Even at $200, CF Industries Looks Cheap

The withering July heat wave tore through the U.S. Corn Belt. The record temperatures brought on drought conditions that were expected to wilt 2012 corn yield per acre to its lowest level in 17 years. And while the crop was hurt, it wasn't nearly as bad as anticipated as farmers are now expected to harvest 10.727 billion bushels, "only" 13% less than a year ago.

Even if it's not the dramatic drought at first predicted, it still means fertilizer stocks like CF Industries (NYSE: CF  ) , Terra Nitrogen (NYSE: TNH  ) , and PotashCorp (NYSE: POT  ) are likely in for a bumper crop of profits… next year.

Corn is an essential feedstock -- used not only for consumption, but for ethanol and animal feed as well -- and has a big effect on how fertilizer companies react. When crop prices soar, as they are now, farmers tend to plant more of it and that means they need more fertilizer. Those making potash, nitrogen, and phosphate will probably see the results when farmers start planting next year's crop. Corn is expected to fetch $7.90 a bushel, a little less than the $8.20 a bushel that was forecast last month but higher than the $6.25 realized last year.

CF, its subsidiary Terra Nitrogen, and CVR Partners (NYSE: UAN  ) are all leading nitrogen producers, so the trend bodes well for all as breaking down nitrogen into various component parts can boost profits. CVR, for example, upgrades more than two-thirds of its ammonia into higher margin urea ammonium nitrate, or UAN, and it's expanding its capacity by 50% to upgrade even greater amounts. UAN accounts for 35% of CF's revenues and almost half of its sales volume (three-quarters of Terra Nitrogen's sales are from UAN).

Both CF and Terra Nitrogen trade north of $200 a share, but CF has been the star performer with its shares up nearly 50% in 2012, compared to a 36% increase for its subsidiary. There have been others who've done better though, as Agrium jumped 54% and Rentech Nitrogen Partners, a new player in the space spun off from biomass alternative fuel maker Rentech (NYSE: RTK  ) , has more than doubled in value.

CF Industries snapshot

Market Cap $13.5 billion
Revenues, TTM $6.4 billion
Return on Investment 24.4%
Est. 5-Yr EPS Growth 10.7%
Dividend & Yield $1.60/0.75%
Recent Price $214.59
CAPS Rating ****

Source: FinViz.com

When it rains it pours, they say, and the long, hot summer was preceded by a mild winter that allowed farmers to get a jump on planting in the spring. So if you look at CF's second-quarter earnings, you will notice sales fell 3.5% because they were pulled forward into the first quarter. A year ago it sold more product in the second quarter than in the first. Yet, gross margins were better this year than last year since CF was realizing higher prices for its nitrogen products.

And that's expected to continue for the rest of the year and into next year. With high expectations for the 2013 corn planting season, strong global demand, and tight domestic nitrogen supply -- not to mention persistent low prices for natural gas, for it takes a lot of energy to produce ammonia -- indicate favorable conditions to continue.

Price is what you pay
At less than nine times earnings expectations, CF carries a lower multiple than any of its rivals, and when you factor in its growth prospects only Intrepid Potash offers up a better value. Even more promising is the fact that its enterprise value trades at just seven times its free cash flow, a very discounted number, meaning investors shouldn't be afraid of that triple-digit stock price.

I'll be rating it to outperform the broad market indexes on Motley Fool CAPS, the 180,000-member investor community where informed opinion is translated in stock ratings of one to five stars. CF carries high honors with its four-star rating in large part because 97% of the 1,279 members weighing in on the nitrogen specialist also think it will beat the Street. But, you can spread your opinion in the comments section below on whether you think CF Industries can grow even higher.

A sky-high opportunity
With 14 analysts covering CF, there's no shortage of attention being paid to the fertilizer shop. But the Motley Fool has found three hidden middle-class millionaire-making stocks flying under Wall Street's radar. Like CF, you probably benefit from their products all the time without knowing it. Want to find out more? Click here for your 100% free report on the three stocks Wall Street's too rich to notice.

Fool contributor Rich Duprey holds no position in any company mentioned. Click here to see his holdings and a short bio. The Motley Fool owns shares of CF Industries. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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