DGI Adventure 07-18-16 Sold Cash Secured Put + Investment Thesis – Compass Minerals International Inc. (CMP) – $70.00 strike – Aug 19 Expiration

This trade was actually executed on Friday 07/15/16. I didn’t get a chance to write about it until today.

Please visit the core philosophies article on my investment thesis process for a deeper explanation of the components of this article.

Dividend Cycle

CMP should go ex-dividend towards the end of August. I expect the payout to be $0.695/share, where it’s been for the first two quarters of this year. It’s reasonable to expect management to raise the dividend sometime next year. After all, they’ve raised it 13 years in a row so far, making them a dividend contender. This trade should expire just before the ex-dividend date. The premium exceeds the dividend payout by ~30%.

Investment

The QC (Quantitative Case)

*As a mining company, CMP doesn’t exactly have smooth cash flows year over year. Just look at the cash flow statement:

CMP Cash Flow Statement Previous 5 Years – Courtesy Morningstar.com

One year they make $252M in operating cash flow, the next year it’s only $152M. They maintain a pretty constant capex spending rate, because you have to. If you look at the aggregate values over the last 5 years, they’ve made $1.02B in operating cash flow, and invested $906M. Last year was an unusually big capex year, which I wouldn’t expect to continue.

The fact that TTM free cash flow is negative is no bueno though. That raises yellow flags no matter how you slice it…

SPL (Strike Price Logic)

There aren’t a lot of options available for CMP (this contract had a total volume of 3 on Friday…I was one of them).

There are a minimum number of expiries and strikes. If I was going to trade out of the money, it was either a $70.00 strike or $65.00. $65 would have been awesome, but way too much downside protection to expect a decent yield. So $70.00 it was. Didn’t hurt that that represents essentially a 4% dividend yield.

QWaF (Qualitative Warm and Fuzzy)

If you’re in the salt mining business, the location of your mines is a huge component of your competitive advantage. Salt isn’t very expensive on $/lb basis, which means shipping costs ultimately play a big role in the all-in delivered cost. Compass Minerals has the premo mine locations in North America…especially the west…and it’s not like anyone’s going to discover new salt mine locations any time soon. Their operations in Salt Lake City also represent one of only three naturally occurring brine sources that produce sulfate of potash (SOP). SOP is a highly specialized fertilizer that commands a premium over plain old potash fertilizers (almond orchards in CA are their biggest market).

It’s highly unlikely that anyone’s going to come up with some highfalutin new deicing technology to replace road salt. And it’s not like municipalities and counties can just decide to forgo those costs.

So CMP enjoys a wide moat, cost-advantaged production position on a commodity with a relatively stable price/demand profile. Which means that as far as mining companies go, CMP is relatively boring. 

I like boring investments that yield 4% and have a history of raising their dividend.

CPR (Cold and Prickly Risks)

Since their biggest product is road salt for deicing, CMP doesn’t do particularly well in mild winters. No one really knows what winters are going to look like as the climate changes. If winter went away, CMP would go away.

Likewise, SOP isn’t a particularly useful product without over 1M acres of almond orchards in California. While we can’t say with 100% certainty what awaits California’s agribusiness industry as a result of climate change, smart money says our current almond production is probably unsustainable.

That’s okay though. Just because it’s unsustainable, doesn’t mean that we’re going to stop growing almonds. In case you hadn’t heard, water flows uphill towards money and power in California, and those almond farmers are some rich and powerful motherfuckers.

I’m not too worried about winter going away and eliminating the need for road salt either. It might get more extreme, which means the good years for CMP will be really good and the tight years will be really tight. But management seems to be pretty prudent about managing seasonality.

This probably isn’t a 50 year investment, but I don’t think things should change too much over the next say 5 to 10?

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