Weekly Stock Call

June 22, 2010
Current Price – US$64.62


CF Industries is the second largest nitrogen fertilizer producer and the third largest phosphate fertilizer producer in the world among public companies. Revenues ($2.6B in 2009) are derived globally through cyclical sales to the agricultural industry. Profitability is driven by factors affecting price and volume, primarily global economic conditions and weather, and by factors affecting cost, primarily raw materials costs, natural gas prices and operational efficiency. While CF Industries is very competitive with industry leaders in terms of operating margins (26.1%) and return on equity (22.9%) they currently trade at a significant price discount to earnings relative to peers (10.6 P/E for CF vs. 24.3 P/E for the industry). I feel that this is a discrepancy that will resolve as the global economic recovery progresses and CF Industries has the opportunity to digest its recent acquisition of former competitor Terra Industries. The acquisition has left CF Industries with a somewhat weaker balance sheet, but a return to greater demand and more positive pricing conditions as we exit the recession would likely lead to an early retirement of the debt used to fund the merger and restore a traditionally conservative balance sheet. In short, CF Industries appears to be an attractively priced and well positioned cyclical stock poised to benefit greatly from increased global demand for food and feed stocks in coming years.


Valuation

Based on a blend of valuation methods (discounted cash flows, dividend discount model and, historical and industry price ratios) I arrive at a current valuation for CF Industries of US$77.24.

Expected return should this price be realized in the markets within the next 12 months would be:

Price yield       19.5%
Dividend yield   0.6%
Total return     20.1%


Risks

• Unfavourable weather conditions reducing the need for fertilizers.
• Subdued global economic conditions limiting demand and intensifying pricing pressures.
• Volatility in natural gas prices, a major component in fertilizer costs. CF Industries undertakes derivative price hedges for natural gas related to forward purchase agreements it has committed to customers.
• Failure of the merger with Terra Industries to result in expected synergies, or unexpected costs or delays associated with merging the corporate cultures.
• Environmental matters, primarily at Florida and Louisiana facilities, provisions for facilities remediation and ongoing legal disputes with the EPA. The material impact of these issues is unknown.

The Numbers

Share Price ($US) 64.62 
Market Cap ($US M) 4,591 
No. Shares (M) 71.1 
ROE 22.9%
ROA 16.3%
P/E Ratio 10.6 
Price/Sales Ratio 1.9 
Price/Book (tang) 1.8 
Current Ratio 2.4 
Interest Coverage N/A 
Total Debt/Equity 0.94


Analyst: David Scollon

Disclosure - At publication of this analysis I hold no position in this security, but may take a long position in the future. I do not take short positions in any of the stocks reviewed on this site, nor do I receive any compensation from the companies studied for publication of my opinions.