Description

CF Industries is a nitrogen products producer listed in the US.

I’ve written before about the nitrogen market (in Yara/OCI write-ups) and won’t go into it in detail right now. I suggest reading those for a more detailed overview.

Summary of sector: Nitrogen

The most common end market (85%) is fertilizer for the agricultural market and remaining 15% is industrial products. Demand for end products is growing at 2.5% ish globally. The urea (largest nitrogen product) market went through a global crash on the back of massive oversupply in production in 2014-2017 and urea prices fell from $450 to $180. Since new plants require $400+ prices to incentivize, no more supply has been ordered over last few years and it takes 3-4 years to build a urea plant so we have visibility on supply side on that timescale. Urea prices bottomed about 18 months ago and have slowly been recovering. Last year they averaged $250. For the next 3-4 years demand will run ahead of supply additions, tightening the market and increasing utilization.

The only thing to warn when monitoring urea prices is that it’s a very volatile market and prices may have averaged $250 ish last year but swung from 220 to 300 and prices averaged $220 in 2017 but swung from $180 to 270 in between. What matters is average price for year and the trend up (unless you’re an uber commodity trader and want to predict any given India or Pakistan urea tender etc). There are Black Sea prices.

I believe average prices will continue to trend up.

Here’s chart for 2011 till 2018.

And here’s some more updated prices upto this week.

CF company overview

CF segments its divisions into sales Ammonia, Granular Urea, UAN, AN and other. Ammonia is the base building block for all nitrogen fertilizers, and this amount only represents the amount of Ammonia sold directly. The rest of Ammonia is used in building other products like urea, UAN and AN. Since all of these products are derived from ammonia, and to varying degrees can be substituted for each other, all their end market prices exhibit strong correlation with each other and since urea is the only significant globally traded product of these, we can use urea prices as benchmark to set local price of nitrogen products in the US.

US market is in deficit (by about half) and will remain so and hence the price is set by international urea prices. The cost is effectively the international price plus freight cost to farmer. Since CF produces more cheaply in-land, it reaps a benefit. While last year international prices average $250, CF’s realized price on granular urea was almost $300.

CF’s share price similarly crashed from $70 in 2014 and bottomed about 18 months at $25. CF went from 12,000 tons capacity to 18,000 tons so it has massively increased operating leverage and (financial leverage since it built the capacity with debt) and since the cost of building the increased capacity is infact “sunk”, it is generating high cash flows at the current prices and bought back almost $500m of stock last year. As urea market continues to recover, CF’s cash flow potential will become apparent.

Assuming urea prices recover $20 per year (fairly conservative) for next 3 years and CF continues to buyback $600m per year of stock, CF will go from 10.5% FCF yield this to 20% in 3 years, EV/EBITDA for 2021 collapses to 4.0x and P/E to 7.5x. I believe the share price can double over next 3 years.

I’d like to warn those who have never been involved with this stock. There is a LOT of noise. Farmers yapping about floods and weather. How much acreage will require urea this year etc. When does the planting season begin? Is there a drought? Is there a flood? Does China ban US soy? Does China buy extra US soy? Blah blah blah. Will we substitute soy for corn, or corn for soy, or both for wheat this season? Blah blah blah. Everyone has a farmer friend they are talking to who has inside knowledge of how much a bushel of corn is fetching in profit. Blah blah blah. The way the stock moves on e.g. a marginal shift in THIS SEASON’s planting of corn versus soy (corn is more urea intensive than soy) due to weather like floods is beyond belief.

Infact currently the share price is depressed since a lot of analysts have published “hot takes” that despite it being 10%+ FCF yield and buying back stock hand over fist, and FCF yield only going up next year, you should be cautious or sell since US has experienced some floods…….. this season. This is silly. US is about 20% of the global market and could have some marginal shift in demand for urea this season since there’s some flooding that could decrease planting season and since soy grows faster there might only be time to grow soy instead of corn …… THIS SEASON….. IN US. So since we’re not addressing global demand for soy or corn or indeed for urea, we might produce more corn elsewhere, or we might have to produce more corn next year as stocks will fall. Weather is weather.

Tldr: CF is cheap and the market is set to continue to tighten.

Catalyst

Urea prices.