Mosaic and CF Industries could be severely undervalued (Part 4)
Continued from Part 3
Source of funding
As Mosaic Co. (MOS) postpones its potash expansion for one or two years, and fiscal year 2013’s working capital increase reverses (largely due to an inventory build-up), we could expect the company to generate a free cash flow after dividends amount of ~800 million per year over the next two years. An additional $2.5 billion of debt, $1.6 billion in free cash flow after dividends, and ~$2.0 billion of existing cash would create room for ~$5.6 billion of purchasing power—the likely minimum amount that the company will use if share prices bottom at the current price.
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Keeping ratios in line
With current debt of $1.0 billion, the addition of $2.5 billion in new loans would increase total debt to $3.5 billion. On the other hand, current equity of $13 billion should increase by $2.8 billion due to earnings after dividends over the next two years and at least $2.6 billion worth of share repurchase using excess cash and cash generated from two years worth of operations should lead to $12.5 billion, giving us a new debt-to-equity ratio of 0.29. This is slightly lower than Potash Corp. (POT)’s current 0.35. And with a debt-to-EBITDA (earnings before interest, taxes, depreciation, and amortization) ratio of 1.23, (using 2013’s EBTIDA figures), there should be enough room for the company to stay under the debt-to-EBITDA limit set by its credit agreements.
Effect on earnings
The addition of $2.5 billion worth of debt would increase interest payments by a minimum of ~$86 million per year based on an after-tax cost of debt of 3.41%. But the maximum possible repurchase of 128.8 million shares from Cargill over the next three years will cut market cap by 30%. After recalculating the new market cap and earnings number, the new price-to-earnings multiple for Mosaic’s business is just 6.85, down 30% from the current raw ratio of 9.83, which reflects an annual return of 14.60%.
Continue to Part 5