Why Agrium targets raising dividends with more free cash flow

Raising dividends

Factors like growing population, climate change, hedge against food inflation, and emerging markets growth drive interest in fertilizer stocks. Investors are also attracted prospects that increase dividend.

Jeffrey Ubben’s ValueAct Capital believes Agrium (AGU) will grow its earnings before interest, tax, depreciation, and amortization (or EBITDA) over the next two years by ~15%–20%. The fund anticipates that the company will raise its dividend to $5–$6 per share by 2016 with the completion of capacity expansions and growth from existing facilities.

Recently, Agrium raised its dividend by 4%, or $0.12 per share, to a total dividend of $3.12 per share on an annualized basis. This represents a dividend yield of 3.2%.

Why Agrium targets raising dividends with more free cash flow

Agrium noted in its earnings release that its investing capital expenditures increased in the first nine months of 2014—compared to the first nine months of 2013. There was increased activity on the Vanscoy potash expansion and Borger nitrogen facility projects.

The company said it expects capital spending to be ~$2.15 billion in 2014. Then, capital spending will “decrease significantly.” It believes a lower capex, combined with benefits from growth initiatives, will drive future free cash flow generation.

In 2013, Agrium returned a 2.73% dividend yield. The company said, in its latest investor day presentation, that it repurchased $1.4 billion worth shares since 2012. It continues to evaluate a buyback to return capital to shareholders.

Analysts believe that since Agrium’s largest business segment—retail—demands much less capital for expansions, this could lead to smaller capex in the future. It could raise the chances of more dividend returns.

Market Realist noted in Agrium’s business overview in July that the fertilizer industry offers an inherent competitive advantage. There are high barriers to entry due to high capital requirements. This means companies in this industry need large amounts of capital to start operating.

An analysis revealed that among its peers, Agrium and CF Industries (CF) have smaller capex-to-revenue ratios. Intrepid Potash (IPI) is a small potash producer. It has a higher capex-to-revenue ratio. IPI has seen large expansions in recent years. Potash Corp. (POT) also has one of the highest capex-to-revenue ratios.

Excluding IPI, all of the other companies are part of the VanEck Vectors Agribusiness ETF (MOO).