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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

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.


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.