Agribusiness is not subject to fads or changing consumer tastes though they cycle in nature. People will always need to eat and agricultural components are found in many manufactured non-food products. Global population growth places increasing demand on all food producers. Jeremy Grantham opined to his investors that we are five years into a "chronic global food crisis." Nitrogen fertilizer companies Agrium (AGU) and CF Industries (CF) are well situated to benefit from this long term trend.
The drought in the central U.S. will drive up the price of food and demand for the type of agricultural chemicals manufactured by Agrium Inc. Agrium is a Canadian manufacturer and retailer of fertilizers selling to markets in North America, South America and Australia. The company produces and markets three primary groups of nutrients: nitrogen, phosphate and potash. Agrium articulates a growth strategy comprised of incremental growth of existing product lines, the introduction of new products and through strategic acquisition.
In a recent development, Agrium reached an agreement for Glencore International plc to sell Viterra's minority interest in a nitrogen facility located in Medicine Hat, Alberta to CF Industries Holdings for $915 million. This divestment by Viterra is related to the definitive agreement reached by Agrium and Glencore for Agrium to acquire the majority of Viterra's Agri-Products business upon Glencore's acquisition of Viterra. In 2011, Viterra's Agri-Products business generated $2.4 billion in revenue and $244 million in EBITDA. Agrium estimates that $100 million of EBITDA is attributable to the retail portion of 2011 earnings.
In another development, the activist hedge fund, Jana Partners, has taken a big stake in Agrium and is now pushing Agrium to re-structure the company. Jana is of the opinion that Agrium can unlock shareholder value by selling-off its retail distribution business. Agrium appears to be unwilling to take this course of action. However this ultimately plays out, the interest shown by Jana suggests there is unrealized underlying value.
Agrium reported revenues of $6,834.0 billion in 2Q12 compared with $6,198.0 billion in 2Q11 representing a 10.3% increase Y/Y. Sequentially, sales in 2Q12 grew about 88.3% from $3,629.0 billion in 1Q12. We see from past years that the second quarter of the year always shows a dramatic change from the first quarter. The first, third and fourth quarter revenues are historically substantially less than the second quarter number. For the trailing twelve months, revenues grew to $16,781 billion as compared to the one year ago period of $13,616 billion, or 23.2%. In calendar year 2011, the company reported revenues of $15,470. Analysts estimate that F12 revenues will range from $15,530 million to $17,554.4 million with the consensus estimate of $16,613.5 million.
In the second quarter, EPS rose to $5.44 year-over-year from $4.60, representing an 18.3% increase. On a sequential basis, earnings growth reflects the model we see for revenue. First quarter EPS was $0.97, down slightly year-over-year from $1.02. On a twelve month basis, EPS jumped 47.9% to $10.30 from the prior comparable period of $6.98. The analyst consensus estimate for calendar 2012 is $10.94 and $9.96 for 2013. Long term growth is a moderate 5.66%.
The operating margin for 2Q12 is 17.4% and 13.7% for the trailing twelve months. In FY11, the operating margin is 13.3%. The five year average is 11.74% with a range of 5.1% to 18.8%. We see that current operating margins are at the high end of their range. With a net profit of $860.0 million for 2Q12, the company has a net margin for the quarter of 12.6%. The net margin for the twelve month period ending June 30, 2012 is 8.9%. In the last five fiscal years, net margins have ranged between 4.0% and 13.2% with an average of 8.22%. Margin expansion is a very positive sign.
Agrium carries $1,946.0 million in cash and $1,607.0 million in long term debt on its balance sheet. The debt to capital ratio is 18.0% and the debt to equity ratio is 21.9%. Agrium generates sufficient free cash to pay off its long term debt in 1.2 years. The company pays an indicated dividend of $1.00 for the trailing twelve months. The company has increased its dividend at the next quarterly, to be paid 7/12/12, will be $0.50 per share. If the annual dividend payment remains at $1.00, the payout ratio based on estimated 2012 EPS is about 9.7% or about 11% of free cash.
Profitability, as measured by return on equity, is a robust 22.5% and superior to the industry median. The company's five year average ROE is 20.74% and represents the cycle nature of this business. In our analysis, we place a great deal of emphasis on returns generated by free cash. Agrium's cash return on invested capital is 14.49%, substantially better than the industry median. It also provides support for the earnings based measures and reflects the effect of debt.
Agrium returns value to shareholders primarily through its dividend program. The company has increased its dividend from $0.11 paid in 2005 to the current indicated level of $1.00. So far, the company has not reduced the number of shares outstanding. However, Agrium has announced a $900 million stock buyback. Pressure from Jana Partners may push the buyback higher.
With a TTM PE of 10.6X, Agrium is currently trading at a discount to the industry median of 13.6X and in line with the industry median on a price/sales basis. Looking at enterprise based values, we find Agrium trading at a discount to the industry on the basis of enterprise value to sales and EV/EBITDA. Our conclusion is that Agrium is undervalued. The 52 week share price change is about 26%. The company trades at its 52 week high.
CF Industries Holdings is a manufacturer and distributor of nitrogen and phosphate fertilizer products worldwide. The Company operates in two segments: the nitrogen segment and the phosphate segment. The company's principal products in the nitrogen segment are ammonia, granular urea, urea ammonium nitrate solution [UAN] and ammonium nitrate [AN]. Its other nitrogen products include urea liquor, diesel exhaust fluid [DEF] and aqua ammonia, which are sold primarily to its industrial customers. Its principal products in the phosphate segment are diammonium phosphate [DAP] and monoammonium phosphate [MAP]. The company's market and distribution facilities are concentrated in the mid-western United States and other agricultural areas of the United States and Canada. It also exports nitrogen fertilizer products from its Donaldsonville, Louisiana manufacturing facilities and phosphate fertilizer products from its Florida phosphate operations through its Tampa port facility.
In the quarter ending June 2012, revenue fell 3.7% to $1,735.6 million on lower volumes and phosphate product prices. Year-over-year, sales declined by 3.7% from $1,801.7 million. For the twelve month period with 2Q12, revenues grew to $6,385.4 million from $5,130.4 million in the one year ago period. In FY11, sales totaled $6,097.9 million. Analysts forecast sales for 2012 in the $5,924.4 million to $6,436.0 million range. The consensus is for sales of $6,190.97 million, about 1.5% higher than FY11.
CF reported a profit of $606.3 million, or $9.31 per share, up from $487.4 million, or $6.75 per share, a year earlier. For the trailing twelve months, EPS surged to $26.23 from $14.11 from a year earlier. Analysts estimate 2012 EPS will range from $23.21 to $28.54, with a consensus of $26.64. Analysts see a long term growth rate of 14.86%.
The company reported operating margins of 57.9% in 2Q12 and 47.5% for the trailing twelve months. In F11, the operating margin was 45.8%. The five year average is 29.04%. The net profit margin for the second quarter is 34.9% compared to 27.3% on a TTM basis, 25.2% for F11 and the five year average of 15.8%. The effects of the cyclic nature of this industry are evident.
The balance sheet for 2Q12 shows cash and short term investments of $1,383.0 million and long term debt of $1,604.8 million. The debt to capital ratio is 24.2% and the debt to equity ratio is 32.0%. CF Industries can pay off its entire long term debt obligation from free cash flow in less than one year. The company pays an indicated dividend of $1.60 which yields about 0.7%. The payout ratio is 6.0%. The company is generating significant amounts of free cash.
CF Industries reports a return on equity of 37.2% despite a very low level of debt in its capital structure. The five year average ROE is 32.8% though it is volatile. The cash return on invested capital is a high 28.77%, reflecting strong free cash flow.
The company returns value to shareholders by a payout of dividends and with an aggressive share buyback program. The modest indicated dividend of $1.60 yielding 0.7% represents substantial growth from the $0.02 dividend paid in 2005. The company's average shares outstanding decreased to 64.3 million in 2Q12 from 69.4 million in 4Q11. In the quarter, the company bought back 3.1 million shares.
On a PE basis, the company is trading at a discount to its industry median. On a price to book or price to sales basis, CF appears to be trading at a premium. When we look at enterprise value to earnings before interest, taxes, depreciation and amortization, CF looks cheap. The share price has risen about 32% over the past 52 weeks and is trading near its 52 week high.
Despite the both companies experiencing solid share price increases over the past twelve months and the fact that both companies are hitting new 52 week highs, we think the shares of both companies are undervalued, at these levels. These are cyclical companies and we are now in the up cycle. The population growth trend will not change anytime soon. The demand for agricultural products only grows. A crop, such as corn is used to feed not only people throughout the world but is also a principal ingredient in animal food-stocks. Corn is also used to fuel our cars. Short term, the drought in the Mid-West is bullish for fertilizer companies and the abundance of cheap natural gas drives down raw material costs to these manufacturers.