CF - CF Industries Holdings, Inc

[boilermaker75]

CF turned up on one of my screens this week and looks interesting.

 

CF formed in 1946 as a fertilizer brokerage operation and in the 1960s diversified into fertilizer manufacturing. They IPOed in 2005.

 

They acquired Terra Industries in 2010 for $4.6 B in cash and shares. In April 2010, they issued 9.5 million shares of common stock in connection with the Terra acquisition and 12.9 million shares in the subsequent public offering. This is what caused the increase in outstanding shares.

 

In 2011 they repurchased 6.5 million shares and in 2012 they repurchased 3.1 million shares.

 

The market cat is $12.02 B, EV $10.92B, and the TTM FCF $1.852B.

 

Earnings were after the close yesterday and the stock is up in pre-market today.

 

http://finance.yahoo.com/news/cf-industries-holdings-inc-reports-200500889.html

 

 

 

[boilermaker75]

I'm interested in CF <$190. I am short some 190-strike puts that expire today. Since CF has pulled back, but my puts are still well out-of-the money, I have written some May 18 190-strike puts. I love these stocks that have weekly options, especially when they have great premiums.

[Palantir]

Good stuff, that share dilution doesn't actually look that bad given that they paid 4.6B for 600M+ in annual FCFE. Are you expecting a dividend increase/bigger buyback with all their FCF?

[rjstc]

I'm interested in CF <$190. I am short some 190-strike puts that expire today. Since CF has pulled back, but my puts are still well out-of-the money, I have written some May 18 190-strike puts. I love these stocks that have weekly options, especially when they have great premiums.

 

Good one Mike. Can you share with us the criteria you use in your screen? Thanks, Ron

[LC]

I pulled up 10 years of financials and compared them to POT (potash corp of saskatchewan). They've done an incredible job catching up...not sure how POT is worth 3x more than CF, especially if you compare the capital investments (POT is spending 4x more on Capex...yet CF is rapidly catching up in terms of earnings & pre-capex cash flows).

 

Can anyone explain how CF has been able to do this?

[ItsAValueTrap]

CF and POT have overlap in their products but their mix of products is very different.

 

Potash is mostly into potash.  You have to find a deposit, get it permitted, and then build a mine (just sinking the shaft can take a while if the deposit is deep).  In Canada this process takes at least 7-10 years.  Most/all of the potash producers are expanding their existing mines (this takes less time than building a new mine).

 

CF is more into nitrogen fertilizers.  Their industry is cyclical and they have benefited from low natural gas prices.  I believe it takes less time to build a manufacturing plant than a mine.

 

Because both are commodity-based businesses, they are subject to commodity prices.  In theory, high prices can't last forever since high prices will stimulate supply and eventually the supply/demand dynamic won't be so unbalanced.

 

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Thanks for bringing up CF I should take a look at it.  The call options look cheap.

[muscleman]

CF and POT have overlap in their products but their mix of products is very different.

 

Potash is mostly into potash.  You have to find a deposit, get it permitted, and then build a mine (just sinking the shaft can take a while if the deposit is deep).  In Canada this process takes at least 7-10 years.  Most/all of the potash producers are expanding their existing mines (this takes less time than building a new mine).

 

CF is more into nitrogen fertilizers.  Their industry is cyclical and they have benefited from low natural gas prices.  I believe it takes less time to build a manufacturing plant than a mine.

 

Because both are commodity-based businesses, they are subject to commodity prices.  In theory, high prices can't last forever since high prices will stimulate supply and eventually the supply/demand dynamic won't be so unbalanced.

 

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Thanks for bringing up CF I should take a look at it.  The call options look cheap.

 

 

Thank you! Could you please share some insights into this cyclical industry? Are we in the middle or the top of the cycle? Normally how long does the cycle last?

[dcollon]

Muscleman,

 

Attached are some numbers that show you some of the changes over the years as it relates to margins.

 

CF_History.xlsx

[boilermaker75]

 

Good one Mike. Can you share with us the criteria you use in your screen? Thanks, Ron

 

Ron,

 

I only occasionally use screens to get ideas. My sources of ideas are varied. I always check out what BRK is buying, I look at message boards like this one, financial sites, and I occasionally will run a screen.

 

The screen I ran had only two criteria, price to FCF under 10 and market cap over $300 million. This resulted in 152 companies.  I picked a few out to look at further based on industry. I did not look at any financial or insurance companies because I have no idea how to evaluate them. (I say that and BRK and WFC are about half of my LTBH positions! I trust in Buffett!)

 

I like companies with little or no debt. I rather do the leveraging than the companies I am buying. I also look at the history of diluted shares outstanding. If there is an increase I want the reason to mainly be that they are acquiring companies instead of turning owner earnings over to management and employees through stock options.

 

I liked CF because it looks like a simple business, they have been doing well their whole existence, share increases were for acquisitions, EV was less than the market cap, and CF seems cheap.

 

Mike

 

[ItsAValueTrap]

Are we in the middle or the top of the cycle? Normally how long does the cycle last?

I have no idea.  I'm not very good at predicting commodity prices.

 

----

So far, here's what I see in CF:

 

1- Management is questionable.  Most people would say that they overpaid for Terra.  (Management may have done this to avoid being taken over by Agrium.)

Here's another person's analysis:  http://myvalueidea.blogspot.ca/2010/03/cf-tra-merger.html

 

I don't understand why they issue dividends beyond a token dividend... especially when they sold stock to buy Terra.

 

2- They got really lucky on commodity prices.  Demand for fertilizer went up *and* natural gas prices went down. 

 

The majority of CF's product is used by corn farmers, so demand is highly tied to the price of corn.  Corn needs a lot of nitrogen fertilizer while other crops need less and (high-yield) soybeans need very little.  If fertilizer costs too much relative to the extra yield on crops, farmers will use less fertilizer.  Demand is elastic.

 

Demand for corn is linked to government policy on ethanol, since laws that subsidize ethanol creates more demand for corn.  Other countries use sugar (instead of corn) to produce ethanol because sugar is a cheaper feedstock.  But US government intervention keeps US sugar prices high.

 

There's other discussions on this forum regarding natural gas prices.  It should go up a little in the long run since many shale producers aren't making money at current prices.  CF has amazing positioning since its plants are in the US where natural gas prices are extremely low.  I think that US natural gas prices will stay low for a long time since there's so much of it in the US.  So CF will be lower cost than foreign producers.

 

3- The LEAPs look kind of cheap.  It could be worth gambling on this stock???

 

4- I'm not entirely sure but it doesn't look like there's huge amounts of supply coming online.  You can read Potash's, Agrium's, and Yara's filings to see what they are doing in the nitrogen fertilizer space.

 

Then again... I'm not very good at predicting commodity prices.

[ItsAValueTrap]

Here are things about the fertilizer companies that confuse me:

 

A- It makes a lot of sense to build new nitrogen fertilizer plants because the returns on them are very high.  The returns on them were crazy high in 2008 (joel greenblatt ROIC of 175%) and they are currently very high (84%).

http://www.gurufocus.com/financials/cf

 

Yet Agrium, Potash, Yara, and CVR Energy have only announced very modest expansions of their capacity.

 

B- Agrium, Potash, and CF issue dividends and keep raising them.  Why?

 

In hindsight, they should've just sat there and repurchased their shares instead of dividends.

 

CF's capital allocation policy makes the least sense since they issued dividends only to sell stock to finance the Terra takeover.

[no_free_lunch]

Not too much to add beyond what ItsAValueTrap has said.  He really nailed it.  This is a play on low natural gas prices relative to foreign prices.  Prices stay low in a relative sense and they mint money, prices merge relatively and it's a crappy business.  I guess if a lot of domestic production came on it could get ugly again as well.

 

Note that they have a phosphate division as well but it is basically break even.

 

Regarding the economics of building new plants, the parties are not being stupid.  If you read the POT literature it sounds like they are attempting to follow some market discipline in regards to supply and perhaps the other players are going along.  Nitrogen was a sub-par business for many, many years so perhaps they are learning.  I view this as a positive.

[ItsAValueTrap]

He really nailed it.

I don't think I really understand this industry... don't take me too seriously haha.

 

Fertilizer prices are probably more important than natural gas prices.

 

2- A degenerate part of me would just buy the LEAPs.  The implied volatility on them is in the 30s (which is kind of low) and this stock has a P/E of around 6.2 if you back out some of the cash it doesn't need.

 

3- Ethanol may continue to drive demand for corn:

 

http://www.bloomberg.com/news/2012-11-16/obama-said-to-reject-request-to-ease-corn-based-ethanol-law.html

 

About 4.5 billion bushels will be used to make ethanol in the year starting Sept. 1, or about 42 percent of the 2012 crop, the USDA estimated on Nov. 9.

 

Gas refiners will have to blend 13.2 billion gallons of ethanol this year.  It rises to 15 billion in 2015.

 

*Corn prices right now may be a little high due to drought in 2012.

**Oh yeah, Obama is from a corn state.

[ItsAValueTrap]

Yara has some great background information on the industry:

http://www.yara.com/doc/37694_2012%20Fertilizer%20Industry%20Handbook%20wFP.pdf

[Packer16]

Interesting idea.  Has anyone looked at UAN (CVR Partners).  It has high margins like CF but is structured as partnership and distributes its cash flow.  It has yield of 9.2%.  Carl Ichan has a controlling stake however.

 

Packer

[no_free_lunch]

Fertilizer prices are probably more important than natural gas prices.

 

Don't forget this is an international market with international suppliers.  US companies are killing it as they have lower cost input right now.  Yes, fertilizer prices help but why are prices higher?  I think it is a combination of industry discipline and foreign producers having higher costs of natural gas.  I think the industry is running at less than capacity and they are only willing to do that in the US mainly because they can make such good money right now on the spread.  If they went to lower or negative margins, historically they have lost their supply discipline as they have high fixed costs to meet. 

 

[ItsAValueTrap]

Did a little more research into this company.

 

1a- I think that their margins and ROIC is very misleading.

 

The replacement cost of their assets is *much* higher than book value.  Right now CF is both buying back shares and building new capacity.  Suppose that the rate of return is the same on both activities.  If CF's P/E is 6.2, then the after-tax return on new capacity is 16%.  This is a very good return but it's not as high as what you might expect from looking at their financials.  The Joel Greenblatt ROIC is ~85% (50%+ after tax).  The actual ROIC is much lower.

 

Foreign producers have higher natural gas costs than CF.  Their after-tax returns are going to be lower than CF's.  I'm not sure what the worldwide utilization figures are (US is probably close to 100%)... with high nitrogen prices, I'd expect a lot of the excess capacity to come back online (Potash for example is restarting one of its plants).

 

1b- I think this is why we won't see a wave of overbuilding come.

 

2- The US imports roughly half of its nitrogen fertilizer.  Now that the US is a low-cost producer of nitrogen fertilizer (natural gas makes up almost all of the cash costs to produce nitrogen fertilizers)... it would make sense in the long run for there to be more production in the US.  Freight costs matter a little bit so CF is very well positioned against foreign production.

 

3- CF's scale and distribution network gives it a very small advantage.

 

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I think this stock will do fine in the long run.

[JBird]

Thanks for posting your insights and links, very helpful. I see the same concerns others have with management, issuing stock when they think its undervalued, etc. What I find particularly egregious is their insistence upon using EBITDA figures as a useful metric. The practice makes me physically cringe.

[ItsAValueTrap]

I don't find their EBITDA figures to be that problematic.

 

In their investor's day presentation, they present EBITDA and free cash flow alongside each other on page 93.  In the context of debt, EBITDA can be a useful measure.

 

CF defines FCF on the last page of that presentation.  Its basically EBITDA - capex - dividends (!!!) - noncontrolling interest.  I find it interesting that they subtract dividends as this makes the figure even more conservative.  (I think that CF should just cancel the dividend.)

 

The problem with FCF is that capex might include expansion capex.  CF is definitely increasing capacity right now, so FCF will understate CF's ability to repay debt.  Hence, EBITDA can be slightly helpful.  CF also gives some detail on what capex is expansion-related and maintenance-related in its 10-K.

[ItsAValueTrap]

Some of their capital allocation doesn't make sense though.

 

They paid a lot for Terra and issued stock afterwards to keep their debt down.  They should have cancelled the dividend... it doesn't make sense to raise and unraise capital.

[JBird]

They're spending $2 billion on the Louisiana plant expansion, so you're clearly right about their Capex figure including expansion capex. I can't find where they discuss details on maintenance cap vs expansion cap? I agree with you on the dividend.

 

In the context of debt, does it make more sense to look at pre-tax earnings/interest rather than EBITDA/interest?

[Gamecock-YT]

I did a lot of work into CF (it nails the valueline screener I use), but I could never get comfortable that it was just a play on natural gas prices. I also felt uneasy that they'd be in a world of trouble if the government allowed foreign companies into the US Market (however small the likelihood of it occurring)

[ItsAValueTrap]

I can't find where they discuss details on maintenance cap vs expansion cap?

 

Oh I guess they don't make things super easy for you.  But there is information in the latest 10-K

 

Major Capital Expansion Projects

 

        In November 2012, we announced plans to construct new ammonia and urea/UAN plants at our Donaldsonville, Louisiana complex and new ammonia and urea plants at our Port Neal, Iowa complex. Our Board of Directors authorized expenditures of $3.8 billion for these projects. In combination, these two new facilities will be able to produce 2.1 million tons of gross ammonia per year and upgraded products ranging from 2.0 to 2.7 million tons of granular urea per year and up to 1.8 million tons of UAN 32% solution per year, depending on product mix. The $3.8 billion cost estimate includes: engineering and design; equipment procurement; construction; associated infrastructure including natural gas connections, power supply; and product storage and handling systems. These plants will increase our product mix flexibility at Donaldsonville, improve our ability to serve upper-Midwest urea customers from our Port Neal location, and allow us to benefit from the favorable pricing advantage of North American natural gas. All of these new facilities are scheduled to be on-stream by 2016. We expect to finance the capital expenditures through the use of cash and short-term investments, cash generated from operations and borrowings. During the fourth quarter of 2012, we incurred capital expenditures of $120.8 million on these projects, contributing to the increase in capital expenditures in 2012 over those in 2011.

 

        We have retained engineering and procurement services from ThyssenKrupp Uhde (Uhde) through their affiliate Uhde Corporation of America for both the Donaldsonville, Louisiana and Port Neal, Iowa expansion projects. Under the terms of the Uhde contract, we are required to establish a separate cash account and grant a security interest in the account to Uhde. We are required to maintain in this account a cash balance equal to the cancellation fees for procurement services and equipment that would arise if we were to cancel these projects. The amount of cash in the account will change over time based on procurement costs and is projected to reach approximately $500 million at certain points in time during the life of the projects. At December 31, 2012, there was no cash held in this account. Cash placed in this account in the future will be considered restricted cash since a security interest in the account has been granted to Uhde. This restricted cash will not be included in our cash and cash equivalents and will be reported separately on our consolidated balance sheet.

 

[ItsAValueTrap]

but I could never get comfortable that it was just a play on natural gas prices.

 

Oh it's absolutely a play on natural gas, corn, and fertilizer prices.

 

Here are some things that are in CF's favour:

 

- Natural gas.  You can read SWN's and UPL's presentations and capex guidances.  The cost of producing natural gas has been going down in the past few years.  I don't know if that trend will continue however.

Capex-wise, they are still drilling.

Production-wise, they are projecting higher output next year.  (!)

I haven't done the work for the higher-cost players.

 

- Corn:  the biggest driver in corn demand has been biofuels.  Silly US laws mean that a lot of corn output is being used to make biofuels.  And the laws are calling for more and more biofuel production.  (Did I mention that Obama is from a corn state?)

This tailwind might slow down however as the ethanol industry hits the "blend wall".

 

Other countries can produce ethanol at a lower price because they use hand-harvested sugar as the feedstock.  American sugar prices are artificially high and Americans make sugar from beets (machine-harvested) instead of sugar cane.

 

- Fertilizer supply/demand:  The US imports roughly 40% of its nitrogen fertilizer.  It will take a while for the US to be self-sufficient.  The endgame is probably for the US to export fertilizer.

 

*I am terrible at predicting commodity prices so don't take this seriously.

 

*I have a small long position in CF.  But... don't take me seriously because I didn't do that much research on this stock.

[no_free_lunch]

Small disagreement here, but regarding the NG it is not so much a play on natural gas prices being low in general but very specifically on NG being low in the US relative to the rest of the world.

 

I am just very bearish on these nitrogen producers.  That is not a short-term call just a general feeling and I guess a long-term call.  I have been lightly following them for years and I just see them as incredibly cyclical.  They got this huge tail wind with the commodity boom leading to higher fertilizer prices and then natural gas prices crashing.

 

They have all known about the shale thing for years and have been reacting accordingly.

 

Fertilizer analysts say a rash of new production plants will drive down nitrogen prices for years to come, reducing the cost of the biggest input expense on Canadian farms.

..

His work shows world urea capacity could reach 285.4 million tonnes by 2017, up 89 million tonnes from last year’s levels.

 

By contrast, demand is expected to increase 15 million tonnes over that same time frame.

 

 

 

http://www.producer.com/2013/04/future-fertilizer-supplies-expected-to-send-prices-down/