BACKGROUND
Take a look at this interesting recent chart, “Best of Breed Shareholder Returns,” showing the Top Ten S&P 500 Index Companies by Total Shareholder Return since August 10, 2005, and find some familiar names (including a board favorite SWKS) and, perhaps, some not so familiar like this one - CF Industries Holdings, Inc. (CF).
Top Ten S&P 500 Index Companies by Total Shareholder Return
Rank / Company / Total Company Shareholder Return (a)
1 / Regeneron Pharmaceuticals (REGN) / 5,667%
2 / The Priceline Group (PCLN) / 5,168%
3 / Keurig Green Mountain (GMCR) / 3,388%
4 / Netflix (NFLX) / 2,880%
5 / Alexion Pharmaceuticals (ALXN) / 2,401%
6 / Monster Beverage (MNST) / 2,287%
7 / Apple (AAPL) / 2,177%
8 / CF Industries Holdings (CF) / 2,067%
9 / Skyworks Solutions (SWKS) / 1,462%
10 / Perrigo (PRGO) / 1,451%
(a) Share price appreciation, including reinvestment of all dividends, since CF Industries’ IPO on August 10, 2005.
Source: Bloomberg. As of May 22, 2015.
Back in 2007, stock prices of agricultural fertilizer companies began a mercurial climb until mid-2008, when stock prices went into a steep nose dive as the financial credit crisis blew up the socio-economic and investment landscape. In 2007, after doing my due diligence, I invested in both CF Industries Holdings, Inc. and the Potash Corporation of Saskatchewan Inc. (POT) and then a year later quickly bailed out. I put agricultural-related stocks on the back burner, and it wasn’t until June 2010, when I took another look and decided to re-invest in CF Industries at $66/share and to pass on potash companies - Potash (POT), Mosaic (MOS) and Agrium (AGU) - that all remained stuck in idle. As CF Industries stock prices steadily climbed upward, I added to my position, during insignificant pullbacks. On June 18,2015, after reaching a 52-week high stock price of $323.98, CF Industries stock split 5:1. The following chart shows that CF has substantially outperformed the S&P 500 and competitors POT, MOS and AGU over the recent past 10 years.
http://bigcharts.marketwatch.com/advchart/frames/frames.asp?..
The purpose of this post is to check the current status of fertilizer companies for investment opportunities.
FERTILIZER INDUSTRY
It’s estimated that the global population will exceed 9 billion by the year 2050, which is about 2 billion more people than today. Feeding today’s world population is already a huge challenge for farmers. Without fertilizer to boost crop production in the areas already cultivated, farmers would need to put additional land into production to keep people fed and healthy. However, soil plus fertilizer produces more crop yield than soil alone.
Although there are 17 different elements critical to plant health, the single most important plant nutrient in today’s commercial fertilizers is nitrogen that is essential for ensuring plants are healthy as they grow and nutritious to eat after harvested. The world simply cannot do without nitrogen fertilizer. Therefore, a consistent long-term demand growth is projected for nitrogen, especially in the world’s developing regions.
In North America during the past 40 years, farmers actually have been able to use less land while tripling food production largely due to fertilization. At present, approximately 40 percent of North America’s nitrogen requirements are currently met through foreign imports. Although there have been many new nitrogen production facility projects announced in recent years, few have progressed beyond an initial announcement. Even after all the new capacity currently under construction in North America comes online, imports will still be required to satisfy over 20 percent of North American demand.
My focus is on North American companies - nitrogen producer CF Industries and potash producers Potash Corp, Mosaic and Agrium. For those unfamiliar with potash, here’s are some excellent Potash Corp short videos that explain what potash is and the mining and mill process:
http://minetour.potashcorp.com/whatis.html
http://minetour.potashcorp.com/
Currently underway are efforts to consolidate fertilizer companies and form cartels and oligopolies. Two informal cartels dominate the potash industry today - the Belarus Potash Company in Russia and the North American Export Cartel that includes POT, MOS and AGU. A major cause of the down trodden state of Canadian potash-oriented companies occurred a few years ago in Russia when Uralkali announced that it was splitting from its Belarus Potash Company joint venture with partner Balaruskali in order to sell potash on its own to China and India markets. This move shattered the industry’s supply-demand landscape and incited a global potash price war. Shares of the 3 largest Canadian potash companies were hit hard, losing almost $9 billion in value. In January 2014, Uralkali, now one of world’s largest potash producers, announced a deal with Chinese companies to sell potash at a 24% discount on year 2013 price. Earlier this year, Uralkali withdrew from its Belarusian cartel, accusing its partner of violating an agreement by selling outside the partnership and sending potash prices downward from $400/ton to $300/ton. In the nitrogen fertilizer industry, CF Industries has been focused on an aggressive consolidation effort to establish a global nitrogen oligopoly by acquiring competitors and entering joint ventures with other major players.
CF INDUSTRIES HOLDINGS, INC.
Business Description
CF Industries, a global leader in nitrogen fertilizer manufacturing and distribution, owns and operates world-scale nitrogen complexes and serves agricultural and industrial customers through its distribution system. Headquartered in Deerfield, Illinois, a suburb of Chicago, the company:
(a) operates seven nitrogen fertilizer manufacturing complexes with 6 million nutrient tons production capacity in the central U.S. region and Canada;
(b) has access to ammonia pipelines from the U.S. Gulf and Oklahoma that provide lowest-cost option for transporting ammonia to distribution points;
(c) operates a network of distribution terminals and warehouses at 82 locations in major grain producing states in the U.S. Midwest with storage capacity for over 1.3 million tons of ammonia and 1.2 million tons of UAN (Urea Ammonium Nitrate solution); and
(d) has access to 32 barges and over 5,000 railcars that provide inland transportation flexibility.
In Fall 2007, the company expanded its international presence, acquiring a 50 percent interest in KEYTRADE AG, a leading global fertilizer trading organization headquartered near Zurich, Switzerland. Subsequent joint ventures include a 50% interest in PLNL, an ammonia production joint venture located in the Republic of Trinidad and Tobago and a 50% interest in GrowHow UK Limited (GrowHow), a nitrogen products production joint venture located in the United Kingdom and serving primarily the British agricultural and industrial markets.
In March 2010, CF Industries acquired fertilizer competitor Terra Industries Inc. for $4.7 billion. This acquisition positioned CF Industries as a nitrogen bellwether and an even stronger player in the global fertilizer industry. CF Industries holds a 75.3% interest in Terra Nitrogen Company, L.P. (TNCLP), a publicly-traded limited partnership of which CF is the sole general partner and the majority limited partner and which, through its subsidiary Terra Nitrogen, Limited Partnership (TNLP), operates a nitrogen fertilizer manufacturing facility in Verdigris, Oklahoma.
In November 2012, CF Industries announced its decision to invest $3.8 billion to construct new nitrogen capacity at its complexes in Donaldsonville, Louisiana, and Port Neal, Iowa. Work on the projects continues to be in line with the last cost projection of $4.2 billion, plus or minus a few percentage points. Upon their completion in 2015-2016, these projects are expected to increase CF Industries’ nitrogen manufacturing capacity by 25 percent.
In March 2014, perhaps due the ongoing global potash price war instigated by Uralkali, CF Industries completed the sale of its phosphate mining and manufacturing operations to the Mosaic Company for $1.4 billion. The net proceeds were used to enhance CF Industries’ leadership as a pure-play nitrogen company.
In October 2014, CF attempted to merge with a major competitor, Norway’s Yara International, that would have created the world’s largest nitrogen fertilizer maker. Both parties backed off, but I expect CF to try again.
On July 1, 2015, CF announced an agreement with Yara International ASA to acquire its 50% equity interest in GrowHow UK Limited for a total cash consideration of $580 million, making GrowHow its wholly-owned subsidiary. At deal closing, the GrowHow business will be consolidated into CF Industries with a cash-free, debt-free balance sheet. GrowHow owns and operates nitrogen production facilities in Ince and Billingham, UK. The GrowHow acquisition by CF is a smart move because the attractive valuation of GrowHow, along with synergies lead to expected mid-teens returns. GrowHow, the largest UK producer of nitrogen fertilizer, has low delivering cost into principal operating regions and its operations have an advantageous position in an import-dependent region - the UK requires over 40% imports to meet its total nitrogen demand. Also, GrowHow expects to benefit from favorable gas cost trends in Europe.
Currently, CF Industries has confirmed ongoing preliminary discussions to acquire some businesses (excluding operations in Egypt and Algeria) of Dutch rival OCI NV, which produces natural gas based fertilizers and chemicals for industrial use with facilities worldwide in multiple North African and European nations and the U.S. OCI is run by Egyptian billionaire Nassef Sawiris.
Corporate Financials
CF Industries and the three North American potash companies are cyclical businesses, where seasonal market supply and demand and weather conditions directly impact their financial state and results of operations and cash flows. Fertilizer prices swing back and forth just like any other commodity,
CF Potash Mosaic Agrium
Industries Corp. Co. Inc.
Market Cap 14.32B 23.06B 15.66B 14.47B
52-wk high 70.32 37.60 53.83 116.81
7/24/15 Price 60.85 27.65 42.89 101.18
52-wk low 47.89 27.50 40.32 82.02
P/E (ttm) 16.59 16.74 14.50 20.12
FWD P/E 12.06 13.50 11.61 11.66
P/B (mrq) 3.56 2.66 1.55 2.36
P/S (ttm) 3.22 3.28 1.74 0.91
EV/EBITDA (ttm) 8.89 9.52 7.49 11.37
In the table below, both CF Industries and Potash Corp show the highest gross, operating and profit margins. Recently, CF Industries management decided to change to a pure-play nitrogen fertilizer company for the following reasons:
(a) nitrogen fertilizer production is a higher margin, growing business with more stable demand compared to the production of phosphate and potassium because nitrogen is depleted in the soil more quickly and, therefore, must be reapplied annually;
(b) there is a huge domestic demand for nitrogen as foreign imports currently fill 40 percent of North America’s nitrogen requirements;
(c) nitrogen is the primary determinant of crop yield; and
(d) corn consumes the largest amount of nitrogen.
Most of CF’s competitors are diversified into other crop nutrients, such as phosphate and potassium, and make significant sales into the lower-margin industrial market.
Another factor impacting margins is the cost of operating fuel. All fertilizer companies (except one that I will address later) rely heavily on natural gas for the production of nitrogen and dry-prilled products like potash and phosphate. Natural gas, which is the feedstock for CF’s process, represents the primary cost for the company. In 2014, natural gas purchases accounted for about 52% (43% in 2013) of its total cost of sales of nitrogen fertilizers. CF Industries expects to continue to benefit from attractive North American natural gas prices. In comparison to feedstock costs in other regions of the world, cheap American natural gas continues to support CF Industries’ higher producing margin. When gas prices fall, it’s great news for their bottom lines.
CF Potash Mosaic Agrium
MARGINS Industries Corp. Co. Inc.
GROSS %
2015 (ttm) 38% 39% 21% 23%
FY 2014 38% 37% 21% 22%
FY 2013 46% 38% 28% 24%
FY 2012 51% 43% 28% 27%
FY 2011 47% 49% 31% 28%
FY 2010 30% 41% 25% 25%
FY 2009 32% 26% 27% 21%
FY 2008 31% 52% 32% 32%
OPERATING %
2015 (ttm) 34% 33% 15% 7%
FY 2014 50% 33% 14% 7%
FY 2013 44% 36% 22% 9%
FY 2012 48% 38% 24% 13%
FY 2011 46% 45% 27% 14%
FY 2010 23% 40% 19% 10%
FY 2009 26% 30% 23% 6%
FY 2008 29% 49% 29% 20%
PROFIT %
2015 (ttm) 20% 22% 12% 5%
FY 2014 29% 22% 11% 4%
FY 2013 27% 24% 19% 7%
FY 2012 30% 26% 17% 9%
FY 2011 25% 35% 25% 9%
FY 2010 9% 27% 12% 7%
FY 2009 14% 25% 23% 4%
FY 2008 17% 37% 21% 13%
In the following table, all four companies have strong ROIC numbers, and their current ROIC-WACC spreads (EVA) indicate that all four are creating excellent value for shareholders.
CF Potash Mosaic Agrium
Industries Corp. Co. Inc.
ROIC
FY 2014 23.1% 12.9% 9.7% 8.2%
FY 2013 28.4% 14.3% 18.7% 10.9%
FY 2012 38.3% 17.0% 21.4% 17.8%
FY 2011 35.7% 24.4% 26.1% 22.0%
FY 2010 17.8% 16.9% 12.6% 12.9%
FY 2009 56.0% 12.5% 27.6% 8.0%
FY 2008 148.9% 50.4% 33.1% 32.1%
7/24/15
ROIC 15.64% 13.22% 9.64% 7.71%
WACC 7.44% 3.53% 7.47% 5.81%
EVA 8.20% 9.69% 2.17% 1.90%
ROE 19.58% 17.11% 10.25% 10.31%
Historically, CF Industries has maintained a strong stable cash flow stream that has been allocated for (a) investments in productive capabilities, (b) mergers and acquisitions, (c) employee compensation and benefits, (d) share repurchase program and (e) dividends.
FCF CF Potash Mosaic Agrium
(million $) Ind. Corp. Co. Inc.
2015 ttm -671 2,607 1,439 -808
FY 2014 -400 1,476 1,365 -820
FY 2013 643 1,588 299 -49
FY 2012 1,852 1,021 1,067 819
FY 2011 1,832 1,237 1,164 687
FY 2010 936 981 445 -104
FY 2009 446 -894 462 1,086
FY 2008 497 1,768 2,175 538
P/FCF - 9.74 11.61 -
FCF/Share ttm -2.63 3.11 3.86 -5.61
Cash (mrq) 1.78B 0.22B 2.52B 0.90B
Total Debt 4.59B 4.20B 3.83B 4.80B
Debt/Equity 103.9% 47.1% 37.5% 76.4%
Current ratio 1.82 1.17 3.24 1.36
Dividend 1.20 1.52 1.10 3.50
Annual Yield 1.9% 5.4% 2.5% 3.4%
Payout ratio 30.0% 75.0% 34.0% 61.0%
Most of the CF capital expenditures $1.808 billion, $0.823 billion and $0.523 billion for FY 2012, 2013 and 2014 respectively were spent on the nitrogen segment for $4.2 billion expansion projects at the Donaldsonville and Port Neal facilities.
Total Cash Flow from Capital
Operatiing Activities Expendititures Free Cash Flow
FY2014 $ 1.408 B $ -1.808 B $ -0.400 B
FY2013 1.466 B -0.823 B 0.643 B
FY2012 2.375 B -0.523 B 1.852 B
For FY 2015, CF expects capital spending of $2 billion to $2.5 billion with $1.5 billion to $2 billion allocated for expansion projects.
In the FY2014 annual report, the CF CEO related that “we provide our employees a safe work environment and well-paying jobs with full health coverage. In 2014, we achieved our best-ever safety performance, and an injury-severity rate that was roughly one-third of the industry average. With our new capacity expansion projects, we are adding over 200 full-time jobs with average pay of over $85,000 per year."
At the end of FY 2014, CF had 2,200 full-time employees and 100 part-time employees.
Stock-based compensation expense has been based on performance by management and employees:
FY 2014 $ 16.6 M
FY 2013 12.6 M
FY 2012 11.9 M
FY 2011 10.6 M
FY 2010 8.3 M
Since 2011, the CF Board of Directors authorized the following repurchase of shares of common stock:
2015 $ 0.7 B
2014 1.9 B
2013 1.1 B
2012 0.5 B
2011 1.0 B
Although CF has been paying uninterrupted dividends since 2005, CF decided to significantly increase dividends over the the recent past 5 years to the current forward annual dividend yield at 1.9% with a payout ratio of only 30%. The annual rate of dividend growth over the past three years was very high at 71%, and over the past five years was also very high at 65.7%.
Given its growth-oriented focus and ongoing consolidation and expansion efforts, CF is currently managing a debt/equity ratio of 103.9%. At the end of 2014, total debt to total capitalization was 40.9%, up from 36.3% at the end of 2013, with increased capital spending responsible for the change. The company has a high current ratio of 1.82 that demonstrates strong liquidity. Additionally, CF increased its revolving credit facility from $1 billion to $1.5 billion, providing CF further liquidity.
REVENUE CF Change Potash Change Mosaic Change Agrium Change
(million $) Ind. YoY Corp. YoY Co. YoY Inc. YoY
2015(ttm) 4,564 7,100 9,209 15,835
FY 2014 4,743 -13% 7,115 -3% 9,056 -9% 16,042 2%
FY 2013 5,475 -10% 7,305 -8% 9,974 -10% 15,727 -2%
FY 2012 6,104 0% 7,927 -9% 11,108 12% 16,024 4%
FY 2011 6,098 54% 8,715 33% 9,938 47% 15,470 44%
FY 2010 3,965 52% 6,539 64% 6,759 -34% 10,743 18%
FY 2009 2,608 -33% 3,977 -58% 10,298 5% 9,129 -9%
FY 2008 3,921 9,447 9,813 ‘ 10,031
NET INCOME CF Change Potash Change Mosaic Change Agrium Change
(million $) Ind. YoY Corp. YoY Co. YoY Inc. YoY
2015 (ttm) 912 1,566 1,106 724
FY 2014 1,390 -5% 1,536 -14% 1,029 -46% 714 -33%
FY 2013 1,465 -21% 1,785 -14% 1,889 -2% 1,062 -29%
FY 2012 1,849 20% 2,079 -33% 1,930 -23% 1,494 9%
FY 2011 1,539 341% 3,081 74% 2,515 204% 1,371 92%
FY 2010 349 -5% 1,775 81% 827 -65% 713 95%
FY 2009 366 -47% 981 -72% 2,350 460% 366 -72%
FY 2008 685 3,495 420 1,322
EPS CF Change Potash Change Mosaic Change Agrium Change
(diluted) Ind. YoY Corp. YoY Co. YoY Inc. YoY
2015 (ttm) 3.67 1.87 2.95 5.04
FY 2014 5.42 9% 1.82 -11% 2.68 -39% 4.97 -31%
FY 2013 4.95 -13% 2.04 -14% 4.42 0% 7.20 0%
FY 2012 5.72 30% 2.37 -32% 4.42 -21% 9.55 -17%
FY 2011 4.40 311% 3.51 80% 5.62 204% 8.68 92%
FY 2010 1.07 -28% 1.95 81% 1.85 -65% 4.51 94%
FY 2009 1.48 -39% 1.08 -71% 5.27 13% 2.33 -72%
FY 2008 2.43 3.67 4.67 8.34
The 2014 reported results were significantly impacted by the sale of the CF Industries’ phosphate business as the gain on the sale of this business partially offset a decline in operating results from CF continuing Nitrogen Product Segments. In the first quarter of 2014, CF sold its phosphate business and recognized a pre-tax gain of $750.1 million ($462.8 million after tax) on the sale of this business.
CF reported net earnings of $1.4 billion in 2014, compared to net earnings of $1.5 billion in 2013, or a decline of $74.3 million or 5%. Diluted earnings per share attributable to common stockholders increased 9% to $27.08 per share in 2014 from $24.74 per share in 2013 as the impact of lower average shares outstanding in 2014 due to the CF share repurchase program offset the impact of lower net earnings. During 2014, CF repurchased 7.7 million shares of our common stock representing 14% of the prior year end outstanding shares, at a cost of $1.9 billion.
Although CF sales volumes decreased, CF had much stronger average sales prices this year, due to the industry having a tighter North American inventory balance than in the first quarter of 2014. CF sold a significant amount of ammonia into this market and as a result, CF was able to realize an average price of $542 per short ton this year compared to $472 last year.
For more information, here is the latest CF Industries Investor Presentation for Q2 2015:
https://www.snl.com/Cache/1500072672.PDF?Y=&O=PDF&D=…
Customers
The principal customers for CF nitrogen fertilizer and other nitrogen products are cooperatives, independent fertilizer distributors and industrial users. None of CF customers in 2014 accounted for more than ten percent of CF consolidated net sales. Sales are generated by CF internal marketing and sales force.
Competition
CF markets are global and intensely competitive, based primarily on delivered price and to a lesser extent on customer service and product quality. During the peak demand periods, product availability and delivery time also play a role in the buying decisions of customers.
For CF Nitrogen Product Segments, CF primary North American-based competitors include Agrium Inc., Koch Fertilizer LLC and Potash Corporation of Saskatchewan Inc. There is also significant competition from products sourced from other regions of the world, including some with lower natural gas or other feedstock costs. Because ammonia, urea and UAN are widely-traded fertilizer products and there are limited barriers to entry, CF experience competition from foreign-sourced products continuously.
Corporate Governance
CF President and CEO W. Anthony Will has held this position since January 2014. His background includes various executive positions at CF since joining in 2007. Mr. Will also serves as the chairman, president and chief executive officer of Terra Nitrogen GP, Inc. (TNGP), a wholly owned subsidiary of CF Industries Holdings, Inc. and the sole general partner of Terra Nitrogen Company, L.P., a publicly traded producer of nitrogen fertilizer products. He has been a member of the TNGP board since 2010.
CONCLUSION
Although I realized excellent returns from my 2010 and subsequent reinvestments in CF Industries, I find CF Industries better positioned today with a favorable low 16.59 PE (ttm) and excellent business opportunities to expand and grow in the nitrogen fertilizer sector. Although fertilizer prices swing back and forth just like any other commodity, in the long run, fertilizer products are necessary in order to increase crop output on a decreasing global farm acreage. The global demand for the nitrogen product is a long term annual need. CF Industries has successfully transitioned to a pure play nitrogen fertilizer company that has re-invested its capital in expansion projects that will increase its nitrogen manufacturing capacity by 25 percent in the near term and target the 40 percent of North America’s nitrogen requirements currently met through foreign imports. Forward looking with a proven highly successful track record, CF Industries continues to aggressively expand its global footprint through joint ventures, mergers and acquisitions.
I’ll mention the second of my one-two punch investment in the fertilizer industry - CVR Partners, LP (UAN), a growth-oriented master limited partnership (MLP) formed by CVR Energy, Inc. (CVI) to own, operate and grow its nitrogen fertilizer business. The nitrogen fertilizer manufacturing facility produces ammonia and urea ammonium nitrate fertilizers. Coffeyville Resources Nitrogen Fertilizers, LLC is a wholly-owned subsidiary of CVR Partners, and directly owns and operates the CVR Partners nitrogen fertilizer plant. CVR Partners does not have a fixed distribution, and, therefore, its distribution rate varies quarter to quarter. At present, CVR Partners’ general partner (GP) does not receive incentive distribution rights (IDRs). A very attractive aspect is that CVR Partners’ GP pays quarterly cash distributions of all the Partnership’s available cash, as determined by its Board, to its unit-holders, making it an exceptionally strong income holding. At present, the annual distribution yield has reached a massive 14.4% for unit-holders.
Instead of natural gas, CVR Partners uses petroleum coke (a form of carbon left over during the oil refining process) as an input for its products. The CVR Partners nitrogen fertilizer manufacturing facility is the only operation in North America that uses a petroleum coke gasification process to produce nitrogen fertilizer. CVR Partners is able to use petroleum coke because its facility is adjacent to a parent oil refinery (owned by CVR Refining) that provides about 70% of CVR Partners’ coke at a preferred price. Petroleum coke is a historically lower cost feedstock than natural gas to produce hydrogen and presents a unique cost advantage over competitors who use natural gas.
The CVS Partners’ nitrogen fertilizer operations is strategically located in Coffeyville, Kansas which lies in the heart of its customer base (Colorado, Illinois, Iowa, Kansas, Missouri, Nebraska, and Texas) and allows CVS Partners to supply its products to these areas without incurring intermediate storage, barge or pipeline freight charges. Because CVS Partners does not incur these costs, it has a distribution cost advantage over U.S. Gulf Coast ammonia and urea ammonium nitrate fertilizer producers and importers.
For more information, here are recent investor presentations.
http://investors.cvrpartners.com/phoenix.zhtml?c=220445&…
I will continue to watch the North American potash companies for any significant developments and actions; the ongoing feud within the Russian potash cartel has created havoc for the potash industry. POT, MOS and AGU are solid, well run companies that others here might find attractive worthy investments.
As always, conduct your own due diligence, especially since the aforementioned companies lie outside of Saul’s portfolio and TMF pay site safety nets.
Regards,
Ray