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CF Industries: Capital Expansion Plans And Nat Gas Exposure May Warrant Low Valuation

A Video summary, along with a full written report is available at www.TheMoorjaniReport.com.

CF popped up on one of my screens and I initially started writing a buy recommendation, but after digging deeper I decided against it. Here's the main points that led me to give a hold recommendation:

Bullish Case:

• CF is the 2nd largest nitrogen fertilizer producer in the world and the 3rd largest public phosphate fertilizer producer.

• CF has strong market position in its Nitrogen segment which makes up 83% of its revenues.

• When compared to other fertilizer companies, namely Agrium (NYSE:AGU), Mosiac (NYSE:MOS), Potash Corp. (NYSE:POT), CVR Partners LP (NYSE:UAN), and Innophos Holdings(NASDAQ:IPHS), CF's EV/EBITDA multiple of 3.4 is much lower than the peer average of 9.03 and the implied discount rate of its free cash flows of 16.75% is much higher than the peer average of 4% showing a potential inefficiency.

• The valuation we used gives a price target of $212.69, which gives a 21% upside compared to April 15th's closing price and our model uses only a 3% growth rate and a high 15% discount rate.

• North American nitrogen producers have a natural gas cost advantage over most global competitors.

Bearish Case:

• CF's peers have more diversity in their fertilizer products and are less susceptible to increases in natural gas, which made up 70% of CF's cash costs.

• Natural gas prices have been rising and will squeeze CF's margins relative to its peers, when current natural gas prices are used the price target lowers to $192.

• The valuation is based on stable commodity prices, therefore if the investor has a negative long term outlook on Nitrate or Phosphate fertilizer, or a bullish outlook on natural gas, this strategy should be reconsidered.

• The company has undertaken a $4.7B capacity expansion plan, creating significant medium term risk.

• In 2012, the company generated 83.5% of its revenues and 93.6% of its gross margin from its Nitrogen Segment, which has many competitors and low barriers to entry.

Recommendation:

The analysis of comparables gives the strongest investment case to CF because of its implied discount rate of 16.75% versus the peer average of 4%. However, this difference may be justified given its large exposure to natural gas and large capital expansion plans. Overall, the evidence points more towards a bullish case, but not enough to recommend a long investment.

Disclosure: I am long CF.

Additional disclosure: I purchased CF prior to assessing their natural gas risk. Therefore I am long CF.