CF Industries Holdings Inc (CF)
Initiation of Coverage
Strong Fundamentals, But Limited Upside – Initiating with Hold
19 September 2011 ¦ 47 pages
citigroupgeo.com
Stock Reflects Much of the Good News – CF is benefiting from a potent one-two
punch of strong agricultural fundamentals and a massive benefit from shale gas which
has more than doubled nitrogen gross margins since 2007. Deteriorating yields for the
US corn crop amid challenging weather conditions have tightened grain inventories.
This has raised expectations for robust fall and spring nitrogen application as US
growers prepare to potentially plant a record ~95mm corn acres in 2012. However, CF
shares have already outperformed fertilizer peers by nearly 23% since the beginning of
July, reflecting much of the positive news, in our view. While the stock may overshoot
on the way up, we see limited upside to our $196 price target.
Nitrogen Tight, But Capacity Growth Could Trump China Effect – US grower
income is expected to increase 31% in 2011 supporting demand for all three major
fertilizers. The tightness in global urea markets is also being driven by the “sliding
scale” tariff policies introduced this year in China. In 2010 the country exported ~7mmt
of urea (17% of global trade), but may only export 4mmt this year. While the rest of
2011 may be tight, ~7% capacity growth ex. China in 2012 could loosen the market.
Benefits of “Price Taking” – Following the Terra acquisition in 2010 CF is now the
largest North America nitrogen producer. Approximately 85% of the cash cost of
producing ammonia is based on natural gas prices, and with “shale supremacy” North
America producers have meaningfully moved down the global cost curve. Citi’s Oil &
Gas team expects gas prices remain below $5/mmbtu through 2014. Because the US
imports ~50% of its nitrogen needs, CF can run full out as the low cost producer and
has become a price taker because prices are set by marginal cost producers.
Strong Balance Sheet, “Peak-Like” Valuation – Deleveraging after the Terra deal
has left a strong balance sheet and net debt to capital of 4%. We expect incremental
cash flows to fund brownfield expansions and stock buybacks. Given the cyclicality of
the nitrogen business and our view that demand growth could peak in 2012, we assign
a “peak-like” 10x forward P/E valuation multiple to reach our $196 price target.
Nitrogen Leads Cycle, but We Prefer Potash – Nitrogen has typically led the fertilizer
cycle – both on the way up and down. We have already seen urea prices and CF
shares lead this cycle. At this point, we prefer potash names which operate in a more
oligopolistic market with high barriers to entry. Our top pick in Ag is POT. |
