The third quarter was a rough one for the fertilizer industry, but CF Industries (NYSE:CF) stood out for a number of reasons. It not only delivered a better set of numbers than peers PotashCorp (NYSE:POT) and Mosaic (NYSE:MOS), but also decided to put more money into its shareholders' pockets at a time when business conditions aren't at best. That's not all. CF Industries also unveiled a plan that will change its business dynamics significantly in the years to come. With so much going on at the company, is it time to consider CF stock seriously? Let's dig deeper to find out.
Why CF Industries outperformed peers
While CF's third-quarter revenue fell 19% year over year, PotashCorp and Mosaic reported 29% and 28% lower revenue, respectively, in the last quarter. Since CF doesn't deal in potash nutrient, it escaped much of the volatility and uncertainty that the other two companies faced after the recent fallout of one the world's largest potash cartels. Hence, CF's sales weren't hit as much as those of PotashCorp and Mosaic.
But CF's end markets haven't been in their best shape, either. Nitrogen prices have eased this year, and the threat from Chinese substitutes look bigger than ever. That said, CF is still in better stead since nitrogen is the most important and widely applied nutrient for crops.
But investors should note that there's more than a sluggish nitrogen market behind CF's lower third-quarter revenue. Otherwise, how did the nitrogen-centric company CVR Partners' (NYSE:UAN) revenue fall only 8% in the last quarter? CVR Partners is just about 10% the size of CF, so it doesn't even enjoy the economies of scale that CF does. So what gives?
Well, CF's numbers would have looked better if it didn't deal in phosphate nutrient. Phosphate sales have dwindled significantly since key market India deferred purchases, leaving PotashCorp, Mosaic, and CF in the lurch. CF reported a 16% drop in its third-quarter phosphate sales. The nutrient has been a drag on the company's top and bottom lines for several quarters, but things are about to change.
The game-changing move
CF doesn't find the phosphate business profitable anymore, which is why it has decided to exit the business completely next year by selling it to Mosaic for a cash consideration of $1.4 billion. It's a major move, because phosphate currently accounts for nearly 17% of CF's total sales.
CF will become a pure-nitrogen play once the deal is through. Substituting a less profitable nutrient with the most demanded fertilizer sounds wise. At the same time, having a diverse product portfolio helps mitigate business risks in the longer run. By giving up on phosphate, CF will become a one-nutrient company, which may give close rivals that sell a variety of fertilizers an edge. For instance, Mosaic has two nutrients, potash and phosphate, to bank on, while PotashCorp and Agrium sell all three essential nutrients. That certainly acts as an advantage in situations where weakness in one nutrient market can be offset by strength in another.
Why investors can expect more
For now, investors can be happy with CF's decision to exit phosphate, because the cash proceeds from the sale could mean greater rewards. How CF will use the cash will perhaps not be known until the deal receives regulatory approvals. But last year, CF had revealed plansPresentation titled Credit Suisse Chemical & Ag Science Conference Presentation to spend $3.8 billion through 2016 to expand its nitrogen production capacity by 25%. Whether CF had already decided to offload its phosphate business when it announced the expansion program is anyone's guess, but the company must have had other avenues in mind to fund its expansions.
In fact, CF is a financially strong company, with $2.3 billion cash balance as at the end of the third quarter and free cash flow of nearly $1 billion over the past 12 months. A comfortable debt-to-equity ratio of 61% and a healthy interest coverage ratio of 17 also mean that CF has leeway to take on additional debt if it wants. That means funding for expansion shouldn't be a problem at all. So chances are that CF may want to share a part of the proceeds from the phosphate sale with its shareholders in the form of greater dividends or share repurchases. Even the 150% quarterly dividend increase that CF announced last month leaves scope for more, because the company still sports an annualized dividend yield of only 1.9%, which is lower than that of every company mentioned above.
CF already dominates the North American nitrogen market, and its growth plans will further widen its moat. A solid financial standing acts as cherry on the cake. CF has consistently outperformed peers, with its stock putting on massive gains of 383% over the past five years. PotashCorp and Mosaic have comparatively returned 66% and 86%, respectively, over the period. With dividends about to get bigger, investors couldn't ask for more. For all this, CF stock currently trades at a paltry eight times earnings. That looks like a sure long-term winning bet to me.