Seeking Alpha
Long only, deep value, value, special situations
Profile| Send Message|
( followers)  

CF Industries (CF) just conducted its first investor day ("ID") in three years. While being overdue, they have been busy since their last one.

Some of the highlights:

- CF fully integrated Terra Industries - an acquisition that increased its Nitrogen Fertilizer production capacity by 140% to 6.2 million nutrient tons per annum.

- CF de-bottlenecked its production facilities - creating an incremental 100k (6.3mm total) nutrient tons of nitrogen fertilizer production capacity.

- CF recently added an incremental 300k nutrient tons (+5%) of production capacity by purchasing the minority interest in Canadian Fertilizer Limited that it did not already own. Located in Medicine Hat, Alberta, Canadian Fertilizer Limited is the largest nitrogen fertilizer plant in Canada.

- CF repurchased a significant amount of stock: 8% of its shares outstanding in 2011 (for $1bn), 4% of its stock in 2012 (for $500mm) and 6% of its stock (that they've announced so far) in 2013 (for $750mm). In total, the company has reduced its share count by 17% since it completed the purchase of Terra Industries and is within $1.8bn of additional repurchases (at current prices) to have bought back all the shares issued in the Terra acquisition. CF has $2.25 billion remaining on their current share repurchase authorization.

Since 2010's ID CF's stock has appreciated 92% through July 1. While that increase, in and of itself, is an impressive three-year gain in light of the S&P 500's 48% increase and the performance of its most widely acknowledged peers (Agrium (AGU) +26%, Mosaic (MOS) -4%, and PotashCorp (POT) -21%), CF's gain has markedly trailed its fully diluted EPS growth of 656% (not a typo) over the same period. Trailing twelve month ("TTM") EPS for CF was $4.50 (adjusted for special items) as of 6/30/2010 vs. $29.52 as of March 30, 2013. Astonishingly, despite the gaudy numbers, CF currently trades at somewhere between a 50%-70% discount to its most widely acknowledged North American peers on an enterprise value to EBITDA basis. This discount exists despite the fact that CF traded in-line with peers as recently as late 2011 (see below).

(click to enlarge)Historical EV/EBITDA CF vs. Peers

The discount is even more extreme when comparing CF to its smaller, pure play, North American nitrogen fertilizer peers (Rentech Fertilizer (RNF) and CVR Partners (UAN).

company (Calcs as of 6/25/13)

EV/TTM EBITDA

EV/TTM EBIT

P/ 2013 E (First Call Consensus)

CF*

3.1x

3.5x

7.0x

Terra Nitrogen

5.8x

6.0x

11.4x

Agrium

5.8x

6.1x

9.1x

Potash Corp

9.5x

11.0x

13.1x

Mosaic

8.0x

10.1x

13.6x

Rentech Nitrogen Partners

9.9x

11.2x

11.4x

CVR Partners

11.4x

13.4x

10.7x

Median

8.0x

10.1x

11.4x

*Pro forma for CFL acquisition, YTD announced share repurchases, and recent bond offering

What are the likely culprits holding back CF's valuation?

1) Volatility of natural gas prices - As over 85% of CF's business is nitrogen fertilizer sales and the biggest input cost to nitrogen fertilizer production is natural gas, CF has significant exposure to natural gas prices. Absent hedging, if natural gas prices rise, production costs increase and margins decrease. CF highlighted at the recent ID that natural gas makes up "70% of the cash costs" of nitrogen fertilizer production. By and large, this reliance on natural gas has been an enormous boon to CF's profitability. The noteworthy ramp in natural gas production from shale formations has resulted in lower natural gas prices. But there are those that believe that low natural gas prices may be fleeting. This camp focuses on how the dramatic decline in rig count (almost 2/3 less natural gas rigs operating now in North America than a few years ago) will arguably lead to sharply higher natural gas prices down the road.

The opposing camp, which CF is apart of, believes that sustained sub $5 natural gas prices are here to stay. They highlight that IRRs on natural gas drilling for the best-in-class producers are compelling even in the $3-$5 range. The ability to generate healthy profits with natural gas selling at $3-$5 per MMBtu range has been driven by dramatic improvements in natural gas drilling efficiency (longer length drilling, shorter set up times, multi-pad drilling, fluid recycling, etc). This thesis, that we have a "new normal" for natural gas prices, appears to hold given the continued, unabated increase in natural gas production despite historically low prices. Between 2007 and 2012, domestic natural gas production grew by almost 26% (from 19.2 trillion cubic feet of dry production in 2007 to 24.1 trillion cubic feet in 2012 according to the EIA) despite natural gas prices that are on average 60% lower in 2012 than 2007 (2007's range was $6-$8 per MMBtu vs. $2-$3.50 per MMBtu in 2012 - EIA).

Beyond the rhetoric of both camps, what's worth noting is the hedging activity of both the domestic producers (such as Southwestern Energy (SWN)) and the purchasers (such as CF). Southwestern Energy, with natural gas finding & development costs of approximately $1.50 per MMBtu and lifting costs of $1 per MMBtu (see SWN investor presentation page pp. 19-20), has been very active hedging in the low and mid $4 per MMBtu range. Over the past 18 months, CF has been active hedging natural gas prices in the sub $4 range through the purchase of calls. CF disclosed in their Q4 earnings release that 90% of natural gas needs through April were hedged with calls at prices "well below $4 per MMBtu." CF highlighted at their ID that their business has very attractive economics even with gas at $5 per MMBtu (see page 97 of their ID presentation). As a result of hedging, the decline to sub $2 per MMBtu natural gas in 2012 was not the boon to CF that it could have been. CF realized average natural gas prices of $3.39 per MMBtu (averaging the four quarters) in 2012 vs. average monthly Henry Hub natural gas prices of $2.75 as per EIA.

Similarly, the dramatic upward move of natural gas prices from the 2012 lows to the recent highs in the low $4 range in April and May has not been an issue for CF as they have been largely hedged this year (90% of natural gas needs through July as of the Q1 earnings release). In sum, CF's profitability is not dependent on rock bottom natural gas prices and CF will flourish even at natural gas price levels that many natural gas bulls are rooting for. With natural gas prices currently sub-$4 and the range seeming to be somewhere between $3.50-$4.50, this issue is arguably overplayed. The near-term likelihood of a spike in natural gas would seem remote especially as we are coming into the lower demand Summer season. According to the EIA (Natural Gas Consumption in the U.S. 2008-2013), over the last three years, the average November though March experienced 36% greater demand for natural gas than the average April through October.

2) Risk of excess capacity expansion - There are three primary risks rolled up into this one a) that North American capacity expansion negatively impacts nitrogen fertilizer pricing b) that capacity expansion increases demand for natural gas and lifts prices and c) that capacity expansions end up costing much more than forecast - decreasing returns on new capacity and further reducing free cash flow during the expansion period. Here are some perspectives on these three concerns.

Expansion's impact on product pricing: North America currently imports almost 40% (source: FERTECON - p. 38 of CF ID presentation) of its nitrogen fertilizer needs. Outside of the Middle East and some places in Africa, no region has lower cost of production of nitrogen fertilizer than the US (see page 34 of CF ID presentation). Given that transportation costs for fertilizer are substantial, strategically located North American fertilizer producers are in an attractive competitive position vs non-North American producers due to the combination of low production and transport costs. It is anticipated by CF that the rise in forecast North American production is going to displace and diminish imports. CF submits that because anticipated North American capacity expansion will still fall short of domestic needs, that the "additions {are} not expected to change {nitrogen fertilizer} floor price{s} materially." See p. 35 of ID. The analogy is similar to what we are witnessing with crude oil imports to the US being displaced by increased domestic production. It is also worth highlighting that most of the forecast increase in production will not be coming online until 2016-18 which provides three or more years of the present supply condition.

Capacity expansion's impact on natural gas pricing - This author believes that the greatest driver of natural gas pricing are a) weather and b) economics for the most efficient natural gas producers (the SWN's, Ultra Petroleum ("UPL"), Range Resources ("RRC"), Cabot Oil and Gas ("COG"), Noble Energy ("NBL") and Chesapeake's ("CHK") of the world). There is estimated to be over 100 years of natural gas supply in North America (source: Potential Gas Committee p. 49 of CF ID presentation). In this context, even with a CF estimated 32% increase in North American nitrogen fertilizer production hitting in 2016-2018 (which would presumably lead to a 32% increase in demand for Natural Gas from the North American nitrogen fertilizer industry), additional demand will, arguably, not be the primary driver of marginal natural gas pricing. Pricing is arguably more fundamentally driven by the cost of production given our abundant domestic resources and ever improving drilling efficiency. So long as drillers are able to achieve ~$2.50 per MMBtu of production and finding costs and ~$1 or less for lifting costs, natural gas should be broadly capped at $4-$5 per MMBtu.

Finally, there's the risk of cost overruns on capacity expansions. CF contends that it is benefiting from a) being one of the early movers in its expansion projects at Donaldsville, LA and Port Neal, IA allowing them to have locked up critical engineering and construction resources more cheaply and b) having the same team that did the prior Donaldsville, LA expansion/upgrade (that was delivered on time and on budget) leading these expansions. In short, this project team has a proven track record.

Author's assessment: Moderate, medium term risk. The risk of cost overruns on two simultaneous large scale projects are real, but the mitigating factors that CF has highlighted are worth keeping in mind. It should also be kept in mind that these are expansions not "greenfield" or de novo facilities being constructed where the costs and complexity are inevitably higher. Despite concerns, there are a couple of other perspectives that are rarely discussed with regards to CF's expansion plans. By establishing itself credibly and early, CF has assuredly induced more marginally capable operators/builders to rethink whether they want to compete with CF's efforts to better domestically supply the market. Also, when CF is done with its fertilizer capacity expansion, the company will have approximately 29% more product to sell.

3) Weather and corn price related risk - There are real 2013 and 2014 risks associated with the weather. Stepping back to 2012, it was almost a perfect year for nitrogen fertilizer producers. The Spring was particularly dry and warm which allowed for early corn plantings and an "extended Fall {fertilizer} application season" (CF Industries annual report). In effect, this pushed fertilizer demand up more into Q1 (from Q2) and Q3 (from Q4). The severe drought that ensued in various parts of the country during the Summer had a wonderful set-up effect for 2013. Despite the largest corn crop being planted (and fertilized) since the 1930s, the drought impacted harvest came in even lower than expected which further reduced inventories, drove high corn prices and the likelihood that more corn would be planted in 2013 than even 2012's post 1930's high. So what's happened so far in 2013? It has been a particularly wet and cold start to the year, but sure enough the US Department of Agriculture is forecasting an even greater number of corn acres planted in 2013 (97.4mm according to the June 28 Acreage report) than 2012 (97.2mm acres June WASDE report). Instead of crop planting and fertilizing being pulled forward earlier in the year, crop planting (and fertilizing) was pushed back further into Q2 due to the wet, cool weather. The effect on CF's order book has been that Q1 revenues were $190mm less (12.5% reduction) than 2012, but CF's customer advances in Q1 for Q2 were $300mm (+75%) greater than they were in Q1 2012 ($700mm vs. $400mm).

Farmgate (per ton price)

April 2012

April 2013

Difference April '12 to April '13

Current (June 10)

Difference April '13 to June '13

Ammonia

~$790

~$860

~$90

~$860

~$0

Urea

~$560

~$560

~$0

~$540

~($20)

UAN 28%

~$370

~$410

~$40

~$390

~($20)

DAP

~$720

~$620

~($100)

~$600

~($20)

Potash

~$620

~$580

~($40)

~$590

~$10

SOURCE: Farm Futures Weekly Fertilizer Review, June 18, 2013

In short, plantings this Spring have robust and CF may very well have a record June quarter and year. Nitrogen fertilizer pricing has been strong (see table above). Nitrogen fertilizer demand should be excellent (as indicated by CF's Q1 reported customer advances). Natural gas prices remain low. CF has 6% less shares outstanding and 5% more capacity with the CFL minority stake acquisition. The risk really lies in 2014 and is premised on the assumption that we have a record yield/harvest in 2013.

The question is will we have the biggest corn harvest on record (combination of record number of acres planted and high yields)? And if we have a record corn harvest, what will that do to corn prices and in turn fertilizer pricing in late 2013 and Spring 2014? The following six factors will have a meaningful impact on determining the outcome.

1) Due to the unusually late and wet planting season, it is likely that the harvest won't be as productive as it could have been. The USDA has already reduced its estimated yield per harvested acre from 158 bushels to 156.5 bushels between the May estimate and June's estimate - June WASDE report. The June 28th USDA Acreage report further states that the quality of this year's crop is meaningfully behind last year: "Overall, 63 percent of the corn crop was reported in good to excellent condition as of June 2, compared to 72 percent at the same time last year."

2) Despite the wet, cold Spring in many parts of the country, significant parts of Nebraska, Kansas, Texas, Colorado and Oklahoma continue to suffer from "severe to exceptional drought conditions" according to the "US drought monitor." As per the June 28 USDA Acreage report, those states represent approximately 20% of the forecast corn harvest.

3) CF believes that the stocks-to-use ratio (currently at more than decade lows and estimated to be at around 7.5% - see page 25 of ID) are likely to increase to only 11-12% which would be well below the decade highs (in 2000 and 2004) of almost 20%.

4) Wholesale prices for fertilizer have declined in June from earlier in the Spring (Farm Futures Weekly Fertilizer Review). This is likely due to the decline of corn futures from the $600-$700s where they've been all year through July to the low-to-mid $500s from the September 2013 contract forward. The wholesale fertilizer market is anticipating less demand under the assumption of a record corn harvest.

5) Current corn stocks are 384mm bushels less as of June 1 (at 2.764bn bushels) than they were last year at the same reading (according to the USDA Grain Stocks Report). If corn demand keeps apace with last year, corn stocks will drop to a meager 600mm bushels by September 1. With plantings delayed this year, it stands to reason that the harvest may also run later than last year making corn even scarcer over the coming months. Complement that dynamic with buyers of September and later corn futures being able to lock in corn at prices they have not been able to secure since early 2012, demand should be strong. A record corn crop is needed to replenish depleted inventories and an anticipated pick-up in demand.

6) The ethanol industry was handed a victory when the Supreme Court recently decided not to challenge the EPA's ability to mandate up to 15% blending of gasoline with ethanol. Currently, with only a 10% blend mandate in place, ethanol production accounts for 42% of the usage of the corn crop according to USDA 2013 estimates. If the EPA compels blending up to a 15% threshold, that would suggest that ethanol could require more than 60% of the corn crop (depending on the corn crops size) to meet the EPA's mandates. As ethanol usage creeps materially higher, so should the demand for domestic corn. This should prove a further support for corn and nitrogen fertilizer prices.

While odds are that this year's corn crop will be meaningfully larger than 2012's, it remains too soon to call how large this crop will ultimately tally. Based on CF's valuation, one could conclude that the market has already assumed the worst. What needs to be kept in perspective is that CF is not the only fertilizer company subject to this weather or corn crop risk. All the fertilizer manufacturers are subject to this risk to one degree or another (hence the reason for the material discount on CF stock?). According to the USDA, the corn crop represents about 40% of the US agricultural usage of each of nitrogen, phosphate, and potash fertilizers (see table below). Further as discussed earlier, if there is less demand for nitrogen fertilizer due to less corn acres planted in 2014, it is likely to more greatly impact high cost fertilizer exporters to the US.

Estimated U.S Plant Nutrient use by Corn Crop (1990-2010)

% Nitrogen used for corn crop

% Phosphate used for corn crop

% Potash used for corn crop

Average

39.8%

40.0%

40.6%

High

45.7%

47.2%

47.2%

Low

35.5%

33.8%

35.1%

Median

39.3%

38.7%

40.0%

Source: US Department of Agriculture

It should also be recognized that US consumption of nitrogen fertilizers is far more stable than that of phosphates or potash according to the US Department of Agriculture. See table below. Going back to 1990, the biggest increase from the prior year in nitrogen fertilizer use was 11% (vs. 31% for phosphates and 44% for potash). But the biggest decline in use was just 9% for nitrogen vs. 26% for phosphates and 34% for potash. The comparative lack of variability of demand begs the question - why are fertilizer producers that are more levered to the more volatile demand for phosphate and potash trading at materially higher valuation multiples than CF? Author's assessment: weather/corn price risk is significant, but overly discounted in CF's stock.

% Change Year-to-Year US Consumption (1990-2010)

Nitrogen

Phosphate

Potash

Average

0.85%

0.49%

0.46%

High

10.97%

30.65%

44.28%

Low

-8.76%

-26.12%

-33.69%

Median

0.69%

0.41%

0.37%

Source: US Department of Agriculture

4) Limited perceived "risk" of a takeout. Going back to 2009/2010, while CF ended up as the victor ultimately thwarting Agrium's hostile bid and winning the acquisition of Terra Industries, CF established itself as a worthy adversary and well capable of avoiding the clutches of an unwanted suitor. With such a history and corporate America's traditional aversion to hostile acquisition activity, what are the chances of another suitor taking a run at CF? It would appear that the market believes it highly unlikely based on a) CF's valuation disconnect vs. that of potential acquirers and b) the Agrium saga. Author's assessment: this risk is higher than the market is discounting.

The most obvious buyer, in this author's opinion, is Mosaic. Mosaic has a currency (their stock) that trades at a 150% premium on an EV/EBITDA basis to CF. They currently have no nitrogen fertilizer production capacity and have publicly announced they are exploring building a $1+ billion nitrogen fertilizer production facility. Why should Mosaic build from scratch when they could buy up the largest and premier North American operator for an EV/EBITDA multiple of say 6x? 6x EV/EBITDA would represent a 25% discount to Mosaic's current multiple and in all likelihood a discount to their all-in costs of building out de novo capacity? Mosaic is increasingly gaining its independence with each sell down by the MAC trusts and the company has significant debt capacity with the lowest debt relative to cash flow in its peer group.

Another strategic buyer could be Honeywell (HON) which has a presence in the space, ample resources, and a materially higher valuation which could make a combination highly accretive. Mosaic and Honeywell are not the only obvious buyers. PotashCorp or Agrium (try again?) could also consider a move as both already have sizable nitrogen fertilizer operations and dramatically higher EV/EBITDA multiples. Presumably neither would run into significant anti-trust issues given the existence of other large industry participants (like Koch Industries, Yara International, and a number of others). In addition, other chemical manufacturers that have significant natural gas exposure and higher valuations could potentially be logical buyers (LyondellBasell (LYB), Westlake Chemical (WLK) and Dow Chemical (DOW) as examples). Koch Industries is the most logical private company buyer. They already have significant nitrogen fertilizer and energy interests, tremendous capacity to do deals, and have recently come out with a stated interest that they plan to be more aggressive on the acquisition front. Finally, there are many interesting potential opportunistic/financial buyers including Berkshire Hathaway [(BRK.A) (BRK.B)], Carl Icahn's Icahn Enterprises (IEP), and others in the private equity and activist hedge fund industries. CF's inexpensive valuation relative to its cash flow is simply too cheap to ignore.

company

EV/TTM EBITDA

EV/TTM EBIT

P/ 2013 E (First Call Consensus)

CF

3.1x

3.5x

7.0x

Terra Nitrogen

5.8x

6.0x

11.4x

LyondellBasell

6.9x

7.5x

10.9x

Westlake Chemical

8.5x

9.2x

13.4x

Dow Chemical

11.9x

17.3x

13.7x

Honeywell

13.1x

14.5x

15.7x

Berkshire Hathaway

10.2x

11.8x

18.5x

Median

8.5x

9.2x

13.4x

5) Lack of long-term shareholders/"trading stock" risk - This risk, it could be argued, is due in no small part to investor composition. PotashCorp and Agrium (both Canadian based businesses) have strong institutional support in Canada. Mosaic has benefited from significant ownership by Cargill by way of the Mac Trusts and investment by sovereign wealth funds (like Temasek). CF has not benefited from any of these dynamics. In addition, one of the greater challenges for the long-term investor is that CF does not provide either annual or quarterly guidance. The stock is subject to volatility in both the natural gas markets and in its end product markets (which are impacted by the weather, the EPA (ethanol mandates), and various global dynamics). The fact though is that CF's competitors are also subject to many if not all of these "volatile markets" risks (yet they still trade at much higher multiples). By definition, as a "basic materials" sector stock a CF shareholder is typically going to be subject to more volatility than a stock from traditionally defensive sectors like telecom, pharma, or utilities. Despite CF's historical volatility, the stock has been a tremendous performer (up more than 10x since its IPO in 2005). Author's assessment: Given CF's excellent strategic position and cut rate valuation, this is a risk that needs to be borne and may subside over time.

Risks the author thinks the investment community should be more concerned about:

1) If CF is not opportunistic/aggressive enough about continued stock repurchase, then it may lose this opportunity to buy back more of its shares at such an inexpensive valuation. While CF's discount to peers has been ongoing for more than 18 months, the persistence of this degree of discount cannot be relied upon. These types of differentials can close quickly as they did in 2011 for CF Industries vs. peers.

2) A derivative to the prior concern, that an "opportunistic" buyer for the business comes along at a mere 30% premium for the company and the management team (either because it is an MBO or because they feel compelled by their shareholder base) takes an offer that is woefully short of fair value. The reason that this is a derivative of the prior point is if CF further increases the velocity of its share repurchase program, it should compel the per share premium on any potential takeout higher.

3) Missing out on the divergence between likely EPS in 2013 and what may be overly conservative consensus sell-side forecasts. So far in 2013, CF has announced over a 6% share count reduction and a "buy-in" of the outstanding CFL minority stake. Between those items, time adjusted for when each item closed, CF should see an approximate 8% increase in EPS vs. last year (all else being equal). Further, as highlighted earlier, nitrogen fertilizer pricing year-to-date is either higher than last year (for Ammonium or UAN) or flat with last year (Urea). More acres of corn are forecast by the FDA to be planted this year than last (meaning the likelihood of more fertilizer sales). Finally, CF's share count may very well be even lower than the 6% reduction already achieved. This author thinks it highly likely that the company will be buying back an additional $750+mm of stock before year end. The three areas holding back EPS growth relative to last year are: a) phosphate pricing is weaker than in 2012 (which at only 15% of their sales is not nearly the issue it is for Mosaic at ~66%) b) higher interest expense from the recent $1.5bn bond offering and c) potentially lower prices for fertilizer in the latter half of the year than in late 2012. Taking all this into account, this author estimates that EPS may be as high as $28-$30 per share this year vs. Street consensus of ~$25 and last year's ~$28.

Conclusion: CF's management team did an excellent job at its investor day a couple of weeks ago and has done an exemplary job managing the company since it went public in 2005. The management team presented openly and honestly at its ID. They discussed how they measure their own performance: absolute level of EBITDA, nitrogen production per share, minimizing safety/lost time incidents, and getting projects done on time and on budget. They discussed the risks to their business and how they were addressing those risks. They focused on what they were doing to drive top performance relative to their measuring sticks. Steve Wilson and crew are conservative, unflashy deliverers of remarkable value for shareholders through both astute operation of their business and smart allocation of their capital.

The only area where CF comes across as a little less forthcoming is their share repurchase program. Rather than taking an approach like DirecTV (without question the leader in the market in this author's opinion with regards to how it telegraphs and implements its share repurchase program), CF announces a big program, waits for inevitable pockets of weakness in its shares, and buys back significant chunks. CF then tells the market about it after the fact. In many ways, CF's approach to share repurchase is highly respectable and understandable. They do not want to be competing to buy back their stock at the cheapest prices, so they deliberately obfuscate on timing. This happened in the last program they announced in 2011. At the time they signaled that they would complete a $1.5BN share repurchase program within 28 months. They completed it in less than 11 months. But with investor memories short and the valuation gap so glaring, the lack of stated aggressiveness can be misleading to the less focused investor. Why does CF have only a $3B announced program over four years when Mosaic (which has less TTM EBITDA, similar investment plans, and sharply higher EV/EBITDA) is indicating that they would like to buy back as much as $5B as soon as the MAC Trusts will let them? Why isn't CF engaging in accelerated share repurchase programs to reduce the diluted share count faster and lock-in its currently low valuation? Why doesn't CF further increase leverage and buyback even more stock over a quicker period? While CF's leverage is now comparable to peers, it is low vs. some other chemical companies that would presumably salivate at the opportunity to issue more debt and buy back their stock at 3x EV/EBITDA (none below could do so as they don't have the cheap valuation).

company

DEBT/TTM EBITDA

EV/TTM EBITDA

CF

0.9x

3.2x

Agrium

1.0x

5.8x

Potash Corp

1.0x

9.5x

Mosaic

0.4x

8.0x

Rentech Nitrogen Partners

1.7x

9.9x

CVR Partners

0.9x

11.4x

Lyondell Basel

0.7x

6.9x

Westlake Chemical

0.8x

8.5x

Dow Chemical

3.2x

11.9x

Honeywell

1.5x

13.1x

Median

0.9x

10.6x

This author believes that CF, in all likelihood, will be buying back another $750mm-$1B of stock before year end and may even be in the market currently. The author's hunch is supported by the facts that:

- CF bought back the last $750mm just a few months ago at an average price ~$25 per share higher than the stock's current price.

- CF announced in its Q1 earnings release that its expansion Capex in 2013 would be $400mm less than originally forecast. Between what looks to be a stellar year and less Capex needs than originally anticipated, there is more stock repurchase capacity in 2013 than originally anticipated.

- CF had year-over-year EPS growth in Q1 of 29% and Q2 is lining up to potentially be the most profitable quarter in CF's history for the reasons discussed earlier. Point being that despite the wet Spring, it is likely that CF's results are running "ahead of plan."

- CF recently completed a $1.5bn bond offering with seemingly little immediate need for the incremental liquidity. They already had pro forma $1.1bn of cash on the balance sheet even after accounting for both the YTD $750mm of stock repurchases and the C$900mm acquisition of the minority CFL stake. CF has a highly cash generative business. Pro Forma for their debt offering they had ~$2.6bn of cash. Their cash generation over the rest of the year should more than cover their capex needs and incremental repurchases. Upshot: plenty of capacity for more share repurchase.

- This is a deservedly proud and astute management team. Their operating performance since going public in 2005 is something that may be unmatched in public markets for any company of its size. Revenues have grown from $1.95 billion in 2006 to about $6bn on TTM basis (3x). Diluted EPS over the same period has gone from $0.60 to $29.52 (~50x)! At the ID, Stephen Wilson indicated on a number of occasions how he was proud his management team's and the company's overall performance. He and his team deserve to be proud. CF's undervaluation would seem to be one of the primary reasons why CF did its first ID in three years. It is also, presumably, a fundamental reason why CF started out 2013 so aggressively on the share repurchase front and why CF did its first investment grade bond deal to further expand that initiative.

In sum, despite the previously discussed risks, CF's current valuation seems materially and unjustifiably low. The risks currently weighing on the company's valuation should be well appreciated and are overly discounted in the stock price. It may or may not take a while for CF's valuation to come back in-line with peers, but at the end of the day, the biggest risk on CF may be for those underweight losing out on the ability to buy dollars for 40 cents. Or more modestly, the greatest risk for those underexposed may be for them to miss out on another 90+% gain between the investor day of a few weeks ago and whenever they have their next one (maybe another three years from now but hopefully sooner).

CF Warranted Share Price

(click to enlarge)

Disclaimers: all information gathered from sources believed to be accurate, but the accuracy of the information cannot be guaranteed. The above represents the opinions of the author and should not be relied upon for buy or sell decisions. Past performance is no guarantee of future results.

Source: Buying $1 For 40 Cents: CF Industries

Additional disclosure: Author is a Registered Investment Adviser and principal of Four Tree Island Advisory LLC.