’s potash business, we will rely heavily on data provided by NTR when discussing the industry’s broader demand-supply outlook in the coming years.

Chart showing potash demand/supply projections to 2025

Nutrien Ltd – Q3 2022 Investor Presentation

Although we acknowledge the downside risks to potash prices as more supplies come online, this is only likely to happen in 2026 and beyond. As the accompanying chart shows, global production of potash is expected to only recover to 2021 levels of 70 million tonnes by 2025 assuming Russian and Belarus shipments stay depressed.

There is an increasing likelihood that the drawn-out war in Ukraine will evolve into some sort of proxy war between Russia and NATO allies as Ukraine is being equipped with more advanced weaponry with no peace deal in sight. Even in the event of a resolution to the war, we are sceptical that economic sanctions will be lifted anytime soon. Thus, we are in agreement with NTR’s assessment that potash supply will remain constrained through 2025.

IPI’s Perfectly Timed Production Boost From Moab Mine

According to IPI’s November earnings call, management shared that the company’s Moab cavern drilling program is on track to start brine production in early Q1 2023. This brine will be available for the 2023 evaporation season, which should give a decent boost to IPI’s potash production volumes in 2023.

Depressed Demand For Potash Unlikely To Be Sustained

Regarding concerns over farmers holding back on purchases to restock depleting inventories, we view this as a temporary phenomenon that will only add to pent-up demand in 2023. Anecdotal evidence also suggests to us that this phenomenon appears to be largely motivated by speculative market timing behaviour by farmers, rather than by real economic reasons.

The biggest factor to watch is agricultural commodity prices, especially corn and soybean prices for the U.S market. Here we note that prices across the board are providing strong incentives for farmers to maximise yields by increasing potash application to improve soil conditions. High forward futures pricing also means farmers can lock in high prices for crops through 2023.

Chart showing agricultural commodity prices

Nutrien Ltd – Q3 2022 Investor Presentation

Oilfield Solutions Business Constructive

Besides potash, we are also optimistic that the demand for water and brine in the Permian Basin will be supported by robust shale fracking activity in the region. Although this is still a relatively small portion of IPI’s business model, we see some scope for expansion in this area as shale fracking activity picks up over the coming months.

Without going into too much detail about the shale fracking business, we hold a constructive view on shale activity so long as WTI crude prices do not fall under US$70/bbl. We add that this view is supported by the fact that the Biden administration has been drawing on the U.S Strategic Petroleum Reserve (SPR) and has announced plans to repurchase crude for the SPR in the future when the price of WTI crude is at or below US$67 to US$72/bbl. This essentially places a floor on how low oil prices could go, which has in turn encouraged a shale boom in the Permian Basin.

Charts showing key metrics for Intrepid Potash's sales of water in the Permian Basin

Intrepid Potash – Investor Presentation August 2022

Stock Buyback At Deep Discount Another Boost For EPS

We are also delighted at management’s decision to continue buying back shares at current deeply discounted levels. IPI’s cashflows are strong given the high prices it is fetching for potash. Even with aggressive capital expenditures of US$44 million TTM, the company was still able to generate a positive US$10.8 million in free cash flows.

So long as potash prices stay elevated, which is our base view, we certainly see scope for management to substantially expand its US$35 million stock repurchase program in the coming quarters. Not only do share buybacks provide a direct boost to IPI’s EPS metrics, but buying back shares at just 5.5x forward P/E is extremely attractive in our view.

Short Term Uncertainties Are A Distraction

Seeking Alpha’s Quant Rating currently rates IPI as a “Hold” with accompanying factor grades indicating a “D-” for Momentum and a “C-” for Revisions. This is in line with what we have described earlier as the market’s short-sighted focus on quarter-to-quarter performance. This obsession over short-term performance has become so reliable at predicting stock price performance in the near term that many investors would rather wait for bearish momentum to reverse and for clarity over earnings to improve before taking a shot.

Tables showing Seeking Alpha's Quant Ratings

Seeking Alpha

Of course, such strategies rarely work well in execution. More often than not, waiting for conditions to align perfectly means paying much higher prices and undermining returns. We encourage investors to look past the short-term uncertainties and focus instead on the favourable economics supporting prices for agricultural commodities and potash over the medium term.

In Conclusion

We see an attractive entry point for investors with IPI trading at deeply discounted levels of just 5.5x forward P/E and 0.58x P/B. Although we acknowledge that the dynamics of the potash market could be volatile in the short term while a supply glut could potentially materialise in 2026, we still see a good runway for strong returns and for IPI to outperform through 2025.

We initiate our coverage of IPI with a “Buy” rating for now, with the intent to upgrade our rating should we see further weakness in the company’s share price.

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