- Weak plantings in 2019 due to adverse weather conditions are likely to lead to strong fertilizer demand in 2020.
- Natural gas, a major component of production costs, has tumbled over the past several months and is considerably lower in price than historical averages.
- Long-term fundamentals of the industry remain positive, based on continuous global growth of consumption of meat and general affordability of fertilizers relative to crop prices.
CF Industries (NYSE:CF) manufactures and distributes nitrogen fertilizers and other nitrogen products worldwide. The business is well positioned in the industry to take advantage of market conditions and an expected increase in global demand growth for nitrogen. Multiple near-term catalyst exist for the business, including: likely strong demand in 2020, the decline in natural gas over the past several months, and positive long-term fundamentals of the industry.
Corn Production in 2019 Was Down, but Should See a Rebound in 2020
Since corn accounts for more acres planted than any other crop produced in the US, corn production has a strong correlation to nitrogen demand. In 2019, adverse planting and growing conditions caused corn production to decrease YoY. However, as a result, there is a strong price incentive for growers in the United States to increase corn production in the near future. In their most recent projection, the USDA estimates that corn planted acres will increase to 94 million in 2020, a 4.8% increase from 2019 89.7 million acres.
Corn was not the only crop that suffered in 2019; other major field crops were affected due to flooding and record rainfall as well. Similar to corn, the USDA is projecting for these crops to bounce back this year as well.
According to USDA projections, soybean acres planted in 2020 will rise to about 84 million acres, up from 76.5 million acres in the previous year. Additionally, total acreage plantings for eight major field crops (corn, sorghum, barley, oats, wheat, rice, upland cotton, and soybeans) are expected to rise by 11 million acres to 249.4 million acres in 2020, according to the USDA. This increase in production should help propel revenue growth for the business. The chart below displays planted crop acres since 1973 for corn, soybeans, wheat, and cotton (as well as the projection for 2020).
The Decline in Natural Gas Will Likely Widen Production Margins
Natural gas is a key component of production costs for the business, accounting for approximately 35% of total production costs for nitrogen fertilizer products in 2019. Natural gas has steadily declined over the past several months and is considerably lower than historical averages.
CF Industries has access to abundant low-cost North American natural gas, which provides them with some of the lowest costs in the industry and positions them firmly on the low end of the global cost curve. As natural gas remains at these levels, the business is well positioned to widen production margins. In addition, according to the company, global demand growth for nitrogen over the next four years is expected to outpace net capacity additions given the limited number of facilities currently under construction around the world with none in North America.
Despite the current low levels of natural gas, the recent move in oil could prove to be bullish for the commodity. Goldman Sachs believes a sharp reduction in U.S. shale oil drilling would, all else equal, will be positive for natural gas prices. This has yet to unfold, but could prove to be a factor in the future.
Long-Term Fundamentals Remain Positive
Producers remain optimistic about the long-term fundamentals of the industry, based on rising consumption of meat around the globe and general affordability of fertilizers relative to prices. Expanding meat production is the main driver of higher corn imports in most corn-importing countries. The graph below provides historical global meat production.
Global meat production has rapidly increased over the past 60 years. As a global average, per capita meat consumption has increased approximately 20 kilograms since 1961. This increase in per capita meat trends means total meat production has been growing at a much faster than the rate of population growth.
Additionally, despite an increase in corn inventories and production pressure on prices, (for the most part trading between the $3/bushel and $4/bushel range) and higher plant nutrient prices, fertilizer has remained at affordable levels. Part of this is due to some softening in fertilizer prices, which will have an impact on revenue for the business. However, this is likely offset by the decrease in natural gas prices.
It Doesn't Come Without Risks
While the 2020 crop outlook projects crops to bounce back following a challenging 2019, the adverse conditions of the farm economy remain. Expectations of slower GDP growth and market disruptions attributed to coronavirus have created additional uncertainty. Weather could once again prove to be a challenge this year. Some farmers are cutting the amount of fertilizer that they apply in an effort to drive costs down and boost yields. Uncertainty around the China Phase 1 deal has optimism suppressed.
However, the fact remains that people have to eat. Government support programs and crop insurance have supported farm income during a difficult 2019 and will be there this year as well. Additionally, the recent decrease in interest rates have kept asset values strong, farm debt-to-asset ratios low, and provided lower financing costs.
CF Industries has sold off with the rest of the market this year, and is down 33% year-to-date. Despite this, there are multiple catalysts for the business in the near term future. 2020 is likely to provide stronger demand to make up for 2019, one of the worst years for farmers in recent history. Additionally, natural gas is at historically low levels which will help boost margins and profitability. Lastly, the fundamentals of the industry remain strong, supported by global growth of consumption of meat and general affordability of fertilizers relative to crop prices.
This article was written by
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