CF Industries Gets Rest Of Medicine Hat Plant

| About: CF Industries (CF)

They'll now have to rename the Canadian Fertilizers Limited (CFL) nitrogen fertilizer plant at Medicine Hat, Alberta, to "CF Limited."

Agrium (AGU) and CF Industries (CF), old nemeses from the fertilizer takeover battle of 2009, wouldn't have made nice bedmates at CFL once Agrium agreed to buy Viterra's retail and agri-product assets, including the 34% minority interest in the CF controlled fertilizer complex.

I just cracked open my CF 2011 "10K" and I have a note beside Medicine Hat asking "Will Agrium be forced to sell the 34% interest in CFL and would CF Industries be a possible buyer?" Answer: Yes to both questions.

The price of $915 CAD million plus profits until the deal closes ($70-80 million) which CF Industries will pay is for 34% of 1.25 million tons of ammonia capacity, which is partly upgraded to 810,000 tons of urea, leaving merchant ammonia of 780,000 (all 2000 lb short tons).

In terms of valuation the deal works out to $2,318-$2,341 CAD per ton on ammonia capacity but since about 38% of the ammonia is upgraded to urea, there is some value there also.

The plant was built in 1976 and the condition of the "metal" is a factor, and when the last plant overhaul occurred, plus pollution abatement equipment needs given more stringent greenhouse gas legislation.

CFL has 60,000 tons of ammonia and 70,000 tons of urea on-site storage and rail loading infrastructure.

Available land to increase the size of the plant is required, or to increase conversion to urea. The plant sits on 160 acres which is not a huge space given this is a big complex already.

Finally, the proportion of agricultural versus industrial ammonia in the mix would impact value: more agricultural customers, better pricing.

The industry rule of thumb has been a ton of annual greenfield urea capacity costs about $2,000 US, but that estimate is moving around because of the increasing complexity in permitting a plant due to more onerous carbon emissions legislation.

There have also been a slew of proposed greenfield nitrogen plants or expansions announced by Yara Belle Plaine (OTCPK:YARIY), Iowa Fertilizer, a venture of Orascom Construction Industries (OTCPK:ORSCY), The Mosaic Company (MOS) and even Agrium itself. So the value of a nitrogen plant down the road could be diminished.

The lead time on greenfield nitrogen plants is 4-5 years but less for brownfield expansions.

Overall, the maximum CFL price of $2,340 CAD/ton seems in line with current valuation, at least on paper.

Strategically, CF gets more fertilizer capacity in the Western Canadian prairies with an asset it already manages. The Prairies have escaped the drought to some extent, so sales this fall should be good.

A good deal for CF Industries in my view. They diversify out of the Southern Prairies and the southern corn belt, where a big question mark resides: will the parched soil recover after two years of extreme drought?

Agrium unfortunately, gets an even bigger CF Industries presence in its Western Canadian bailiwick.

Agrium reported Q2 earnings of $5.47 per share this morning on $6.83 billion U.S., versus $5.40-$5.50 guidance and $6.6 billion analyst estimated revenue.

A big piece of their robust profits came from record nitrogen fertilizer gross profit of $431 million out of wholesales total $673 million. This was on 1.3 million tons of sales which were down 9%. Lower natural gas cost helped, which was $2.62/MMBtu (compared to $4.00 prior year). Margin per ton was a stellar $332/ton versus $226 last year. Cost per N ton was only $241 versus $274. Nitrogen fertilizer production was very profitable. So CF is buying good cash flow.

Agrium is taking $900 million of the proceeds they "saved" not having to pay Glencore for the plant, and buying back stock, something we have argued they should have been doing all year. The Dutch Auction process will begin in September and end in October.

The markets for both fertilizer stocks and stocks overall may be quite different in character by then. The Dutch auction is less discretionary than an outright share buyback (as favored usually by CF Industries).

At our $100 US short-term target for the stock, they would buy back 9 million shares or 5.7% of the outstanding.

Disclosure: I am long CF.