The title of my CF write ups has changed dramatically over the past couple of months. It went to from “CF stands for cash flow in CF Industries”, then “CF Industries, putting the puzzle together”, finally now to something that borders along the lines of “CF Industries, is it safe to come out of the foxhole yet?”. I’m not quite sure of the answer – save for a few spots in the sector 2016 is going to be a tough year for anything agriculture related – but judging where sentiment is, taking a look at CF is probably timely.
I don’t think that there is any rush with this stock, given where the short term fertiliser outlook is not sure how much interest there is in these names. There was a recent uptick in N fertiliser prices following the anticipation of the spring rally, indeed prices went from low $200/st on low volumes in the US to $260/st recently, however futures for April are already pointing to lower levels. The stock has also been owned by the who’s who of hedge funds and there has been rotating out recently as the share price collapsed so there is also a question of when these holders would eventually throw in the towel given the bleak near term outlook.
I think the attraction in the stock is management’s plan (whom are also shareholder friendly) in putting a company together in the downturn that could enjoy significant increase in earnings as the cycle normalises over time. If all goes well, by 2016/2017 CF will have increased its own production capacity by 24% via brownfield expansions, secured a long-term off-take agreement with a long-time client and an investment at a very attractive valuation, further increased its capacity by nearly 40% via M&A, potentially re-domiciled to Holland and began to return nearly a substantial amount of its current market cap via buybacks.
There is definitely execution risk, which makes the story complicated thus the stock will likely trade on sentiment for the next few quarters as all the pieces fall in their place. However, I’d argue that even in the base case there is upside to CF (though modest) on through earnings. If the transactions close (and the sell side gets more clarity) and management delivers on their capital return plan the story could be very interesting for a large and mature business like CF.
Brief primer on nitrogen fertiliser
Nitrogen is an essential fertiliser along with phosphate and potash and is the N in the NPK love triangle. The key difference compared to P and K is that N has to be applied every year to enable a certain crop quality as well as yield thus demand is rather inelastic. Without going too much into agronomics, N fertiliser will give farmers a certain improvement on yield (vs not applying anything), while P and K improve crop quality and yield even further. However, normally due to affordability EM farmers often skip applying them in a given year (most EM farming is very inefficient and happens on a small scale thus long term agricultural development is usually sacrificed for saving money). I’d also add that the supply/demand balance, while not perfect for N either, is much more challenged for potash and phosphate. While nitrogen is a “sticky” product it is a commodity - US urea is very much the same as Chinese urea, thus the cost curve is key.