Dividend payers often have an outdated reputation for being stodgy, mature, low-growth companies. This is far from the truth. In the past 40 years dividend growers returned 9.5% annually compared with only 1.6% for non-dividend payers, with significantly lower volatility.
Agrium Inc. (TSX:AGU)(NYSE:AGU) can be expected to benefit from this edge over time, as management has made clear its intention to make returning cash to shareholders a key priority. This intention was signaled earlier in 2015 when management decided to raise its target payout ratio from 25-35% of free cash flow, to 40-50%, and repurchase 5% of its outstanding shares.
Agrium’s Q1 2015 earnings confirmed this intention, as management increased the dividend 12% to $3.50 per share. While management’s focus on returning cash is a key component of Agrium’s transition into a top dividend payer, the real driver of this comes from the fundamentals of the company’s business.
Agrium has significant and stable earnings growth ahead
The first important quality in a top dividend payer is what was just mentioned—management’s prioritizing of returning cash to shareholders. Ultimately, though, dividend growth needs to be fueled by the businesses long-term earnings power, and the company’s ability to grow earnings in a way that supports dividend increases.
Agrium is currently an integrated business, with its wholesale fertilizer segment generating about half of its earnings, and its retail segment generating the other half. It is the integration between a volatile commodity-driven wholesale segment, and a stable, cash flow-producing retail segment that provides Agrium with the basic formula it needs to produce a stable, growing dividend.
On the wholesale side, Agrium is in the process of expanding its nitrogen and potash capacity. The company is increasing its potash capacity by one million tons—from two to three million—via its recently completed Vanscoy potash mine expansion. This production will ramp up over the next year or two, and bring Agrium’s cash flow up with it.
Agrium is also growing its nitrogen business, which currently represents the largest segment of its wholesale business. Agrium is expecting to grow capacity from five to seven million tons through the expansion of its Borger nitrogen facility, as well as its expansions in Egypt and Argentina.
Agrium possesses a few key competitive advantages that should work to maintain both potash and nitrogen margins as these expansions progress. Agrium’s nitrogen operations in Alberta have access to some of the cheapest natural gas in the world, which in turn supports Agrium’s margins, and Agrium’s wholesale operations in general benefit from lower freight costs due to proximity to end markets.
These capacity expansions will allow Agrium to take advantage of several positive, long-term macroeconomic trends. These include increasing protein demand from China and India, and decreasing arable land, both of which will require increased fertilizer use. In addition, both China and India vastly underutilize fertilizer (particularly potash) compared with both the U.S. and global averages, and this should increase as both companies look to modernize their agricultural sectors.
Agrium will see huge free-cash-flow growth as its expansions finish
The above factors will drive Agrium’s earnings before income, taxes, depreciation, and amortization (EBITDA) forward by an estimated 32-46% over the next three years, which represents an impressive 10-14% compound annual growth rate (CAGR).
In addition to this earnings growth, Agrium will see its capital expenditures come down significantly, as the Vanscoy and Borger expansions finish. Agrium spent $2.5 billion on total capital expenditures in 2014, and after 2015, this is expected to be a low $800 million.
The result of an EBITDA growing at a CAGR of 14%, and rapidly falling capital expenditures, will result in enormous free cash flow. With Agrium’s commitment to pay out a larger portion of free cash flow, the buyback of shares (which reduces the total share count), and the possibility of a nearly $6 per share dividend by 2017, this is likely.
The math seems to check out on this—currently, Agrium sees potential for $1.6 billion of free cash flow by 2017. This would work out to $11.67 per share, and with a 50% payout ratio, Agrium could have a $5.83 per share dividend by 2017.
