CF Industries Earnings Show Weak Demand Spans Nitrogen & Potash Fertilizer

With CF Industries (NYSE: CF  ) reporting third quarter and year-to-date revenues that are down 19% and 10%, respectively, it seems that nitrogen fertilizer producers are not faring better than potash producers like Potash Corp. (NYSE: POT  ) , or Mosaic (NYSE: MOS  ) , which also recently reported lower revenues and earnings on falling prices and volume. Dealer reluctance to take on price risk has now spread to nitrogen-based fertilizers, with the most likely reason being the drop in corn prices, which is creating some uncertainty about what farm economics will look like in the near future.

Nitrogen
The company's Q3 nitrogen revenues tumbled 20% to $876.3 million due to lower volumes and prices alongside potash and phosphate prices. The company attempted to price its product competitively during the quarter. Figure 1 illustrates that, in comparison to Potash Corp., when the company had the lowest price it also won on volume during the quarter.

Potash Corp. vs CF Industies Avg Price Received for Nitrogen Fertilizer

UAN is the company's biggest seller in terms of volume. The average price received in Q3 for UAN only dropped 7.4% due to better than average relative demand. Tons sold were still down 10% year over year. However, farmers prefer UAN because it is easier to use than urea.

Phosphate
At 526,000 tons, third quarter volumes were surprisingly about 2% higher than a year ago .  At an average price of $420 per ton, CF Industries received a lower price than both Potash Corp. and Mosaic during Q3. As figure 2 illustrates, the company priced the product to attract demand.

Avg Phosphate Price Rec'd CF Indsutries vs Mosaic and Potash Corp.

In late October, CF industries announced that it was selling its phosphate business to Mosaic. In addition to the $1.2 billion price tag, Mosaic agreed to transfer $200 million in asset retirement obligations to its balance sheet. Additionally, Mosaic will become a major customer, agreeing to buy 600,000 to 800,000 tons of ammonia annually for up to 15 years beginning no later than 2017. Pricing will be variable and based on the cost of natural gas delivered to CF Industries' Donaldsonville, Louisiana plant. This insulates the company from volatility in one of its primary production costs. As a bonus, as soon as the deal is completed sometime in 2014, Mosaic will buy ammonia from the company's production facility in Trinidad and Tobago using Tampa-based market pricing.

Are the shares over or undervalued?
Despite hitting a low of $170.28 on July 1, the stock has bounced back to a recent closing price of $220.50 per share. In my opinion, the move higher is due to activist investor Dan Loeb of Third Point LLC, who bought shares of the company in the summer and began pushing for a larger dividend. The company eventually acquiesced and raised the quarterly dividend from $0.40 to $1.00 on Oct 17, with the new yield of roughly 1.8% possibly providing a little more downside protection to the stock price. This is a different stance than the company had earlier in the year.

On February 20, 2013, during the company's conference call for Q4 and the full-year, CEO Stephen Wilson said that he did not think a nitrogen fertilizer stock would ever be a yield stock and share buybacks were the best method of returning cash to shareholders. Frankly, I agreed, given the boom and bust nature of both the fertilizer and crop businesses. However, by August that sentiment seemed to soften a bit as Mr. Wilson said the company welcomed shareholder comments on this topic during his Q2 conference call opening remarks.

Relative to its peer group the stock is trading at fair value in my opinion.  At 2.27, its price to sales ratio is about equal to the group's mean average of 2.30. Even if corn acres planted drop to a still historically high 92 million, the opportunity to sell nitrogen will be strong. However, what price will maximize revenues and profits? Going forward, that is the question.

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