Eric Gregg

Long only, deep value, value, special situations
Eric Gregg
Long only, deep value, value, special situations
Contributor since: 2013
Company: Four Tree Island Advisory LLC
Corn futures for March show corn at $3.53 per bushel. March 2014 corn was at $3.81 per bushel so corn is off 7% year over year. Nitrogen fertilizer is off ~1/3 from a year ago at current pricing. Potash is down a similar amount and phosphates are down ~25%. Given that fuel and fertilizer are down materially more than corn futures, that should help farmer profitability considerably in 2016.
Also Corn was sub $2.00 per bushel from 2000-2005 so not sure what you mean about grains being at 20 year lows. Corn futures are more than 75% above the levels 10 years ago. Wheat similarly was sub $4 per bushel for first half of the decade (2000-2005) and it's currently about 25% above those levels.
I think you're speaking of CVR Partners which uses Petroleum Coke to produce nitrogen fertilizer.
CF has two major Canadian production facilities (Medicine Hat, Alberta which is the largest in Canada and Courtright, Ontario) so CF is not immune to the benefits of producing in Canada and shipping to the US. Both facilities are very close to the US border and both sell into the US.
The fact of it is they can drop fares and keep or still improve margins because fuel prices are dropping more substantially than fares. Fuel costs were 33.6% of revenues Q3 2014. They were 20.2% of revenues Q3 2015. Fuel costs could very well stay in the ~20% area or even drop into the high teens % of revenues even with fare cuts due to the precipitous decline in jet fuel prices.
The question here isn't whether JBLU is going to have a tremendous quarter (which they are lined up to do on the back of significant growth in volumes and dramatic decline in fuel prices). The question is whether we're going into a recession and whether pricing and volumes are going to have a rapid decline? I believe that while pricing may be softer, even if RASM declines by 10% (which would be meaningfully more than what's projected in December) profits should still grow considerably (on the back of the a 30% decline in fuel prices, double digit volume growth, share repurchase and debt pay down). Volumes should benefit from lower ticket prices.
In terms of whether we're going into a recession? That's the $64 million question. Certainly the energy, materials and some parts of the industrials sectors) are already in recession. But there are some strong areas in the market (autos, technology, healthcare) as well.
We already have our answer. Cf and Oci have come out with a joint statement communicating that they are still fully committed to the deal and that they are looking at moving the domicile to the Netherlands and other changes to the structure to make it work. They highlight the strong strategic logic for the deal and significant synergies associated with the deal. It looks like they believe they can preserve a version of scenario A outlined in this article. Stay tuned.
I fully agree with your sentiment Barry.
The scenario you outline, that corporate tax reform is enabled and that statutory corporate tax rates are lowered to 15-20%, would be so transformative and positive for the US economy that I frankly shudder when I consider all the positive potential ramifications including: greater domestic investment, more jobs, lower corporate indebtedness, higher long-term tax revenues, better returns for all investors (including underwater pension funds, retirees, anyone in America with a 401k or 503c), etc. Paul Ryan being speaker of the house and having this as a major agenda item gives me some hope, but as you highlight this will also require the right presidential administration and that is far from assured. As highlighted in a WSJ editorial this week, Elizabeth Warren views the problem as Corporate America's not paying enough taxes. We have countries around the world devaluing their currencies and sticking with or lowering their corporate tax rates to make their coporations and economies more competitive while our current national political persuasions are to ignore the state of play (and in so doing hamstring our economy). Could the scenario you propose come to pass, sure but I would qualify it as a low probability event and would not count on it. There's a lot that will happen between now and November 2016 and even if the right administration wins the White House, there are significant vested interests in keeping the corporate tax code the way it is.
Yes the Netherlands scenario would address one of the newly tightened US Treasury guidelines, but there is another new guideline that focuses on % ownership and is squarely aimed at inversions where more than 60% but less than 80% of the ownership of newco is comprised of the existing US acquiror's ownership base. As currently contemplated, ~75% of New CF will be held by existing CF owners. Could all these guidelines be worked around, highly likely yes. But a) at what cost in terms of lost synergies and CF control and b) what's to prevent the treasury from issuing another set of guidelines post a potential restructuring of the deal? One could certainly imagine a scenario where CF set up Newco in the Netherlands and bought back a slug of stock before closing the deal so that existing owners of CF only ended up controlling 59% of Newco. Just not clear that what that would entail would be worth it. Should CF give up more than 40% of the company to acquire 33% more in production capacity? Especially when a meaningful amount of that production capacity (Geleen, Netherlands) is in a higher cost of production jurisdiction? The synergies have to be substantial for the deal to make sense.
I agree - buying just Wever on a standalone basis is always another option or (Wever and Beaumont). As they have already obtained HSR approval - there shouldn't be any major regulatory issues. Just a matter of price and structure.
A few thoughts:
1) I recommend going back and reading my article from April entitled "Still Able to Purchase $1 for 40 cents." In that article I spend considerable time discussing how CF is significantly differentiated from either its widely acknowledged peer group or the other pure play North American nitrogen producers.
2) I also recommend reading the transcript from CF's presentation yesterday at the Morgan Stanley's Global Chemicals and Agricultural Conference (check edgar and their 425 filing on 11/9/15).
3) Finally, to answer your question directly, I would argue CF has three things that provide a moat to its operations: the scale of its North American nitrogen production network, the geographic positioning of its NA nitrogen production network and finally its advantaged distribution network.
These attributes contribute to CF's "moat" vs. other North American manufacturers in the following ways:
Scale of CF's North American nitrogen production network - CF's scale is important for two primary reasons: 1) it provides redundancy such that when any one facility is down, a number of other facilities can pick up the slack and 2) because of its scale CF is able to enter significant supply agreements with the biggest customers (a la CHS, Orica and Mosaic) that could be very difficult if not impossible to replicate for CF's competition. In terms of the facility redundancy, you can see the negative impact of being beholden to only one or a couple facilities with both CVR Partners (which had to suspend its distribution this past quarter due to unplanned downtime) and Rentech Nitrogen (which had various issues at both its Pasadena and East Dubuque facilities over time).
Geographic positioning of CF's facilities - The bulk of CF's production capacity is in the interior of the US and Canada. Port Neal, Iowa is in the heart of the corn belt. Courtright, Ontario has great access to the midwestern states. Woodward and Verdigris, OK as well as Yazoo City, MS, are right in the middle of the country. Medicine Hat is located right in the middle of Canada's prime rapeseed growing area. Donaldsville has (and with work they are doing on the facility) and will have remarkable ability to export. Having these facilities located where they are mitigates delivery risk (there have been times when trains were disrupted coming out of Canada or moving things by barge up the Mississippi has been challenging). It also can help on price achieved by CF. As indicated in YogaNatureLover's response, CF typically achieves a premium over the course of a quarter to the wholesale rates quoted in either Tampa or NOLA as they a) time their sales well and b) have facilities better positioned relative to where the bulk of the nitrogen imports come into North America.
CF's advantaged distribution network - Comprised of over 6,000 rail cars, over 1mm tons of UAN and Ammonia storage capacity, over 32 liquid river barges and connection to both the NuStar and Magellan pipelines, CF's distribution network allows CF to supply nitrogen where its needed when its needed to maximize profitability. This distribution network has been an important contributor to CF's ability to consistently achieve average prices on its fertilizer that exceed the wholesale pricing in NOLA and Tampa over most quarterly periods.
All of the above helps provide a moat against other North American manufacturers.
Couple thoughts.
1) all the hedging that cf has done over the past 6 months (and the hedging that cf has generally done over the last number of years) has been aimed at mitigating that risk. Cf has generally hedged to limit the risk of spiking natural gas prices to a point where cf would be unprofitable or have severely impaired profitability. Now if you believed that natural gas prices were likely to spike and sustain at high levels (with those higher levels outlasting cf's hedges). And if you believe that the us's competitive advantage in terms of much lower cost natural gas vs most of the world is lost, then there would be a major issue. But as highlighted in my article as well as some comments above, I think that it is highly unlikely to happen for the forseseeable future. In fact we've been seeing the opposite - North American natural gas prices have dropped even lower this year - and especially over the last few months.
2) if you believe at all in microeconomic theory, one of the reasons we're seeing lower nitrogen prices right now is precisely because natural gas prices are so low. With lower natural gas prices, US producers, especially, can sell nitrogen at lower prices and still earn a healthy margin (as was evidenced by cf's margins in q3 when you make all the reasonable adjustments highlighted in my earlier comment). So if energy prices were to make a pronounced move higher all around the world, it would follow that nitrogen fertilizer prices should also move higher.
I believe there's a very simple reason why CF hasn't hedged OCI's needs. A deal isn't closed until it's closed. It would be a foolhardy idea to hedge in anticipation of the deal closing and then, if for some reason the deal didn't close, have to unwind the hedges at what could end up being significant costs. I believe it unlikely that the deal won't close, but there are still shareholder votes that have to be taken and certain regulatory hurdles that need to be overcome.
There's a chance that CF is looking at their total gas needs pro forma for OCI included and saying to themselves that with the hedging they've already done, they're at the right hedged/unhedged mix. But the biggest driver has got to be that they don't want to take what appears to be the low risk that the deal doesn't close and they end up having to unwind hedges at a loss.
This was a messy quarter for a number of reasons:
- Nitrogen fertilizer prices were weak
- The mark-to-market hedges on natural gas worked against them
- They had a number of transient/one-time costs (significant transaction fees for the OCI and CHS deals, costs on the expansion projects that hit opex, and unallocated overhead associated with the Woodward, OK major turnaround)
- Finally, CF upped the cost estimates on their expansion projects by another 10%. The cost estimates going into this quarter were $4.2bn, the estimates now are approximately $4.6bn.
All of these headwinds occurred during what is consistently the seasonally weakest quarter of the year for CF so the magnitude of the impact looked that much more severe.
Despite all those headwinds, CF's actual adjusted results (in terms of Gross Margin and EBITDA) were consistent with last year's Q3 - which is impressive considering the decline in various realized nitrogen fertilizer prices over the prior year period.
Q3 2015 Q3 2014
Revenues $927.4 $921.4
COGS $762.4 $620.3

Loss/(Gain) on Nat Gas Derivatives $125.9 -$12.1

Cogs Adjusted for Nat Gas Derivatives $636.5 $632.4

Actual Gross Margin $165.0 $301.1
Adjusted Gross Margin $290.9 $289.0
Q3 2015 Q2 2015 YTD 2015 YTD 2014
EBITDA as Reported $256.3 $338.3 $1,411.9 $2,211.0
Adjustments (as per inv pres slide 21) $84.0 $25.3 $120.1 -$655.3

Adjusted EBITDA $340.3 $363.6 $1,532.0 $1,555.7
In short, CF's results were appreciably better than they appeared at first blush when making the adjustments highlighted above. But we are in a market where investors are generally operating with a "when in doubt, blow it out" sensibility. I'm not surprised based on how convoluted the quarter was that the market took it down 10% yesterday. The biggest concern is where is pricing in nitrogen fertilizer going? And when will it recover?
There were a number of positive comments made on the call suggesting some of the preconditions necessary to a firming of nitrogen pricing are already in place (lower Chinese participation in recent Indian tenders, likelihood of lower Chinese exports in 2015 and again in 2016, higher expected corn acres planted in 2016 than 2015, certain international suppliers suspending operations at current levels of profitability, etc). I firmly believe that the product markets are either at (or very near) their bottom and in a strong position to recover, but the question traders are asking is when, precisely, will the product markets recover?
If you are an investor in CF and believe, as I do, that a) we are much closer to the bottom of the market in product pricing and that pricing will inevitably recover and b) CF will follow through post the close of CHS and OCI with a massive return of capital to shareholders - then this is a time to hold on or add more if you don't already have a full position in the stock.
If you believe that nitrogen product pricing will either a) go lower and stay there or b) sustain at these multi-year low levels - then CF's stock is going to continue to have a bumpy ride and you are in all likelihood a seller of the stock.
I plan to write a more full Q3 recap and perspectives on CF based on the earnings release and CF's earnings call. With any luck, I'll have it out by the end of next week or early the following week.
Finally, getting to your specific question Ernie, I agree this was a material charge to earnings due to hedging. Nymex spot natural gas dropped ~11% from 6/30-9/30. (Recognize that low natural gas prices are generally a very good thing for CF and have allowed them to places hedges at prices well below the 5 year and 10 year average natural gas prices that are close to or above $4 per MMbtu - but in the short term if prices go lower after hedging there's clearly a negative mark-to-market impact). CF had a lot of hedges out through 2017 going into Q3 and the Company added approximately 60% to their hedge position in Q3. Further CF extended some hedging to 2018. Will the unrealized hedging losses reverse themselves? All depends on where nat gas prices go from here. We are having a very warm fall, but one would expect temperatures to cool as we approach the holidays and that should lead to some firming in natural gas prices. If the quarter were to end today, I would suspect given natural gas about 6% lower than the Q3 close, that they would have further mark-to-market losses to take. But if forward natural gas prices firm between now and quarter end, then there maybe no further negative impact from unrealized losses and some of last quarters losses could reverse themselves. It principally depends on where spot natural gas prices (and the forward curve) ends up at quarter end.
Having cooler Fall weather is highly important from another perspective as well. As highlighted in the CF earnings call most farmers are waiting for 50 degree weather to lay down their Fall ammonia application. Current forecasts suggest that that type of weather is coming to the corn belt in the coming weeks.
In terms of CF's acumen with hedging, they have done a good job historically of protecting against spiking natural gas prices but that has come at the cost of not enjoying the full benefit and paying higher than market prices when natural gas quickly declines. Back in the first half of 2014 when nat gas spiked higher to the mid-$4s to low $5s per MMbtu, CF averaged realized prices $0.55 lower than Henry Hub spot. Between Q3 2014 and Q1 2015, CF paid prices $0.38 above Henry Hub spot as average Henry Hub quarterly spot prices declined from $4.58 to $2.90 per MMbtu.
Upshot, it is not clear to me why CF hasn't exclusively used collars which would have allowed them to better participate to a greater degree in these natural gas prices that are near decade lows. But it is very easy to second guess on hedging when in the short term the execution on existing hedges looks sub-optimal and its unclear how much capacity was available for CF to put on collars. Further, it is worth mentioning that ~47% of their remaining 2015 and 20% of their 2016 needs are either unhedged or subject to collars where natural gas hasn't broken through the lower bound (and all the OCI nat gas needs are unhedged according to CF). So if natural gas prices stay low, CF will be enjoying low market prices (assuming they persist) on that % of their unhedged need.
Big picture, many investors have historically impressed upon CF that they should be hedging to take out the risk of an upward spike in natural gas prices. Natural Gas costs in the US are currently amongst the lowest in the world so locking them in at these prices, from a global perspective, seems like a pretty smart thing (natural gas in Europe is in the $6 area and in Asia it's closer to $9-$10). But with prices in the US moving even lower than from where CF set the hedges, in the short term that has imposed a headwind that we saw play out in Q3's results.
This is not the call from CF's earnings - this is the CF/OCI deal call.
Good question and good catch. While adjusting for opex would make a difference on the theoretical value in the case that CF would sell all their capacity along the lines of the CHS deal, the magnitude of the upside in CF is still material and the difference in the impact on value adjusted for Opex is not dramatic.
Few points:
1) If you look at opex for CF it consists of two line items: SG&A and Other Operating - Net. Other Operating - Net has principally been foreign exchange hedging related losses or gains, some of the costs associated with the expansions at Donaldsville and losses related to disposals of assets. Other Operating - Net has ranged between $-20mm (Q3 2013) to +$26mm (Q3 2014) over the last eight quarters. In the context of "in the theoretical case" where CF sold all its capacity out, I would argue this line item should also be zeroed out. FX hedging costs should be assumed to be $0 over time (and fx hedging may not even be entered into if all capacity was called for) and the expansion program CF is currently in will soon be over.
2) That leaves SG&A which is a relatively low % of revenues. It has ranged from 2.7% (Q2 2014) to 4.1% (Q3 2014) or revenues over the last eight quarters (3.2% median as a % of revenues) or $33-$45mm ($39mm being the median quarter over the last eight). In the context of SG&A, you then need to ask, how much of SG&A is "Selling and Marketing" related. In the event that CF did sell off all its capacity for 80 year agreements (like the CHS agreement), they presumably wouldn't need any "sales or marketing" effort on an ongoing basis. Might this represent as much 10% or more of SG&A? Could very well. Countering that savings, there's going to be opex on the expanded facilities. There's got to be operating leverage on these expansions so let's assume opex increases 15% on the 25% capacity expansion. So taking $39mm median opex per quarter, dropping that to $35mm of opex after savings on no longer needed selling and marketing efforts and then grossing $35mm up 15% that gets you to about $40mm per quarter of pro forma run-rate, quarterly opex.
3) Put a multiple of 12x (same multiple used in my M&A synergies calc) on that $160mm per year of estimated opex and that arrives at $1.9 bn = $8.24 per share at CF's 233mm share count. That reduces the theoretical warranted value of CF if all their capacity was accounted for in deals like CHS's to $111 from $119 in the article. That price is still a slight premium to the $108 warranted price I laid out in the article that takes into account all the moving parts.
In terms of anything below the opex line, the enterprise value calc assumes that all debt is paid off (so no interest expense) and if all gross margin was going out to the door to the minority interests, there would be not profits to tax so no tax expense on any income.
Kind Regards,
MPC actually beat when you adjust for a $0.17 charge they took for cancellation of the ROUX project. Adjusted for Special Items EPS was $1.93 vs. $1.82 (11 cent beat).
Interesting, not sure how that's the case unless you waited a while to buy the stock - like right after the announcement of some of the deals announced in August. Last article was published on April 20 closing stock price that day was $57.59. Inclusive of dividends the stock is down 7% (or about $4 per share) since then as of October 8 close. Not even in the same ballpark of the $10 you've indicated.
Regardless while I welcome short term gains, unlike your perspective I seek out opportunities where a long-term view should lead to superior returns. If you go back and look at the first time I wrote on CF (published initiation piece on July 5, 2013), the stock is up 56.9% (inclusive of dividends) through October 8 close over those two years and five months. And if you go back and look at CF's stock price performance since its IPO, if that's what "losing all your money" in a commodity stock looks like when taking the "long view," then I think a lot of people would welcome doing just that (total return since CF's August 2005 IPO is ~18x as per their most recent investor presentation).
In terms of Nitrogen prices being lower for longer, I think there's a real possibility of that and I highlighted that in the article. The point being that it's not just about N prices, it is also critically about natural gas prices. And frankly, the lower N prices go (so long as natural gas prices stay low in North America as compared to the rest of the world) the better CF is relative to foreign competition. Further, we have a had a few back-to-back years of near perfect growing conditions and record corn harvests. Might we experience imperfect or adverse weather conditions one of these upcoming years that will impact agricultural production and thereby drive ag prices materially higher? (At some point it is inevitable). Such a scenario would drive the potential upside in CF's share price materially higher than what I've already outlined.
Hi Chris,
As you surely appreciate from the write-up, I'm taking the long-term view on CF. With so much potential long-term upside, I typically look at short term volatility in the stock as an opportunity to add exposure. Might tomorrow's WASDE report impact things, sure could. But since I started writing the above article (took a few weeks to complete), henry hub spot natural gas prices have declined 10% and corn futures prices are up ~4%. So even WASDE takes corn down a little, we've got more room now than even a few weeks ago because of continued weakness in natural gas.
In terms of Galeen, what I've read states that the CAN plant will be back online this quarter and the costs related to the incident are fully insured. Anyways, none of that should have any impact on CF so long as that holds true - that everything is well back on-line before the completion of the merger. And in terms of having an impact on a long-OCI position, if you're involved in OCI right now you're looking to the close of the deal with CF and looking for any headwinds that will prevent or delay that close. I don't think you're going to be too worried about a fire that only impacts that one part of their production at Galeen. Ammonia is back online already and UAN and melamine should be back online by the end of the week.
Good to hear you're long CF.
Thanks for soldiering through the article.
I'm not sure that I'm quite following you in terms of discounting the share price? Are you effectively talking about dilution? Given that they aren't buying shares in CF directly (but in a specific operating subsidiary which is not anticipated to be publicly traded) that makes that difficult. Also, as I understand it CHS will be obtaining the gross margin economics on the product it purchases. So when it comes to how this will impact the income statement and balance sheet I see this as a minority interest expense that will be coming out of the income statement (somewhere below the gross margin line) with no share count impact. Given that in the valuation section of my piece I used a range of EBITDA that was broad (and focused in on the middle part of that range not the high end) I think that sufficiently covered the decreased income that will be flowing out through the minority interest. CF's "Unallocated cash slide" included the expected out-flow of cash to CHS given the arrangement so that part is covered in terms of indicative free cash flow allocable to share repurchase, debt pay down and dividend increases.
Courtright isn't a big project, but just another nice little bump for the company and indicative of management's consistent focus on maximizing value from their assets.
Kind Regards,
Scroll up and you'll see some of my comments on this topic above, but a current update:
Based on Farm Futures reports - UAN 32% is currently around $220 vs. $240 last August (-8.3%) and Ammonia is approximately $549 at midwest terminals vs. $650 last August (-16% vs last year). Wholesale Ammonia prices will be less than what they are at the terminals but decline highlighted is a reasonable proxy for the decline in wholesale prices.
Importantly, Natural Gas costs have declined at a materially higher rate (30%+) than the wholesale prices of Nitrogen Fertilizer - which is why margins have been expanding significantly (Gross Margins up over 500bps in Q2).
For more on historical fertilizer prices see:
Thank you for the kind remarks.
Not sure what you mean about the dwindling net profit, margins and fcf.
Operating income was up 19% in Q2 over Q2 from the prior year. Operating margins were up to 48% vs 36% in the prior year quarter. Net profits were up over 12% and would have been up meaningfully more if they hadn't had a significant swing to the negative in q2 2015 in earning from equity affiliates.
If you are looking year to date vs the prior year first half, you have to take into account that they sold their phosphates business which led to a mammoth gain in q1 2014 which needs to be backed out for the sake of a comparable comparison.
In terms of free cash flow, they are in the end stages of a multi year build out of a 25% increase in their production capacity. Capex was elevated last year and even more so this year (2x the capex in q2 2015 vs q2 2014). The capex program should be complete by the end of 2016. Run rate capex is $500-$600mm per year or $125-$150mm per quarter according to management which is ~$450mm less than what they just spent in q2.
In terms of dwindling sales, yes pricing has been more muted in 2015 than 2014, but as the margins, operating and net profit (affected for special items) indicate, profitability is exploding as nat gas prices have declined materially more than the prices of fertilizer. And when all this new operating capacity starts coming online (starting in q3 and in earnest in q4 thru the rest of 2017) the year over year comps in fertilizer sales volumes (and in turn revenues) is going to start looking increasingly robust.
Finally, when you look at the bottom line eps numbers - things look even more robust with all the accretive share repurchase they have done and plan to do. Management in their most recent investor communications has indicated that they could be sending between $10-$11 billion more to shareholders between now and 2019 based on conservative assumptions (this is beyond the current dividend extrapolated out). Assuming that $10 billion of that is in share repurchase that's $2.5 billion per year of share buybacks in each of the next four years. At the current market cap that suggests that cf could buyback about 17% of its stock each year. If you want to think about it as downside protection, back of the envelope math suggests that net earnings would have to drop every year by -17% with all the forecast share repurchase for eps to just stay flat. And with all this capacity coming online and cf having now hedged significant amounts of its forward gas needs at very attractive levels, it is highly unlikely that net earnings are going down from here over the next 2.5 years.
In short, when you dig in on the cf story, the outlook is remarkably robust and the past performance has been impressive.
A few points to highlight from TNH's Q2 results released this evening:
- Gross Margins improved by 530bps to 67.5% from 62.2% over Q2 2014
- Gross Margin declined $500k (-0.5%) despite the UAN plant turnaround extending into early Q2 impinging their ability to have a full Q2 of UAN capacity
- Realized Nat Gas costs were 34% below last year
- With tight ammonia markets in Q2, weaker UAN market, and the impact of the delayed re-start of the UAN facilities - company elected to shift product sleight to more ammonia (26% of volume sold in Q2 2015 vs. 15% of volume sold in Q2 2014)
- With company and other market participants indicating that the ammonia market is expected to remain tight through the rest of 2015, likely that TNH continues to shift to more outright Ammonia sales for the rest of 2015 (author's opinion not stated by TNH/CF)
- EPS increased $3.31 (Q2 2015) vs. $3.16 (Q2 2014) +5% year-over-year
- Company is building cash back-up on the balance increasing Q2 cash balance to $72mm from $60mm in Q1
- Q2 Distribution increased to $2.36 from $2.08 in Q1
- Having completed $67.4mm of capex YTD - company has completed 80% of the 2015 capex guidance (mid-point of $80-$90mm range) in the 1st half of 2015
Its not just TNH, UAN and RNF have all been tattooed over the the last two sessions. Thru 2:30 this afternoon, TNH -8.3% since the Friday, July 31 close, RNF -8.5% and UAN -10.9%.
There's very little news flow on any of these names, but volume has spiked on both TNH and UAN to more than 2x the average daily volume.
TNH reports tomorrow. UAN had strong results when it reported late last week. The irony is that CF is strong today going into earnings while TNH is down.
While there are many possible reasons why these stocks are off, I have witnessed aberrant behavior in the past specifically in CF right before earnings. Is it possible that some sharp traders are pushing the stock around in the hopes of flushing out weak hands and buying more stock in advance of earnings? Might it be that some MLP focused funds are consolidating around core traditional MLP positions and lightening up on variable distribution fertilizer MLPs? There are a number of others things it could be. We'll see. . .
Yes - per Matthew's point. While the comments about the PC market being likely to pick up later this year don't hurt, the stock price's reaction today is all about the progress on the MOFCOM front. WDC confirmed in the Q&A on their call that Operating Expense savings should be about $400mm per year with COGS synergies being "material" on top of the OpEX savings.
Assuming COGS savings would be at least another $200mm per year and with WDC's low tax rate, all those synergies add up to ~$2.35 per share per year. Put a multiple of 10x those earnings and you arrive at a $23.50 higher warranted stock price . . . The market has begun to price in the seemingly higher likelihood of a near term approval by MOFCOM of WDC's integration of its businesses.
Herztical - thank you for the comments.
Couple thoughts.
In terms of TNH's distribution yield relative to interest rates - there has been very little correlation. So in theory if investors were trading TNH based on a spread to, say, the 10 year treasury we would have seen a higher distribution yield back in the 2010/2011 period when the 10 year treasury traded at ~3.5% (not the 2.2% it is at now). But in fact the distribution yield was sub 7% for most of that period. Past may not be prologue, but those that invest in TNH are largely not going to be those tempted into 10 year treasuries even when they hit a 4% yield. People invested in something like TNH are compelled by the superior yield as well as the favorable tax treatment of MLP distributions vs. that of interest income on most fixed income products.
In terms of fertilizer prices, the decline in natural gas prices (the biggest cost for TNH) appears to have been approximately 30% in Q2 with that continuing so far in Q3 (using Henry Hub spot as a proxy). Wholesale gulf UAN prices were down approximately 10% in Q2 with that continuing in Q3. What matters for TNH, like the refiners, is effectively the spread. So long as natural gas price have and continue to trade at significantly greater discounts to what UAN and Ammonia have sold off to over the comparable period, profitability should benefit. Continuing with the refining analogy, a number of companies are trading at levels near all-time high's (MPC, VLO, TSO) in that space largely because the crack spreads have blown out to highly profitable levels.
Revenues are down for all the refiners because gas and diesel prices are down, but profitability is exploding. TNH is not in the situation that it was back in 2012/2013 when natural gas costs were particularly low (mitigated by TNH's hedging program) and UAN prices were at or above $300 per ton, but they are still looking much better positioned than in they were in 2014 when they were contending with materially higher nat gas prices and much higher capex needs.
A couple thoughts Mad:
Not clear how this rumored deal would impact TNH. I would not invest in TNH based on this rumored deal per se (I will provide a couple thoughts on this deal from a CF perspective further below). The best reason to invest in TNH is the likelihood that distributions will be meaningfully greater over the coming quarters and the stock should respond in kind. That said, OCI does have a majority interest (79%) in OCIP which is also a variable distribution MLP. There may be some logic to combining OCIP with TNH if a merger were to occur between CF and OCI. But unless CF looked at doing this merger as a time to just clean up all outstanding minority interests, its unlikely the merger would have any direct impact on TNH. And make no mistake if CF attempted to use its call on the outstanding public TNH shares, it would not necessarily be a good thing for TNH common shareholders given the call provisions highlighted in my article.
Focusing on CF and the potential combination OCI is more interesting.
If CF is indeed looking to re-domicile to the Netherlands through an acquisition of OCI, that could be a very attractive deal depending on the premium that would be required to combine with OCI.
In terms of industrial logic, contrary to what Chris indicated above, OCI is now a pure play global fertilizer and industrial chemicals company. They de-merged their construction business in March of this year. In fact, when all of their new facilities are completed by the end of 2015 they will be on track to be the 3rd largest nitrogen fertilizer producer in the world. That said, given how global the agricultural nutrient business is and how fragmented the supplier base is, CF (the acquirer) would undoubtedly make the argument that one needs to look at CF's global market share when evaluating any anti-trust concerns. Further, even with the addition of OCI's oncoming capacity in the US, CF won't even come close to having the consolidated position in nitrogen fertilizer production that Mosaic has domestically in phosphates. In fact, Chris Damas made the similar argument that Mosaic wouldn't be able to close on the deal with CF when they agreed to sell their phosphates business to Mosaic because it would make MOS the far-and-away dominant North American producer. That deal went through in May of last year undoubtedly because of the same arguments that CF would make in an OCI combination - that bulk fertilizers are a global market and CF is far less than 50% of the global market even with a combination with OCI. Further, given the de facto cartel situation with Canpotex and Potash as well as the they way the Chinese address the nitrogen fertilizer market (and the fact that more than 40% of domestic nitrogen fertilizer market is sourced from imports), there are a number of reasons the justice department should let a CF/OCI deal go unchallenged.
In terms of OCI being a high cost ammonia producer, that is an outdated and misrepresented view of OCI. Pro Forma for the completion of their Iowa Fertilizer Company facility in Q4 of this year, 76% of OCI's production will be in places with low cost natural gas: namely Egypt, Algeria and the USA. Algerian Natural Gas in June (according to Index Mundi) traded at about $2.76 per MMBtu - very similar to the US. Eqypt also has very low priced natural gas (unfortunately for companies like Apache which have E&P operations there).
Finally, if CF were able to re-domicile to the Netherlands in the context for this deal, not only would CF be able to have a more globally competitive nitrogen fertilizer business that could export from multiple continents to the best end markets, the tax savings on a go forward basis for CF's North American business could be substantial. CF is currently headquartered in arguably the most hostile US state, Illinois, from a corporate tax perspective in a country (the US) that has the highest federal corporate tax rates of any OECD country. It should be no small surprise that a bevy of Illinois based companies have either tried to or have re-domiciled out of state or overseas (Walgreens (tried), Abbvie (tried), Jelly Belly (did), Office Depot (did), Eureka (did)). Corporate tax rate in the Netherlands is 25% vs. 35% federal and ~9.5% state corporate income tax rate in Illinois). Finally, the argument above about "the boys from Chicago" not wanting to move to Antwerp does not make a lot of sense. Just because a potential pro forma CF was headquartered in Amsterdam, doesn't mean that the whole senior executive team would need to live there (if any). They might just spend time there for board meeting and various other required acts. And btw, "the boys from Chicago" probably have more flights to choose from to get to and from Amsterdam than any other airport in the US (and frankly the flight is easier to Amsterdam from Chicago than it is from say New York - the red-eye is long enough from Chicago that you can actually get a full nights sleep rather than a long nap).
Anyways, the deal between CF and OCI could, depending on terms and structure, could be a home run. OCI gets a nice premium and OCI's assets gain, arguably, the best management team in the industry.
Chris - you are right on only half the plant being down in Q1 (one of the two ammonia plants and one of the two UAN plants). I've updated the article to reflect that. The good thing about that it lessens the risk of the restart on full production if there was any tempered ramp of those fully turned around facilities. The major point though is fully intact, a major part of TNH's production capacity (over 40%) in Q1 was offline and is fully back online starting the first week of Q2.
Thank you for the added color on TNH's history back in the early '90s.
Given the strong secular trends in capex spend and low nat gas costs, I didn't want to focus this article on the ups and downs in the corn and wheat markets, but this is as good a place to do a little of that as any.
As you're well aware corn futures are up 20% in just the last three weeks. Wheat futures are up a similar percentage. There are a confluence of factors that have led to these spikes including the state department visa system being down for a number of weeks that prevented many agricultural workers from being able to make it North of the Mexican border, heavy rains impacting the wheat crop, and the lower acreage and stocks report of which you highlighted that have all come to pass. Further as stated in the June 26th Weekly Fertilizer Review: "Growers scrambling to find nitrogen for applications disrupted by flooding are facing higher prices as June ends." So as of the last of these updates, nitrogen fertilizers were also on a strong pricing trend.
Jrad. Excellent background. Thank you for it.
Davidaexp - please take a look at my write-up on CF Industries published in April entitled "Still Able to Purchase a $1 for 40 cents: CF Industries." There is a broad discussion of the oncoming capacity expansions in the US and how even when all of the capacity expansions come on-line, there still is expected to be a material deficit of domestic production vs. domestic demand. Currently ~40% of the US's nitrogen fertilizer demand is imported. All the capacity expansions that are coming on-line aren't even close to bridging the gap to make the US self sufficient in nitrogen fertilizer production. It is anticipated that added domestic production will crowd out imports because the US is the low cost producer due to our low cost of natural gas and low shipping costs (we don't have to get it here from overseas).
In terms of Rentech Nitrogen, RNF's majority owner (Rentech, Inc) has been under significant pressure to maximize shareholder value from the activist investor community. Rentech has been perceived as a poor operator and has a sorry history with regards to capital allocation and shareholder value destruction (the stock trades for 1/3 of its 2013 high). Rentech Nitrogen and Rentech, Inc have had a multitude of write downs over the years. Further, Rentech, Inc's debt has exploded over the last few years and the sale of Rentech Nitrogen may very well be necessary to relieve the financial burdens of Rentech, Inc's over-leveraged balance sheet.
In terms of corn prices, yes they've sold off materially since 2012/2013, but we're seeing a major offset for that for TNH and the other nitrogen fertilizer manufacturers with the significant sell-off in natural gas prices. It's important to point out that nitrogen fertilizer is a non-discretionary fertilizer, it needs to be applied annually (vs. phosphates and potash that are banked by the soil and can be, arguably, more easily deferred).
Finally, there has been significant pick-up in discussion of a major El Nino event transpiring in 2015/2016 ( If that comes to pass, that could very well lead to the types of weather that could be very constructive for agricultural commodities. If that were to come to pass, the estimates I walked through in this article may prove to be highly conservative in terms of future earnings and distributions . . .
Ty Vivianna - appreciate the feedback.