For a $2 billion company, Compass Minerals CMP is surprisingly full of superlatives. The company owns two world-class assets--the largest rock salt mine in the world, and the largest solar evaporation potash facility in North America. This unlikely pairing also happens to have some of the lowest production costs in the world. Based on these irreplaceable assets, Morningstar awards Compass with its highest possible business quality ratings--Wide Economic Moat and Positive Moat Trend.

I've had my eye on Compass off and on for a while. It's a great company that is well positioned to systematically create shareholder value for many years. Given our new focus on firms strengthening their competitive advantages, Compass could make an ideal holding for our portfolio.

World-Class Assets

Let's start with the better-known commodity--salt. Although the largest users of salt in the United States are chemical plants (salt provides the chlorine atoms to make things in PVC), Compass' primary product is highway de-icing salt, which accounts for the vast majority of volumes. The remainder, which typically has higher purity content, goes into a variety of things such as animal feed, consumer de-icing, food processing, and water softening. Collectively, these ancillary uses form the Consumer & Industrial segment, which commands pricing about 3 times that of simple bulk de-icing salt.

Despite the lower pricing, highway de-icing is probably a better business that makes full use of the company's cost-advantaged assets. Compass' flagship mine, Goderich, is thousands of feet beneath Lake Huron in Ontario, Canada. This is the largest and one of the lowest-cost rock salt mines in the world, with a recently expanded 9-million-ton-per-year capacity. There are two keys to Goderich's success: The most important is geology. Prehistoric oceans have endowed Goderich with a mammoth salt seam--up to 100 feet in height. This is several times as high as the average salt mine in North America. The second key factor is location. Goderich is on Lake Huron and has a deep-water port. Shipping costs are a large percentage of final delivered cost for salt, so Compass' efficient water transportation, combined with an extensive system of 95 salt depots over its service area, is not easy to replicate. Goderich serves a broad swathe of the Snow Belt in the Upper Midwest and along the St. Lawrence River system, as well as most of southeastern Canada. Needless to say, these are some of the snowiest heavily populated areas of North America. Compass has two other main rock salt mines that are significantly smaller than Goderich. There's Cote Blanche in Louisiana, which uses the Mississippi-linked river systems, and Winsford in the United Kingdom that serves a crescent on the western side of the country. To round out the de-icing salt portfolio, Compass' solar evaporation facility in Utah produces salt as a co-product along with potash. This is sent into the northern Great Plains and Rockies.

As you might imagine, salt use isn't terribly sensitive to the economy. There is no cheaper way to de-ice highways, and the cost of traffic accidents far outweighs the cost of rock salt. Each year, Compass participates in thousands of auctions run by governments of all stripes. In general, the current year's pricing is a bit higher than the year before. Over the past few decades, rock salt prices have gone up 3%-4% a year, and volumes up about 1%. Of course, volumes tend to fluctuate quite a bit based on the weather. Compass had a huge winter in 2007-08, and volumes haven't quite recovered since. That aside, selling salt tends to generate solid operating margins (low 20%s most years). Compass' cost structure is highly variable, so it adjusts production easily to meet demand and preserve margins in poor years. Cash flow tends to be steady as well, allowing the company to return capital to shareholders as well as invest in several exciting growth projects.

The biggest of these growth projects is the firm's potash business. Conventional potash, going by the chemical symbol of KCl, is a potassium-providing fertilizer. Potassium, of course, is one of the "holy trinity" of plant nutrition: nitrogen, phosphorous, and potassium, or NPK. Compass, however, provides a slightly different form of potash, going by the chemical symbol of K2SO4. In English, that's potassium sulfate, sulfate of potash, or SOP for short. The difference between KCl (potassium chloride) and SOP is that the latter is used on crops intolerant of chlorine. Thankfully, this involves some of the highest-value crops grown in the world--vegetables, fruits, nuts, potatoes, tobacco, turfgrass, and cotton, among others. Compass claims that these, planted on 4% of our farmland, produces 40% of our agriculture by value. As a result, K2SO4 tends to sell for $100-$150 per ton premium to generic potash.

You wouldn't think producing fertilizer is a good business, but once again, Compass has a world-class asset at its disposal. Almost all of its production comes from the Great Salt Lake in Utah, whose saline waters are full of valuable minerals. For more than four decades, Compass has operated a 43,000-acre solar evaporation system, using water from the Salt Lake's brinier northern arm. In essence, water is pumped into a series of huge and shallow ponds, and the sun, over the course of three years, evaporates the water and leaves minerals--potash, salt, and magnesium chloride (a super de-icer and specialty fertilizer).

The Great Salt Lake is, to say the least, an unusual geographical feature. Its salty waters have been distilled by a hot desert sun for millennia, and are literally impossible for a swimmer to sink into. Compass has a unique lease arrangement with the government, and it's probably impossible to get 43,000 acres by the lake to replicate this arrangement. Only one other place in the Western Hemisphere has anything similar to this--a lakeside facility in the high deserts of Chile. Of course, the biggest benefit to having the sun do most of one's work is that it's largely free. As such, Compass has some of the lowest SOP production costs in the world. China, the world's largest consumer and producer of SOP, is largely reduced to buying KCl and reacting it with sulfuric acid, producing SOP as well as hydrochloric acid. This is a much higher cost, as well as a much less environmentally friendly procedure.

Being a low-cost provider, Compass makes very good margins on its fertilizer segment. SOP contributes a bit less than 20% of sales, but more like a third of EBITDA. With luck, this figure will increase further in the coming years.

An Expanding Moat

For all the above-mentioned reasons, it should be fairly clear that Compass has a pretty solid economic moat. But the relevant question for us is: How are these advantages getting stronger?

I think the biggest driver is the company's efforts to expand production at its Utah ponds. Today, Compass has the capacity (assuming good weather) to produce about 375,000 tons of SOP per year. This is a lot of potash, but it could be even more. It turns out one key weakness of the Utah facility is that a lot of brine is seeping through the soil on the sides of the ponds. Over the three-year SOP production cycle, even slow leakage adds up to a lot of material. Compass has recently begun working on a practical solution: it is driving concrete "dikes" into the sides of the ponds, which will make it much harder for brine to escape through the subsoil.

It will take several years for us to see the benefits. But once everything is up and running, this "Phase II" expansion will add up to 220,000 tons of capacity, or an increase of 60%. Beyond that is "Phase III," which we are not currently putting a lot of hope on, but may turn out to be a huge call option. Compass is currently trying to obtain leases and permits to construct another 61,000 acres of evaporation ponds. This is an extremely ambitious endeavor that will face a variety of environmental challenges, so success is many years out, at best. However, if Compass manages to pull this off, production in Utah could increase another 140% in the years ahead.

Beyond simply increasing SOP production, the Phase II expansion has several other merits. First, because operating costs at the ponds are more fixed than variable, the extra 220,000 tons will materially lower production costs per ton, moving Compass even lower on the global SOP cost curve. Moreover, production of co-products salt and magnesium chloride will increase greatly. The incremental margins should be very high, further helping the overall cost profile of the Utah ponds because these products are literally laying on the ground waiting for a shovel to pick them up. Compass is busy trying to expand the market for magnesium chloride, especially as a fertilizer. This will be important as it commands a substantial price premium over salt (more than $100 per ton, versus $50).

Recent Unfortunate Events

If you pull up CMP's stock chart, you may notice that it hasn't gone anywhere since 2010, and in fact, is trading for a lower level than it did in 2008. Although Compass is fundamentally a strong company, a few things hadn't gone its way in the last year or two.

Most dramatically, a tornado struck its Goderich mine last summer. The same tornado somehow managed to hit mine buildings several miles apart, causing substantial damage. The underground mining works were obviously unaffected, but the top-side power distribution and salt processing facilities were mangled, hurting both production and costs. Although insurance will eventually cover most of the damage, the near-term effect was bad.

Second, weather has proven to be a cruel mistress for both the salt and potash segments. This past winter was one of the driest and warmest in recent memory. Here in Chicago, normally a wintry city, I recall only two snows that stayed on the ground for more than a few days. In the first quarter, Compass recently announced that salt volumes are down 27%. Moreover, following mild winters, Compass' pricing power is usually reduced. So we are expecting price increases well below the 3%-4% average in the coming bidding season. Things were just as bad in Utah. During the last summer, termed the "evaporation season," the weather was cool and wet. This is likely to disrupt the production cycle for several quarters, reducing harvests and forcing Compass to buy high-priced KCl as feedstock to make SOP. For 2012, production costs per ton for SOP will likely be $85, or 30%, higher than for 2011.

Also, the potash industry went through a sort of bubble in 2008, when KCl prices verged on $800 per ton (and Compass was charging close to $1000 for SOP). Only a few years prior, prices had been more like $200 per ton. No surprise, pricing quickly collapsed by half during the financial crisis. It has come back a bit since, but is still well off its highs. In my opinion, we are unlikely to see the heady days of 2008 again for many years.

While the potash boom is likely over for the foreseeable future, the weather-related events are likely anomalies. Utah is normally hot in the summer, and it usually snows quite a bit in Chicago. It's a good bet that normalcy will eventually reassert itself.

Some Risks and Valuation

To me, an investment in Compass has two big risks, one near term and one long term. The long-term risk is much more important if we want to be long-term stockholders, so we'll address that first.

The potash boom a few years ago, though relatively short, had one lasting consequence: It showed people that there might be a lot of money to be made in potash. Indeed, even after the collapse in 2009 and the rebound since, prices are a lot higher than they were in 2006-07, and miners are making healthy margins.

As such, potash projects are now "hot" for miners of all stripes. The incumbent giants like PotashCorp and Mosaic are expanding capacity, but upstarts like Vale, Agrium, BHP, and K+S are jumping into the fray as well. Morningstar tracks all these plans, harebrained and otherwise--and there are about 51 million tons of capacity willing to come online between now and 2020, if everything goes to plan. Current annual potash demand is a bit less than 60 million tons, and grows at perhaps 3%-3.5% per year. So the expansions, if everything works perfectly, have the potential to swamp the market.

Of course, not everything will work perfectly. Of the 51 million tons on the drawing board, 22 million is "brownfield," or expansions of current mines. These are generally lower cost and have a higher probability of success. Many of the "greenfield" projects (brand-new mines), are likely to run into problems and delays.

Nevertheless, it seems certain that a lot of potash will come onto the world markets in the next decade, and that pricing is more likely than not to stagnate or fall. As such, we are currently modeling falling realizations for Compass (down 15% in the next five years), which eats up some of the dramatic capacity expansion. Thankfully, because costs are falling as well, margins should remain solid.

The problem of course, is that the potash market falls even more than we anticipate. This will have a big impact on Compass' growth and earnings over the foreseeable future. While the company will make money in nearly any conceivable scenario, we do not have much of a margin of safety buying at the current valuation if margins were to compress and earnings stagnate.

The next risk will only be a factor in the next year or so. As we outlined earlier, Compass has several near-term challenges to overcome. Salt volumes will be poor, pricing will be less robust than usual, and costs for potash production will rise dramatically. As such, 2012 earnings will likely be poor. In fact, I think Compass is likely to produce $3.50-$3.80 per share, versus current expectations of $4.60. In fact, I think it's nearly impossible for the company to make $4.60, which roughly equals earnings from 2011, without many of the current problems. Based on my lower estimates, the stock at $73 isn't cheap: about 20 times earnings. Therefore, there is certainly room for investor sentiment to come down, which may spell a buying opportunity.

I haven't decided if I want to buy Compass today or not. It's a great company with some very interesting opportunities. I think the most likely possibility is that it makes good money for us in the long run. But on the other hand, the margin of safety today isn't quite as high as I would like--I would dearly love to buy shares in the low to mid-$60s. Of course, there are the near-term implications to consider. For now, we'll likely continue to keep an eye on the company. If a more favorable price emerges, we can begin to buy stock, and hopefully get a further opportunity to average down if investors really panic about 2012's prospects.

--Mike

This earnings season is wrapping up on a high note for us. Two of our most recent reports, Core-Mark CORE and AMN Health AHS both turned in very good results. Here are the highlights:

Core-Mark

Core-Mark delivered another impressive quarter. Compared with last year, revenue improved 22% to $2.1 billion, gross profits were up 19% to $110 million, EBITDA increased 59% to $17 million, and adjusted earnings per share was $0.39, versus $0.13. The Forrest City acquisition and the Alimentation contract were critical to driving the stronger results, but Core-Mark continues to execute extremely well. Operating expenses adjusted for the Forrest City deal and the Florida expansion were down about 21 basis points from last year, which is great news, especially when Core-Mark's operating margin is well under half a percent.

The company seems to be setting up a good 2012. It's gaining share in cigarettes, with sales up nearly 18% versus a 4% sales decline for the industry category as a whole. Core-Mark has around 12% market share in cigarettes, so there are still opportunities for share gains. The recent acquisitions have shifted its cigarette efforts toward fair trade states, where cigarette prices tend to be higher, and it earns additional income from its cost-plus pricing model. In addition, vendor consolidation and fresh initiatives are off to a roaring start, and Core-Mark is on track for about $120 million in incremental sales this year, with some upside potential here. The firm continues to focus on solid capital allocation, and has repeatedly highlighted that it will take national contracts at a lower margin in exchange for the lower investment requirements, which keeps returns on capital very high. We always like to see this type of shareholder-oriented thinking at our companies.

Overall, we're quite happy with the quarter. At nearly $43 per share, Core-Mark doesn't strike us as a huge bargain at perhaps 11-12 times adjusted 2012 earnings per share of $3.50-$3.75. However, for investors interested in a reasonably high-quality firm at a decent price, we think Core-Mark is a good choice. As it stands, it remains a long-term holding for us, as we continue to see its competitive advantages improving over time, thanks to the natural benefits of additional scale and networks in a distribution business.

AMN Healthcare

Although the stock price has been incredibly volatile over the past 12 months, AMN's actual operating results have been surprisingly placid. As the economy seems to be bouncing slowly along a bottom, the firm has only recovered a small part of the revenue it lost since 2008. Still, growth proceeds slowly, with the most recent quarter up 5% from last year.

But this low rate of growth covers up a few "green shoots," and I think more bullish signs are emerging. For example, the vital Nurse business (which makes up most of the revenue) is actually up 14% from a year ago, despite a very mild flu season. Order counts are apparently up even more as spring wore on, and the company reported that more nurses are becoming willing to work on assignment as the labor market is tightening. Case in point--wages for nurses are rising now, when wage growth in the rest of the economy is largely stagnant. All these bode well for faster and more sustainable revenue growth for the next 12 months than the preceding 12.

Furthermore, the MedFinders acquisition seems to be finally bearing operational fruit. As restructuring and integration costs fell off, the income statement and the operational synergies begin to take shape, adjusted EBITDA rose to $17.5 million, the highest in many quarters. Granted, though gross margins were a little higher than average and will likely decline slightly, there is now a clear upward trend in EBITDA, and free cash generation is improving greatly as well. Perhaps as a sign of its stronger financial standing, the company renegotiated its credit agreement (in exchange for a fee) to lower run rate interest expenses by about $1.5 million per quarter. I expect the pace of deleveraging, which had been slow so far, to quicken from this point.

I think one of the biggest mistakes I made in buying AMN when I did a few years ago was to underestimate the extent that its results lag the overall market. During the last recession almost a decade ago, revenue and profits actually bottomed in 2004. By that time, the general economy and stock market were well into their respective recoveries.

So, the price of our being (way) early this go-around was sitting on losses (down 24%) while the market soared. That said, with signs of improvement firming gradually quarter by quarter, I'm feeling more optimistic that the road to profits is much more clearly marked today than it had ever been for the last two-plus years.

--Mike & Stephen

The impressive market rally we've witnessed since October 2011 finally took a pause last month as European concerns return to the headlines. The S&P lost about 0.63% for the month, while we lost 0.4%. For the year, we are up 16.9%, versus the index at 11.9%. However, since January 2010, we are up 17.9% versus 31.5% for the S&P.

The reason we had a decent April, despite suffering losses in most of our individual positions, was that some of our largest holdings performed well. Carter's (CRI), our largest investment, increased 9% on strong earnings. AMN Healthcare (AHS) was up 11%, in part because the company managed to convince its bankers to reduce its interest rates. TripAdvisor (TRIP), which was a modest position, rose 5% as well on no material news. This stock is enjoying a big day today, which we'll address in a bit.

On the losers column, we had AMD leading the pack at an 8.3% loss. My trigger finger was twitching madly on the day it reported earnings, but unfortunately I held back (stupidly), and the stock quickly lost $1 in value. In either case, we are likely to see AMD exit the Opportunistic Investor soon. Life Technologies (LIFE), Core-Mark (CORE), Autoliv (ALV), and Anixter (AXE), all lost between 5% and 6%. Of these, weakness in Europe and Asia are clearly impacting Autoliv the most. 2012 growth will be extremely anemic, with potential for slightly falling margins. Cloud Peak (CLD) continued to decline, losing another 3.4%. Natural gas has rebounded slightly in the last few weeks, which is breathing a little sign of life into energy-linked stocks, including Cloud. Nevertheless, the stock is down about a third year to date, and what happens this summer will have a big impact on our results over the next two years. I have my fingers crossed for a blister this July.

With earnings season once again in full swing, there are a few additional pieces of news to report. First, Charles Schwab (SCHW) put out strong numbers in the first quarter. The interest rate environment was terrible, of course, but the firm continued to attract a lot of new assets, and trading activity was strong. The firm is far from being out of the woods, but after listening to the conference call, I feel very comfortable that the management team has the firm's long-term strength in mind. I am very tempted to buy some more stock in the near future.

Last night, TripAdvisor (TRIP) released excellent first-quarter results. The stock is up about 17% today, and we have a paper profit of nearly 70% in a short period of time. As we talked about last time TRIP reported, investors had thought 2012 was a "lost year," with several large headwinds. As it turns out, these fears, while valid, were a little overblown. Whereas people were expecting revenue growth in the mid to high teens, TripAdvisor clocked in at 23% in the first quarter. Traffic counts at all of the company's properties continue to soar (+39%, according to Comscore), and the feared decline from Expedia was much less than expected. The company disclosed that traffic growth at its international sites are 3 times as fast as the core U.S. site, which I took to be a positive. Remember, Google, and especially its base of reviews, is much weaker in many of these international locations. Thus, entrenching its first-mover advantage in these sometimes less net-savvy locales is a positive for TripAdvisor's economic moat. Margins were still weak, as management is investing heavily in a bunch of growth prospects. Given the fast evolving competitive landscape, I think this is the right thing to do.

While I'm largely happy with our investment, TripAdvisor is now decidedly a rich stock trading for about 30 times 2012 earnings. As always, Google is nipping at its heels. Over the past few years, Google has amassed a large base of reviews about hotels, restaurants, and attractions, especially in the U.S. Late last year, Google launched an "experiment" called Hotel Finder, leveraging these reviews. It's actually a pretty neat website, with much better mapping tools than TripAdvisor.com, along with some other innovative features. I have no doubt Google will continue to improve its offerings, which is not only a threat to TripAdvisor, but also to companies like Expedia and Priceline in the long run. I don't think Google's site is compelling enough to threaten Trip yet, but it hasn't put its full firepower behind the Hotels gambit either. We'll have to keep a very close eye on things, and if TripAdvisor ends up with a truly outrageous valuation, we'd probably be sellers.

Cash and Our Plans

At the end of last month, we had drawn our cash down to 8% of our portfolio. After selling several positions--none of which carried positive moat trend ratings--we are back up to 20%. If we sell AMD soon and do not buy anything else, we'd be looking at over 25%. It's not our intention to carry this much cash, and we'll have to find a way to deploy some of it soon. As we've mentioned recently, we will probably invest a chunk of this free capital into some of our existing positions.

In our March performance update, we also mentioned that we were looking at Compass Minerals (CMP) and OpenTable (OPEN). We recently highlighted Compass, which reported very soft first-quarter earnings a few days ago. Unfortunately, the market essentially ignored the results, and seems ready to forgive the company for a poor 2012. We hope that the salt contract negotiations will surprise to the downside in pricing, which may create a buying opportunity. Meanwhile, I don't think it's a good idea to jump in at this price. The margin of safety is not large.

OpenTable was another story. A month ago, I was very intrigued by the company, and was bullish on its prospects. However, during the past weeks, we (meaning Morningstar analysts) engaged in an extensive debate over Open's prospects. Looking deeper at the industry and the company's operating metrics, we became much more bearish. In fact, during our trend review process, we stripped OpenTable of its positive trend rating (it's now rated stable), and I think there is a good case to be made for a negative rating. In short, switching costs are falling, competition is intensifying, and worst of all, diners just do not seem to be that engaged with the opentable.com platform. In fact, more and more reservations seem to be routed through restaurants' individual sites as opposed to the central Opentable site. With that, we actually had to scrap the article we were writing for this company. On the plus side, we were fortunate in our decision. OpenTable reported disappointing results last night, with alarmingly decelerating growth, and the stock was clobbered today.

Watch List Updates

In the future, for this section, I will try to highlight at least a couple of companies that either were awarded positive moat trend ratings or had them stripped away in the last month. I won't be able to address everything, but instead am keeping it to the interesting ones.

Vera Bradley (VRA)

In April, we awarded positive trend ratings to a few specialty pharmaceutical companies: Momenta (MNTA) and Regeneron (REGN), which I unfortunately don't have a great understanding of. However, we also awarded the positive rating to a small, newly public retailer: Vera Bradley (VRA).

Vera Bradley is a fast-growing retailer famous for its cheerful, slightly funky, and vividly patterned purses and tote bags. Sales have grown very quickly in recent years, with strength in all of the firm's distribution channels. The company had remained very small throughout most of its 30-year existence, but built a loyal following. It's only in the last few years that it's made a big effort to grow out of its shell.

Despite the growth, absolute sales remain very modest, at $460 million, and valuation is not crazy (20 times 2011 earnings). If this brand has some long-term growth prospects, the stock might be quite cheap. VRA is currently trading for a 20% discount to our fair value estimate. I'm intrigued and might be taking a closer look.

Best Ideas

Icon (ICLR) / Covance (CVD)

I've consistently recommended these names for many months now, and the thesis has not changed. In fact, Covance just reported decent first-quarter results a few minutes ago, with modest growth and strong bookings. The company also bought about 10% of its stock in the quarter, which I think is a very good decision.

Charles Schwab (SCHW)

Schwab is probably squarely on top of my "averaging down" list. They are getting to the point where interest rates can't physically get much worse, and are able to slowly gain operating leverage simply through modest asset growth and upselling advisory services. With the bank segment no longer growing quickly, Schwab should be in a good position to start releasing capital to shareholders in the coming months and years. I don't know when rates will start improving, but I'm fairly confident that Schwab's fortunes are decidedly rebounding off a very rocky bottom.

Covidien (COV)

Covidien hasn't done much since we bought the stock. The firm actually released very positive first-quarter earnings last week, with higher-than-expected growth in devices. R&D spending continues to increase rapidly, and is near the firm's long-term goals. I sense that we are not far from the point of positive operating leverage, as investment in sales and R&D reach equilibrium. Valuation is not crazy low, but I think this is a good long-term holding for us.

--Mike

For the last couple of weeks, we've been saying we'll sell AMD for a while and average down on several other companies in our portfolio. We put that into action today. Here are the details:

Sold 1,149 shares of Advanced Micro Devices (AMD) at $7.39 for total proceeds $8,483.22 after commissions

Bought 27 shares of Covidien (COV) at $55.46 for total outlays of $1,507.41
Bought 22 shares of Anixter (AXE) at $69.03 for total outlays of $1,528.65
Bought 150 shares of Charles Schwab (SCHW) at $13.71 for total outlays of $2,066.48
Bought 24 shares of Autoliv (ALV) at $62.35 for total outlays of $1,506.39
Bought 35 shares of Baker Hughes (BHI) at $42.91 for total outlays $1,512.19
Bought 22 shares of Covance (CVD) at $47.51 for total outlays of $1,055.19

Total Outlays: $9,176.31 after commissions.

This series of transactions roughly maintained our total cash levels (about 20% of the portfolio) after selling a large position in AMD. We originally had high hopes for this investment, but after several major disappointments, our thesis was clearly not working out. We ended up losing about 10% from our average cost basis, which, while not a fatal mistake, was certainly not what we were looking for.

In order to keep our cash balance at a reasonable level, we decided to increase our stakes mildly in six of our holdings. We consider all of these long-term investments. Some have hair on them--especially Baker Hughes--but all are trading for very reasonable valuations, and almost all are trading for large discounts to their fair value estimates. Needless to say, in terms of where investors should put "new money," these are on the top of our recommended list, as well.

--Mike