CF reports Monster Quarter; Imagine if They Had Increased Production

Earnings for CF Industries (CF) came in better than I could have imagined.

Estimates $537M revenue, and $0.97 EPS
Actual $583M revenue, and $1.52 EPS

As I have stated repeatedly the past few weeks, analysts are really underestimating forward earnings growth for the entire fertilizer sector. I'm just Joe Schmoe, not a fertilizer analyst, so not sure why they are still so wrong, other than their natural conservative nature. Just last week I waxed poetically....

CF Industries has yet to report but 08 estimates 90 days ago $3.27. Thirty days ago $4.19. Now? $4.93. Only wrong by 51% (and we are still awaiting the new estimates post earnings) from 90 days ago, and wrong by 18% (so far) from 30 days ago. Oops.

Back to the valuations. I hesitate to even post the PE ratio on 08 estimates because as I've shown above, its faulty at best since the estimates are rising monthly. But as of "today" this is how it stands

POT on 07 - 33x, on 08 - 25x
MOS on 07 - 20x, on 08 - 17x
CF on 07 - 16.7x, on 08 - 16x

Again, better than expected and the stock just got cheaper instantly on current and forward earnings estimates. This is a >50% beat on the bottom line, and margin expansion of a serious manner, as pricing power benefits the entire industry - look for those 08 estimates to take a huge hike-up. So we were talking a company that was valued at 16.8x 2007 estimates, and 16x faulty 08 estimates (remember 2008 was at $3.27 just 90 days ago; they just did $1.52 in 1 quarter, a traditionally slower quarter).

We could be talking about 11-12x 08 estimates for a company growing in excess of 50% with pricing power for the next few years. Pricing is so strong it has detached from the normal seasonal trends (see below)

• “The sharp improvement in third quarter performance is a clear reflection of the optimism pervading U.S. agricultural markets today,” explained Stephen R. Wilson, chairman and Chief Executive Officer of CF Industries Holdings, Inc.
• “Seasonally slow third quarter demand typically results in price pullbacks during the period,” Wilson noted. “This year, it seems that the prospect of record farm income for 2007 and the optimistic outlook for next year’s spring planting, coupled with what appear to be low fertilizer inventories throughout the supply chain, led many customers to begin locking in their fertilizer needs earlier than in the past. This helped produce continued pricing improvement for almost all of our products, not just compared to last year, but also in relation to this year’s strong second quarter,” Wilson explained.
• It also drove a sharp increase in the company’s Forward Pricing Program (FPP) bookings for the fourth quarter and the spring of 2008. “Improved pricing produced substantial margin improvements in both our nitrogen and phosphate segments for the quarter,” he added.
• The third quarter’s 46 percent increase in net sales helped CF Industries achieve a nearly six-fold increase in gross margin to $151.3 million compared to the third quarter of 2006.
• During the quarter, the nitrogen segment benefited from significantly improved pricing from year-earlier levels for all products, reflecting a positive outlook for North American agricultural markets and a favorable supply/demand situation in world markets.
• Net sales for nitrogen totaled $388.8 million, up 41 percent from $275.4 million in third quarter 2006. Segment sales volume for the quarter totaled 1.35 million tons, comparable to 1.38 million in 2006’s third quarter. (so for the same amount of product vs a year ago, they got 40% more revenue)
• Gross margin on nitrogen was $80.2 million, up substantially from $9.6 million in the year-earlier quarter, due to significantly higher prices. Gross margin in the 2007 quarter represented 20.6 percent of sales, compared to 3.5 percent in the 2006 quarter.
• Prices for nitrogen products not only showed substantial improvement over the year-earlier quarter but, in the case of urea and urea ammonium nitrate solution [UAN], continued to improve over strong second quarter 2007 levels. The average selling price for ammonia was $366 per ton for the quarter, up substantially from $293 in third quarter 2006 but down from $390 in 2007’s second quarter. Average selling price for urea was $334 per ton, up from $226 in the 2006 quarter and from $331 in 2007’s second quarter. For UAN, the $230 per ton price in this year’s third quarter compared to $155 in the year-earlier quarter and $206 in 2007’s second quarter.
• The company’s phosphate segment enjoyed significantly improved sales revenues and gross margin compared to the year-earlier quarter, as pricing for both diammonium phosphate [DAP] and monoammonium phosphate [MAP] strengthened compared to both third quarter 2006 and second quarter 2007 levels. Worldwide demand in phosphate remains strong, which has clearly strengthened the North American market, CF Industries’ primary focus in phosphate.
• Third quarter average selling price for DAP was $388 per ton, up substantially from $241 in last year’s third quarter and from $349 in this year’s second quarter. The third quarter average selling price for MAP was $403 per ton, again up substantially from $243 in last year’s third quarter and from $341 in this year’s second quarter.
• Phosphate net sales totaled $194.1 million in the quarter, up 58 percent from $123.2 million in the year-earlier quarter. Phosphate sales volume totaled 497,000 tons, down modestly from 510,000 tons during third quarter 2006. Phosphate gross margin for the quarter totaled $71.1 million, or 36.6 percent of sales, up substantially from $16.2 million, or 13.2 percent of sales, reported for third quarter 2006. (pricing is so strong that revenue was up 58% despite LOWER volumes year over year)

What's left to say; a home run on all counts. Now on to guidance.

• “We are looking forward to a strong fourth quarter, as this year’s large harvest, historically high crop prices, and the prospect of another excellent crop year in 2008 have buoyed the farm economy,” Wilson commented.
• “As of October 25, 2007, we had approximately 3.5 million tons of product booked under our FPP, significantly higher than the 939,000 tons at that time last year,” Wilson explained. Approximately 1.5 million of those FPP tons were scheduled to ship in the fourth quarter of 2007, with the majority of the remaining volume scheduled for the first quarter of 2008. The margins built into the company’s forward orders reflect the upbeat outlook for nitrogen and phosphate fertilizers for the fall and spring.
• “Looking at nitrogen, demand could benefit from an early harvest this year, which could give farmers plenty of time for fall ammonia application, assuming favorable weather. With today’s record wheat prices, it is possible that acreage for that crop could be at its highest level in many years,” Wilson explained, adding that wheat is also a significant user of nitrogen fertilizer.
• In phosphate markets, Wilson suggested that expected record farm income could lead farmers to increase fall application rates. Phosphate, unlike nitrogen, is retained in the soil from season to season, so farmers can vary application rates each year. When farm income rises, as it will in 2007, it can provide an incentive for farmers to increase phosphate application rates.
• The CF Industries executive noted that recent volatility in crop prices had created some uncertainty regarding planting intentions for the coming spring season. “We typically have a better handle on the acreage outlook by this time of year, but today the outlook is still a bit murky. While there is a general belief that farmers will plant substantial acreage next spring, the various crops are still ‘competing’ for available acres,” Wilson pointed out.
• “For corn, the current expectation is that 2008 could see a decline in acreage, but to levels we would still consider very good by historical standards. However, the potential decline in corn acreage could be offset by a crop price-induced increase in wheat acreage as well as, to a lesser extent, increased acreage of sorghum. Both wheat and sorghum use significant amounts of nitrogen fertilizer,” he explained.

So now we have more visibility and backlog building in an industry that usually has very little of each. And they threw in a little dividend to boot.

Due to CF Industries (CF) being exposed more to nitrogen and less of a global player and more of a North America player, it has traded at a major discount to peers. But much like crude oil is becoming a worldwide resource, and inventory levels in the US don't affect worldwide prices, the same seems to be happening in fertilizer. As more demand is drawn into emerging markets, the global price still goes up, even for those producers serving just the North American market. While I don't expect CF Industries to get a multiple similar to Potash (POT) or even Mosaic (MOS) [remember, potash production has a much wider moat or higher barriers to entry than nitrogen or phosphate], I'd expect this sort of growth to push the multiple to a higher level.

The one risk is natural gas prices, but so far they have been moribound and with natural gas as a 'local' commodity, unlike crude, and the US economy slowing, I don't expect ng to be picking up substantially in price anytime soon - hence the inputs for CF Industries business should remain relatively tame.

>The story here is gross margin expansion. Expect the same and more of it next year - as Potash CEO said, 2007 was the year of volume, 2008 will be the year of margin. The amazing thing for CF Industries is these knockout numbers came on similar (or in some cases lower) volumes than in 2006 year ago levels.... just imagine if they actually increase production...

Long CF Industries in fund and in personal account