Why IPI’s high PE ratio does not necessarily mean it is overvalued
The PE ratio (Price over Earnings ratio) is a number that shows how many times the earnings are investors willing to pay for the company. The uninformed investor usually associates a high PE ratio with an overpriced company but most of the time there is a good reason behind the number. The PE ratio is often drive by the perceived risk and growth prospects. Since it went public in 2008, Intrepid Potash, Inc. (IPI) has had a considerable large PE ratio: almost three times that of its competitors.
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IPI is a potash-only company
The potash business is considered as a oligopoly due to the small number of firms in the market. Compared to other fertilizers, the potash market is more likely to maintain higher profits as producers can simply scale back production to to keep prices afloat during bad times. None of IPI’s competitors are potash-only producers. Along with potash, they also produce either phosphate, nitrogen, or both. The market for these products is more diversified.
Opportunity to expand and reduce costs
IPI operates and sells in a market that imports 85% of its potash consumption. It is very difficult for IPI’s competitors to gain market share because they are the market. In more intuitive words, they can only eat each others revenues. The U.S. does not only import most of its potash, but it is also one of the largest consumers in the world. It is much easier for a potash consumer to change from importing potash to getting it from a local producer. So, IPI could gain market share and grow its earnings faster than its competitors.
Over the past couple of years, IPI has heavily invested in production facilities. Many of these are expected to start producing in the current year. Also, the new production facilities, such as the HB Mine, will lower the cost of production. With higher production come more sales. With higher sales and lower costs come higher earnings.
However, the main reason for which analysts expect the PE ration to increase as much as the graph shows is that earnings are expected to decrease considerably. It is up to you to decide whether these predictions are justifiable or not.