March 2015 - The Quarter that Was

The TSX had an OK start to the year, with a 1.8% return over the quarter. Of course, energy was down another 1.9%. Declining crude prices continued to put pressure on energy stocks, but technically stocks are behaving well having put in what may be their low in December with higher highs and higher lows since then. The US S&P 500 was up just 0.4% in the quarter. But currencies added 9.1% for Canadian investors!!

 

As this is my first blog of 2015, I thought it would be useful to share how I think about Investing and my long-term goals for my portfolio. My long-term goal is to compound capital at a high rate of return while minimizing the risk of permanent loss of capital in any individual security or holding. In other words don’t lose money but outperformed the major market indexes. So far so good!!

 

I expect to continue to hold a 60/40 (60 % equity, 40% cash) allocation in about 40 to 50 investments, and estimate that my typical holding period will be long-term, typically ten or more years.

 

Recently I was approarch by a fellow investor and his advice was to sell equities because of technical indicators he seen on another blog which could cause a market crash. Personally I have no time for technical indicators or reacting to other people investment advice when managing my portfolio. I tried to keep in mind of some famous quotes by Warren Buffett on Investing ;

 

 “A prediction about the direction of the stock market tells you nothing about where stocks are headed, but a whole lot about the person doing the predicting.”

 

 “We have long felt that the only value of stock forecasters is to make fortune-tellers look good.”

 

I couldn’t agree more and as a matter of fact “time arbitrage” can be an investor advantage. For example by taking advantage of the opportunity for long-term profit offered when short term investors sell due to disappointing short-term macro or business progress – this has always been a major source of profitability for my portfolio. In my experience, stock prices are often much more volatile than the underlying value of the business they represent.

 

I believe it is self-evident that the value of a business is the present value of the cash that it will generate for distribution to its owners over its lifetime. For the high quality, simple, predictable, low-leverage businesses in which I prefer to invest, their discounted expected lifetime cash flows generally do not change meaningfully due to events in Greece, greater Europe, or technical indicators in the markets.

 

As always for my quarterly blog I like to profile one of my holdings;

 

Portfolio Update - Agrium

 

I began taking a position in Agrium last year when the stock was in the low 80s.

 

Agrium is a well-diversified crop input company. The company’s Retail division operates North America’s largest agricultural retail network and has significant operations in Australia. Agrium Wholesale has significant operations that produce nitrogen fertilizers, along with sizable operations that produce phosphate and potash fertilizers. Agrium’s nitrogen operations are primarily located in Western Canada with access to low cost natural gas and located near higher netback regions – Western Canada and Western US nitrogen prices are typically priced at a premium.

 

EPS estimates have increase with the start of many positive trends for Agrium's operations in 2015. The increase was primarily attributable to lower nat gas input costs and a more favourable CAD/USD exchange rate. While not immune to agricultural headwinds, I continue to argue the longer term outlook for Agrium retail segment remains underappreciated. I base my argument on (i.) further cost reductions (incl. asset rationalization) and working capital improvements, (ii.) global growth in private label initiatives, (iii.) additional improvements in Australian Retail (an emerging theme), (iv.) Viterra results continuing to surprise to the upside.

 

I expect Agrium to focus capital on the following (i.) maintaining its core asset base , (ii.) growth investments with minimal returns of ~12% (in excess of AGU's 8% WACC), (iii.) sustainable dividend growth, (iv.) opportunistic share repurchases.  

Capital Allocation- Show Me the Divy!

 

Agrium free cash flow inflection in 2016 can support much higher dividends: I  forecast  significant  free  cash  flow  starting  in  2016  based  on sustained Retail cash generation, improved nitrogen earnings due to Borger expansion start-up, and continued ramp-up of the Vanscoy potash mine.  Additionally,  I  expect  capital  expenditures  will  decline  from approximately $2B in 2014, to $1B in 2015, and then $600M in 2016. I believe this oncoming free cash flow inflection will allow management to significantly increase its dividend while remaining confident that the company can support its dividend payout even in a downside scenario. I think a $5/share dividend by 2016 is not unreasonable, and even extreme downside scenario would support dividend payments well in excess of $4/share.