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Summary

  • The company’s nitrogen business continues to outperform by moving more volumes at higher than expected prices.
  • With strong demand outlook in the near-term and lifting nitrogen prices, the company is well positioned going into the spring.
  • CF remains committed to its buyback program and may finish it earlier than expected.

CF Industries' (NYSE:CF) (the world's second-largest nitrogen fertilizer producer) most recent results help explain its strong performance in recent quarters. The company's nitrogen business continues to outperform by moving more volumes at higher than expected prices. Strategically, the company has addressed investors' concerns around the near-term impact of elevated natural gas prices by hedging natural gas at levels below $4 per mmbtu. The company is using its position as one of the largest producers of nitrogen to look for opportunities to export its products, particularly in the Latin American market. CF has also been de-risking returns from industrial sales and its long-term contract with Orica is one of the examples.

The company continues to buy back shares under its $3 billion buyback program and remains committed to complete the remaining $1.4 billion buyback program by late 2014 or early 2015. The company's expansion projects also remain on schedule and on budget. Despite challenging conditions, CF continues to perform better than expectations. Going forward, with a strong demand outlook in the near-term and lifting nitrogen prices, the company is well positioned going into the spring.

CF Industries has had a strong run in the last few months and outperformed its peers. The company is up ~30% in the last six months. In comparison CVR Partners LP (NYSE:UAN) is up 8.5%, S&P 500 is up 10.5%, and Dow Jones is up 6.7% during the same period. Investors' opinion of CF Industries continues to change and more and more investors now view the company as a cash flow generator with cyclical upside rather than a low multiple deep cyclical company. However, despite a strong performance in the past six months, the company is still trading at a discount compared to its peers and has upside potential.

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Source: Google Finance

The Deerfield, Illinois, based company was trading at ~$190 in September and earlier this month the stock price went as high as $264. A range of reasons both inside and outside of CF industries have contributed to an increase in the company's share price. A multi-year period of high corn prices has also come to end. The company has taken a number of investor friendly actions following investments by a number of activist investors including Dan Loeb, who made an investment in CF through his Third Point LLC hedge fund. The company sold its phosphate business to Mosaic (NYSE:MOS) and also did an ammonia off-take agreement with the Plymouth, Minnesota, based company. As a result of these agreements, MOS joined Agrium (NYSE:AGU) and Yara International with cancelled greenfield plans and announced that it will not go ahead with its planned ammonia expansion. The cancellation of greenfield projects by three existing producers have also helped in addressing investors' concerns about an expected over expansion in U.S. nitrogen.

Urea prices during the same period, after bottoming out at ~$275 per metric, began to rise as the nitrogen cost curve exerted itself and both European and Chinese producers trimmed production and exported less as prices went below marginal cost. During the period when CF's stock rose from ~$190 to $260, urea prices increased to over $400 per metric ton New Orleans while corn prices declined to nearly $4.00 per bushel, which tells us that nitrogen prices are more a function of the global cost curve than the corn acres.

Increasing Investor Confidence

CF's actions in the last few months have increased investor confidence in the company. The Deerfield, Illinois,-based company has become more transparent with its corporate and capital structure goals. The company has been consistently buying shares, which has also helped address investor concerns that CF would not be able to execute its large scale capex program and complete its $3 billion buyback at the same time.

Another thing that we have noticed in the company's approach is its more holistic approach toward managing the company's order book. In the past, each decision, be it gas purchase, nitrogen sale or transport, was largely taken in isolation. However, these decisions are now more consolidated across the value chain to optimize margin for the entire company. In addition, the company is conducting a more rigorous global market analysis than ever. The company is focusing more on netback than a single market concentration. The U.S. has traditionally been the company's core market and even now that is the case. However, the company is actively looking for opportunities to build relationships in new markets, particularly the Latin American markets. CF Industries is optimizing its portfolio, and the company is willing to take a lower net back on its exports to increase the total profit opportunity of the balance of its tons sold in the U.S. CF's recent off-take agreements with Orica and Mosaic have not only provided the company with healthy returns on ammonia and ammonia nitrate but should also give the nitrogen producer more confidence from a debt leverage perspective.

Creating Shareholder Value

CF is consistently making efforts to create shareholder value. The company is more interested in creating consistent and sustainable shareholder value rather than being large just for the sake of it. CF believes that if provided with options to either grow nitrogen volumes or buyback shares, the company would most probably opt for buybacks, provided the stock is trading at below its fair value. Growth for the sake of growth is not the company's policy. CF's strategy is to increase shareholder value the most on a risk adjusted basis. If there is an attractive opportunity within the United States, the company could consider buying other U.S. nitrogen facilities at the right price. However, that option seems unlikely as there are very few opportunities out there that would fit in the company's plans. At the same time, the company is also not planning to build additional facilities only to serve its export market. CF believes that it would lose the competitive advantage of its U.S. distribution network and would likely not have a cost advantage over other imported tons.

MLP Or No MLP?

Although the company could consider an MLP option with regard to its new facility, as long as its current facilities are concerned, CF Industries has made it clear that no MLP is likely, at least not in the near-term. Due to a number of factors, including the company's ability and willingness to buy-back shares, ability to borrow at less than 4% after tax, willingness to lever up within the comforts of its investment grade rating, the company believes that faster buybacks and more leverage represent a better risk/reward to shareholders than creating an MLP like structure out of its existing facilities. The company is not necessarily against the MLP option, but as mentioned earlier CF is more focused on creating the best shareholder value on a risk-adjusted basis.

Well Executed Hedging

CF has also been executing its hedging program very intelligently. Investors expressed concerns about the impacts of elevated natural gas prices. However, the company has hedged most of its 1H14 needs at less than $4 per mmbtu which positively surprised the market. The company's hedging program has evolved over the last few years and is now focused more on limiting the risk of unexpected shocks to the natural gas cost curve. Before the company announced the details of natural gas hedging, markets were of the opinion that elevated natural gas prices would adversely impact the company's results and had resulted in lower expectations. However, the company caught the market off guard by its well-executed strategy.

CF Should Benefit from an Increase in Demand

After a strong 4Q13, CF Industries should continue to perform well in 2014. Heading into the spring season, the company is well positioned to benefit from an expected increase in demand. The company expects 92 million acres of corn to be planted in North America this spring and also high global planted acres. Both high domestic and global plating should provide strong support for nitrogen demand. The company not only expects to operate at full capacity but is also expected to sell all of its production.

Assuming normal weather prevails, North American ammonia demand should be strong through 1H14. Moreover, for both urea and UAN, strong spring demand is expected and, through the first half of 2014, pricing for these products are expected to remain strong.

Valuation

Despite of recent strong performance, the company is still trading at a discount compared to its peers. It has price/earnings ratio of 10.4, compared to the industry average of 15.2 and UAN's price/earnings of 12.7. CF has a forward price/earnings ratio of 9.0 vs. 11.2 for UAN. CF is trading at a price/book ratio of 2.8 compared to the industry average of 3.3 and 3.4 for UAN. The company has a price/sales ratio of 2.8 compared to 4.6 of UAN.

Conclusion

As the company's capital structure transformation takes shape and the market continues to recognize its strong cash flow generation potential with cyclical upside, CF's re-rating should continue in 2014. The company is well positioned to benefit from strong fertilizer demand in the domestic market and continues to look for opportunities in the export market as well. Moreover, low North American natural gas prices also provide a cost advantage to CF. Although the company's stock has performed strongly in the past few months, going forward, the market should continue to incorporate the impact of the company's heavy share buyback program and organic growth scheduled to come online in 2015 and 2016.

Risks: Although the company's strong balance sheet and low-cost structure provide it protection, the volatile nitrogen market could adversely impact company results. An unexpected and steep decline in corn prices could also provide a risk to our thesis on CF. Major capacity expansion resulting in supply outpacing demand are also a potential risk to CF.

Source: CF Industries Has Further Upside Potential