Buy CF Industries for Future Growth
Douglas is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
As last Friday’s shaky jobs report all but guarantees the next round of quantitative easing from the Federal Reserve, the resulting upward pressure on inflation is bullish for commodities. While both hard commodities, like gold and silver, and soft commodities, like corn and wheat, will benefit from the news, those companies that remain one step removed may make the best investments. Under these conditions, fertilizer companies provide an excellent way to gain exposure to commodities while providing greater stability and long-term upside than direct investments. Under this thesis, CF Industries (NYSE: CF) is a buy at current levels.
CF was upgraded Friday by Feltl & Co. from buy to strong buy. Nitrogen-based fertilizer companies like CF and Terra Nitrogen (NYSE: TNH), of which CF owes the majority interest have far outpaced phosphate-based companies including Mosaic (NYSE: MOS) and Potash Corp. of Saskatchewan (NYSE: POT). This has been largely driven by persistently low natural gas prices that have allowed the nitrogen-based companies to keep costs down.
On a valuation basis, CF appears to be the best value, trading a trailing twelve month multiple of just 8.2 relative to 13.8 for Mosaic and 15 for Potash Corp. These multiple are even more impressive when you consider the extent to which CF has outperformed the others thus far this year. Despite runaway performance comps (see chart), CF maintains the most aggressive valuation by a significant margin.
An Interesting Aside
One of CF’s chief competitors in the nitrogen business is Rentech Nitrogen Partners (NYSE: RNF). The company recently raised guidance and looks like it may be one of the big growth stories for the industry, targeting a 17% increase in EBITDA if it hits its projections. With a current dividend yield of 13.6%, the stock has appeal.
The three factors that would-be investors should keep in mind before racing into the stock are: the low average daily volume (ADV) of the stock, the questionable sustainability of the dividend and the limited institutional participation in the name. The stock currently trades less than 400k shares per day, meaning that it may be exposed to a liquidity squeeze under extreme conditions. This can make it hard to exit the stock quickly and can increase volatility. Secondly, based on an analysis of the company’s free cash flows, it is questionable whether it will be able to maintain its dividend even with significant growth.
The last, and potentially most important, factor to consider is that because the company is a limited partnership, many institutional investors – specifically hedge funds – cannot participate in the name. Essentially, the tax treatment of L.P. investments is such that many hedge funds prefer to simply find other options. Limited institutional participation can prove to be a significant negative for a company over time. While these factors do not preclude an investment, it is always preferable to go in with one’s eyes open.
Where most companies are somewhat subject to the vagaries of consumers, fertilizer demand has nowhere to go but higher. With the bulk of quality land already in use, population growth will require the increased use of fertilizer to make less desirable land farmable. By 2040, experts project that the planet will have nine billion mouths to feed, meaning that supply must keep pace. To this end, the International Fertilizer Industry Association has predicted that demand growth will reach double digits by 2016. With numbers this strong stretching out well into the future, owning shares at such attractive valuations is a very easy call.
When you consider the long-term prospects for the fertilizer industry, the positive economic landscape created by approaching quantitative easing, the superior valuation metrics and the recent catalyst of an analyst upgrade, CF Industries should be added to your core portfolio. Not only will this name provide your portfolio with insulation against inflation in the near-term, it has the potential to accelerate its growth well into the future. For each of these reasons, CF is a strong buy.
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Mr. Ehrman has no positions in the stocks mentioned above. The Motley Fool owns shares of CF Industries Holdings. Motley Fool newsletter services recommend PotashCorp. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.