Undervalued Dividend Growth Stock of the Week: Compass Minerals International, Inc. (CMP)

I went to the movie theater just the other day.

And as I sat there during the previews, thinking to myself for a bit, it occurred to me that a lot of people come to the movies to escape reality for a couple of hours.

In many ways, I get it. But in some ways, it’s sad.

Shouldn’t our lives be a bit more exciting… like a movie?

I’m not saying we all need to be action heroes.

But there is certainly a big difference between a typical movie and the typical, everyday pattern that most people are familiar with.

However, that typical, everyday pattern is necessary for most of us, as we can’t have a roof over our head or food in our belly without the routines – especially as it relates to our jobs.

Yet it’s entirely possible to be free of certain routines – routines that are perhaps not terribly enjoyable – which could allow us to live our lives in a more exciting manner.

Maybe Hollywood won’t be calling us up. But we can be the movie stars of our own lives.

I can say that I feel a little bit like a celebrity each day I wake up.

That’s because I’m free of a lot of everyday routines that I don’t like.

This freedom has occurred via financial freedom, which itself was achieved by living below my means and investing in high-quality dividend growth stocks like those you’ll find on David Fish’s Dividend Champions, Contenders, and Challengers list.

The six-figure dividend growth stock portfolio I’ve built as a result of that saving and investing now generates five-figure passive dividend income on my behalf – and that passive income is growing all by itself, because these are high-quality dividend growth stocks that don’t just pay dividends, but they routinely and regularly increase their dividends.

So what’s wonderful about achieving financial independence via dividend growth investing is that your life’s movie can only get more amazing over time. That’s because your movie’s budget is increasing year after year, allowing for more special effects, exotic location shots, etc.

But you have to yell “Action!” first. You have to take action.

And that’s exactly what today’s article is all about…

In order to help you readers, I’m going to provide an actionable idea by highlighting a high-quality dividend growth stock that appears to be undervalued right now.

The undervaluation is key, as undervaluation confers a number of benefits to the long-term dividend growth investor.

The price of a stock only represents how much it costs. But the value of a stock represents how much it’s worth.

When you’re able to pay a price that’s apparently well below intrinsic value, you’re locking in a number of extraordinary advantages.

An undervalued dividend growth stock should offer a higher yield, greater long-term total return potential, and less risk.

This is, of course, relative to what the same stock would otherwise offer if it were fairly valued or overvalued.

The higher yield comes about because price and yield are inversely correlated; all else equal, a lower price will result in a higher yield.

That higher yield not only positively impacts the current yield one can expect from a stock, but also the long-term aggregate income they may come to collect.

In addition, the higher yield also positively impacts total return, as total return is comprised of income (via dividends or distributions) and capital gain.

And capital gain is also given a possible boost via the “upside” that exists between the lower price paid and the higher intrinsic value.

If a stock that’s worth $100 is purchased at $75, there’s $25 worth of upside that may very well be realized in time, which is on top of whatever organic increase in stock value (which price may very well follow) that would ordinarily occur as a business sells more products and/or services and becomes worth more.

Of course, more potential upside means less potential downside.

When you pay much less than a stock is worth, you institute a margin of safety that operates as a “buffer” for the investor.

Just in case the investment thesis is incorrect, or just in case some kind of large and negative event comes to pass that impacts a business, you limit the odds that the investment becomes worth less than you paid.

If you pay full price (or more) for a stock, there’s no wiggle room. But if you pay much less than it’s worth, you have a lot of wiggle room.

With all of this in mind, undervaluation is clearly and hugely beneficial for the long-term dividend growth investor.

Fortunately, it’s not terribly difficult to estimate the intrinsic value of just about any dividend growth stock out there, which gives the investor a lot of information from which to make an intelligent long-term investment decision.

In fact, there’s a great resource right here on the site that totally streamlines the valuation process.

Part of his overarching series of lessons on the dividend growth investing strategy, fellow contributor Dave Van Knapp wrote a fantastic lesson on how to go about valuing dividend growth stocks.

Once you have a high-quality dividend growth stock in mind, and once you see that it’s undervalued, it’s time to yell “Action!”

Well, the following dividend growth stock, which appears to be undervalued right now, could help you to live your life more like a movie…

Compass Minerals International, Inc. (CMP) is a producer of essential minerals, including deicing salt and sulfate of potash.

I usually shy away from the idea of investing in cyclical commodity companies.

Any company that lacks pricing power – because they’re price takers on a commodity – is less in control of its own destiny.

In addition, a company dealing in commodities is usually hard-pressed to build strong brands.

And there are also high fixed costs to be concerned about.

Perhaps most importantly, a cyclical business will often find it difficult to pay out growing dividends year in and year out over a longer period of time. It’s not easy to cultivate that kind of corporate culture – rewarding your shareholders with increasing dividends regularly and reliably – if the underlying profit is too cyclical to allow for the necessary wherewithal.

However, Compass Minerals bucks a lot of these trends, running a very solid business that regularly generates the profit necessary to pay out a big – and growing – dividend.

This is largely because of two aspects that work in the company’s favor.

First, the main commodity in question here – deicing salt – tends to see uniform demand. Unlike what we see in a certain TV show, winter comes every year for the northern parts of North America. Climate change may have some negative impact on this, but the long-term trend doesn’t seem to have shifted very much.

And with the Great Lakes area being one of the snowiest areas of the continent – making it an attractive region for the company – Compass Minerals is able to deliver its product for a lower cost than its competitors due to the massive (and well-located) Goderich rock salt mine in Ontario. This is the world’s largest active salt mine.

The company’s solid business model and operational excellence allows for the wherewithal to routinely and regularly pay an increasing dividend, which has been demonstrated by the company paying out an increasing dividend for 14 consecutive years.

And over the last decade, the dividend has grown at an annual rate of 8.6%.

While that dividend growth rate is impressive in and of itself (it’s certainly well in excess of inflation), it’s made to be even more impressive by the fact that the increases have been pretty consistent. Outside of the most recent dividend increase, Compass Minerals has been relatively constant with the dividend raises.

That dividend growth rate is also really impressive when you consider that the stock yields 4.45% right now.

So we’re talking a utility-like yield with dividend growth that is well in excess of what you’ll find with most utilities.

That yield, by the way, is almost 150 basis points higher than the stock’s five-year average yield.

You can see a bit of what I noted above (undervaluation resulting in a higher yield) playing out here.

The only drawback, though, is the fact that the payout ratio, at 80.7% is rather high.

Compass Minerals will sport a high payout ratio (like they do now) one year, then the payout ratio will drop back down within a year or so. That’s the nature of their cyclical business. When earnings are depressed, the payout ratio naturally rises. However, they’ve demonstrated a knack of being able to work within these confines quite well.

That said, very near-term dividend growth (over, say, the next year or so) could be minimal until the business recovers.

The key is making sure the long-term dividend growth evens out into a very nice number over a longer period of time – and that’s the case here.

In order to build that expectation for future dividend growth, and in order to build a valuation for the business and its stock, we need to look at underlying business growth.

We don’t invest in where a company has been. We invest in where it’s going. We invest in that future operational revenue and profit growth, which will fuel growing dividends and capital (and thus total return).

However, we must first look at what the company has done over the long term in order to start estimating its future growth trajectory.

So what we’ll now do is look at what Compass Minerals has done over the last decade in terms of top-line and bottom-line growth. And we’ll then compare that to a near-term professional estimate for future profit growth.

Combining the past and future in this manner should give us a good idea as to what kind of overall growth Compass Minerals is capable of, which will help us not only build that expectation for future dividend growth, but it’ll also help us value the business and its stock.

Compass Minerals has increased its revenue from $857 million to $1.138 billion from fiscal years 2007 to 2016. That’s a compound annual growth rate of 3.20%.

This isn’t bad. I usually like to see mid-single-digit top-line growth from a relatively mature company like this one, but its cyclical nature means any one snapshot of the long term could look a bit rosy or bleak, depending on the time frame in question.

Meanwhile, the company increased its earnings per share from $2.43 to $4.79 over this same period, which is a CAGR of 7.83%.

The excess bottom-line growth doesn’t seem to be due to the business being significantly more exceptional today than it was a decade ago.

What looks to have occurred here is, Compass Minerals simply had a somewhat off year in terms of net income for FY 2007, which negatively skewed that year (and positively skewed the 10-year look at EPS growth).

Still, fairly solid numbers here. And you can see that the long-term dividend growth roughly tracks long-term EPS growth.

Looking forward, CFRA believes Compass Minerals will compound its EPS at an annual rate of 9% over the next three years, which would be a nice acceleration from what we see transpired over the last decade.

This would be a moderate acceleration off of what we see transpired over the last decade. CFRA cites the strong fundamentals and higher salt volumes for 2018, indicating a belief in a normalization of the business.

In addition, Compass Minerals recently acquired full ownership (they previously owned 35%) of Produquímica Indústria e Comércio S.A., one of Brazil’s leading manufacturers and distributors of specialty plant nutrients. This move is predicted to be accretive moving forward, which is factored in by CFRA.

One area of the business where I see room for improvement is the balance sheet.

Compass Minerals has historically been moderately leveraged, but the aforementioned acquisition has stretched the company’s resources a bit more than I’d like to see. As such, the accretive nature of the acquisition has to materialize, which would allow Compass to outgrow the balance sheet and improve the numbers.

That said, the long-term debt/equity ratio is at 1.67, while the interest coverage ratio is a bit under 7.

Profitability, however, is an area of strength for the company. They sport numbers that would support the idea that their competitive advantages are significant (especially considering the fact that this is a commodity business).

Over the last five years, Compass Minerals has averaged net margin of 13.34% and return on equity of 25.59%.

This is a very solid business.

While I’m not personally interested in a lot of exposure to commodity businesses, I also recognize that certain commodities are extremely necessary to everyday life. Oil is a good example. Deicing salt is similar in that regard, although it’s obviously far more seasonal. This seasonality is one reason why Compass Minerals continues to diversify and strengthen the business.

At the right valuation, and assuming the business and dividend are high in quality, a business like this makes a lot of sense as a long-term investment.

Well, the valuation may just be right…

The stock is trading hands for a P/E ratio of 18.11 – and that’s off of depressed earnings. Yet that is still below the five-year average P/E ratio of 20.1 for the stock. Investors are also currently paying much less for the company’s sales compared to the five-year average. And the yield, as shown earlier, is substantially higher than its own recent historical average.

So the valuation may be right, but how right might it be? What’s a reasonable estimate of its intrinsic value?

I valued shares using a dividend discount model analysis.

I factored in a 9% discount rate and a long-term dividend growth rate of 5.5%.

That long-term DGR is well below the company’s demonstrated earnings and dividend growth over the last decade. It’s also well below the near-term forecast for earnings growth.

However, I think the seasonality and cyclicality of the business, especially as there’s somewhat of a transition at play here, demands a conservative view.

The DDM analysis gives me a fair value of $86.81.

The reason I use a dividend discount model analysis is because a business is ultimately equal to the sum of all the future cash flow it can provide.

The DDM analysis is a tailored version of the discounted cash flow model analysis, as it simply substitutes dividends and dividend growth for cash flow and growth.

It then discounts those future dividends back to the present day, to account for the time value of money since a dollar tomorrow is not worth the same amount as a dollar today.

I find it to be a fairly accurate way to value dividend growth stocks.

Even with a rather conservative look at long-term dividend growth (assuming a go-forward rate that is far lower than historically demonstrated), the stock still looks very cheap. Of course, my viewpoint is but one of many, which is why I like to compare my valuation to what select professional analysts conclude. This adds depth and perspective.

Morningstar, a leading and well-respected stock analysis firm, rates stocks on a 5-star system.

1 star would mean a stock is substantially overvalued; 5 stars would mean a stock is substantially undervalued. 3 stars would indicate roughly fair value.

Morningstar rates CMP as a 4-star stock, with a fair value estimate of $84.00.

CFRA is another professional analysis firm, and I like to compare my valuation opinion to theirs to see if I’m out of line.

They similarly rate stocks on a 1-5 star scale, with 1 star meaning a stock is a strong sell and 5 stars meaning a stock is a strong buy. 3 stars is a hold.

CFRA rates CMP as a 4-star “BUY”, with a 12-month target price of $69.00.

I substituted the fair value calculation with the TP for the latter firm, as the FV was nonsensical within the context of their analysis. Averaging the three numbers out gives us a final valuation of $79.94, which would indicate the stock is potentially 23% undervalued right now.

Bottom line: Compass Minerals International, Inc. (CMP) is a high-quality company that controls the world’s largest active salt mine – with the mine’s scale, geographical formation, and location providing the business numerous competitive advantages. Recent diversification looks to accelerate growth off of a base that is already fairly strong. With a 4.4%+ yield, 14 consecutive years of dividend increases, and the possibility of 23% upside, this dividend growth stock is a compelling long-term investment idea.

— Jason Fieber

Note from DTA: How safe is CMP’s dividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is 46. Dividend Safety Scores range from 0 to 100. A score of 50 is average, 75 or higher is excellent, and 25 or lower is weak. With this in mind, CMP’s dividend appears average, with a moderate risk of being cut. Learn more about Dividend Safety Scores here.

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