CF Industries (CF) is a global leader in fertilizer manufacturing and distribution, the second largest nitrogen fertilizer producer in the world and the third largest phosphate fertilizer producer among public companies. Elenchus Capital Partners have recently invested in CF Industries for the following five reasons.
First, CF Industries has excellent free cash flow. In the last twelve months, CF Industries has generated $2.3 billion of free cash flow compared to $936.3 million (2010), $496.8m (2008) and $144 million (2006). Furthermore, this strong free cash flow is likely to be sustained for the foreseeable future as a result of high fertilizer prices (due to high farmer demand for fertilizer products and high global demand for grain commodities particularly corn) and low production costs (due to continued low natural gas prices, which account for approximately 45% of the total production costs for nitrogen fertilizers).
Second, CF Industries is highly profitable and very conservatively financed. It has a return on equity of 25.3% and achieves gross and profit margins of 52% and 23% respectively. It currently has $1.4 billion in cash and is liable for $1.6 billion in debt, primarily as a result of its acquisition of Terra Industries in 2010.
Third, CF Industries repurchased 6.5 million shares at an average price of $153.49 for a total of $1 billion during 2011, thereby increasing shareholder value and actively demonstrating management's continued belief in the firm and its excellent prospects.
Fourth, CF Industries is planning to invest up to $1.5 billion on additional capital projects over the next four years to increase efficiency at its North American operations to meet growing demand for products.
Fifth, CF Industries is very attractively valued. At a P/E of approximately 9, the firm is priced significantly lower than its competition: PotashCorp 13.2 (POT), Terra Nitrogen 12.9 (TNH), Mosaic 10.5 (MOS) and Agrium 9.4 (AGU). Furthermore, CF Industries owns 75% of Terra Nitrogen, which is focused entirely on nitrogen fertilizer production but valued significantly higher than its majority stakeholder. Moreover, CF Industries has a P/E slightly below Agrium, which has had negative free cash flow for the last two years, and an average profit margin of 7.9%, while CF Industries generated free cash flow of $2.3 billion and $936.3 million during the same period at an average Profit Margin of 15.91%.
In addition, based on the following very conservative assumptions - annual growth rate of 3% for the next 5 years and free cash flow of $790 million for 2012 which includes the planned increase in annual capital expenditure by $375 million to $675 million - CF Industries is worth approximately $245 a share, which amounts to a 41% discount at its current share price of $174.
However, as with any investment there are always potential risks to achieving this upside. The following three variables must be monitored as they are essential contributors to the continued growth of CF Industries:
- An increase in natural gas prices could significantly reduce profit margins and free cash flow, particularly in the nitrogen fertilizer segment given that natural gas accounts for 45% of the cost of producing nitrogen fertilizers.
- A decrease in fertilizer prices, most likely due to excess supply or reduced global demand, could also significantly reduce profit margins and free cash flow.
- Continued low or negative growth throughout the global economy particularly in the US could reduce the demand for agricultural products and as a result the demand for agricultural fertilizers.
Disclosure: I am long CF. Elenchus Capital Partners are long CF Industries at an average price of $170 a share.