Possible Q3 2012 Earnings Surprise For CF Industries?

 |  About: CF Industries Holdings, Inc. (CF), Includes: AGU, MOS, POT
by: Bengal

I have recently been looking at the latest (Q2 2012) financial reports of CF Industries (NYSE:CF). They sold approximately 3.5 million tons of nitrogen products (predominantly ammonia, granular urea, UAN and AN) in the 2nd quarter of 2012. By comparing their Q3 2011 to their Q2 2011 results, I am assuming they will have approximately 20% lower sales in Q3 2012 (relative to Q2 2012), due to seasonality factors. So this would predict sales of approximately 2.8 million tons for Q3 2012. Assuming the same product mix as in Q2, and prices per ton for Q3 of $715, $425, $310, and $257 for ammonia, urea, UAN, and AN, respectively (as compared to $635, $522, $324, and $257 for Q2), I calculate net income of $425 million and earnings per share of $6.63 for Q3, 2012, which is about 16% above consensus estimates of $5.72 per share. This assumes no reduction in share count as a result of CF's $3 billion buyback program (any buybacks would increase earnings per share).

Key to my calculations are an assumption of an average price paid for natural gas of $3.725/mmBtu during Q3 2012 (as compared to $4.32 in Q2 2011 and $3.13 in Q2 2012). I've also assumed no net change in phosphate contributions for CF relative to Q2 (phosphates are a relatively small component of CF's earnings).

POT and MOS, who are two other large fertilizer companies, are primarily in the potash and phosphate markets, and a key reason for their earnings disappointments for Q3 2012 was the fact that China and India were holding out on renewing their 2013 potash purchased from Canpotex, which is a POT, MOS, and AGU joint venture for selling their potash production internationally. As compared to nitrogen fertilizers, potash is "banked" in the ground, and it is not necessary to apply it for each planting season. China and India have been holding out in order to get price concessions from Canpotex, which Canpotex has so far been unwilling to entertain (your classic standoff situation).

Nitrogen fertilizers, on the other hand, cannot be banked in the soil...they are more like "use it or lose it" fertilizers. If you have a drought one year that results in low yields of crops, you still have to apply the same amount of new nitrogen fertilizer for the next planting, whereas you could apply less potash.

CF exited the potash market in 2009 and focused entirely on nitrogen (and to a smaller extent on phosphates). Nitrogen prices are quite high historically due to tight global supply/demand. With corn prices close to historical highs, expectations are for a large planting season in 2013. Orascom Construction Group, which is an Egyptian based company, is moving forward with the construction of one of the world's largest (nitrogen based) fertilizer companies in Wever, Iowa (yes, our Iowa). Why would an Egyptian company set up shop (which won't come online until 2015-2016) in Iowa to make nitrogen based fertilizers? Well, there are several reasons, all of which point to CF's strengths - massive global demand for nitrogen based fertilizers for the production of food and biofuels (yes, ethanol is made mostly from corn), a huge competitive cost advantage in the US resulting from the shale boom sending natural gas prices to a fraction of what they are in most of the rest of the world (with the exception of the Middle East), and various other government programs that are coming on line that require nitrogen products, such as a recent EPA mandated law that most new diesel commercial and non-commercial vehicles manufactured in the US after Jan 1, 2010 will be required to have "Urea tanks." Urea tanks inject an automotive grade of urea ("DEF") into the exhaust stream in order to eliminate up to 90% of the nitrogen oxide that is produced (nitrogen oxide is a major contributor to smog).

CF will report earnings on November 5, 2012.

Disclosure: I am long CF, MOS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.