CF Industries (NYSE:CF), a global leader in fertilizer manufacturing and distribution, is the second largest nitrogen fertilizer producer in the world and the third largest phosphate fertilizer producer among public companies. In North America the company is the largest manufacturer and distributor of nitrogen. In 2012, CF generated more than 80% of its revenues from its Nitrogen segment.
The company reported 2Q13 adjusted EPS of $8.53 beating consensus estimates of $7.62 by 12%. The headline EPS of $8.38 was adjusted for an unrealized loss of -$0.19 per share from natural gas derivatives and a $0.04 per share gain from FX. Higher than expected realized prices for nitrogen were the primary reason of the beat.
Global nitrogen prices have been under pressure in 1H13 due to increase global exports, particularly from China, where weak domestic consumption, lower coal prices, and reduced export tariffs have driven a collapse in floor Chinese production costs to below $300 per metric ton and have resulted in urea oversupply in China.
CF remains cautious on the near term nitrogen pricing primarily due to increased supply from China; however, the company also sees more than expected maintenance outages and continued gas supply problems in Egypt, Pakistan, Trinidad, and Argentina as the potential offsetting factors for higher Chinese output.
Although the near-term challenges to nitrogen pricing remain the outlook for nitrogen fertilizer volumes remains positive for 2014 planting season because of high estimated planted acreage. CF expects 92 million acres of corn planting in 2014, down from roughly 97 million in 2013, but still high by historical standards. Moreover, despite a lower nitrogen pricing environment, solid farmer economics and a wide disparity in global energy prices should also continue to support outsize returns for North American producers.
CF Finds Itself To Be Undervalued
During the 2Q13, CF repurchased an additional 2.6 million shares for a total of $474.2 million, implying an average price of $182 per share. The second quarter repurchases bring the 1H13 total to 5.1 million for a total of $982 million.
CF is aggressively repurchasing shares, and has bought $1.1 billion worth of shares YTD. The 5.8 million shares bought YTD (0.7 million bought in the first month of 3Q13); represent about 9% of company's shares outstanding at the beginning of the year. CF has a $3.0 billion long-term share repurchase authorization, and the company's strategy appears to be to repurchase shares meaningfully at current prices rather than delaying. The $3.0 billion share repurchase program ends in 2016, but the pace of buyback suggests that it will be completed well before the 2016 expiration.
Moreover, as activist shareholders including hedge fund Third Point LLC are asking for more dividends, the company said that it is open to examining how it returns cash to investors, suggesting that it is open to the idea of dividend increases.
Chairman and Chief Executive Officer, Stephen R. Wilson, commenting on the issue of returning cash to shareholders said, "We continue to have a significant amount of discussion with investors, among management and with our Board of Directors about what methods of returning cash to shareholders are most appropriate for CF Industries. We are -- and we continuously assess the best path forward in this dimension of our business. To date, our analysis led us to the belief that executing share buybacks has been the best way for us to return cash to shareholders, especially since we believe that the earnings potential of the company is not fully reflected in the market price of our stock".
Expansion Projects On Track
CF is also on track to be one of the first companies to bring on new capacity in North America. The company has now been granted air permits for its expansion projects Donaldsonville, Louisiana and Port Neal, Iowa. Donaldsonville, the larger expansion, is to come on stream in 2015 and Port Neal in 2016.
CF is trading at very attractive valuations. The company is trading at a significant discount to its historical average and S&P 500 price-to-earnings (P/E) ratio. It has a current P/E ratio of 6.6 compared to its own 5 years average of 11.1 and S&P 500 P/E ratio of 11.6. CF has a PEG ratio of 0.74 and forward P/E of 6.6, compared to 15.4 of S&P 500.
The company has price-to-book ratio of 2.2 compared to the industry average of 2.7 and CF's own 5 years average of 2.3. It has price-to-sales ratio of 2.0 compared to the industry average of 2.2. Finally CF has a price-to-cash flow ratio of 6.2 compared to the industry average of 9.8.
The company has a dividend yield of 0.9%
CF Industries is a stock for long-term investors. CF is benefiting from favorable agricultural fundamentals, including low domestic grain stocks, high crop prices, and above-average returns for farmers. The firm grain prices and elevated farmer income should result in improved purchases and application of fertilizers in the near term.
The company also reported strong quarterly results driven by the strength of its nitrogen operations, while the company's commentary and outlook reiterated the stability of its natural gas cost advantage (CF is now 90% hedged for August-November production at $3.67 per MMBtu) and the strength of its distribution capabilities. Natural gas is the main feedstock and fuel for all nitrogen fertilizer products and the company should continue to benefit from the advantageous disparity between U.S. natural gas prices and the prices being paid by offshore exporters.
The company is also aggressively repurchasing its stock by virtue of a $3.0 billion share repurchase program. CF's growth projects also remain on track. The air permits are secured for both Donaldsonville and Port Neal and construction is expected to begin in the next several weeks. Chinese nitrogen exports are expected to continue to keep pressure on the prices in the near-term but the company's discounted valuations over-compensate the near-term risk nitrogen industry is facing.
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