Why This Stock Looks Good Even at 52-Week High
Neha is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
I was probably expecting a bit too much from this fertilizer king. At a time when most players rocked the Street with stellar results, CF Industries’ (NYSE: CF) second-quarter numbers missed Street estimates on both top and bottom line. Yet, none of it could prevent its shares from doing a ‘Bolt,' racing their way to the finish line to hit a new 52-week high.
A lot has been written on its low sales and profits, but I want to highlight some key strengths CF reflected during the quarter, which could take it far.
As I had expected, ammonia and urea sales volumes were much lower in CF’s second quarter, as a large part of demand got pulled in during the strong first quarter. But prices of nutrients remained firm to offset low volumes -- a trend evident in the last quarters of other nitrogen players like CVR Partners (NYSE: UAN) and Rentech Nitrogen Partners (NYSE: RNF) as well.
But what acts as a huge advantage for CF, particularly in a business where product prices can be highly volatile, is its operational flexibility (enabling product mix according to needs). Although urea ammonium nitrate (UAN) earlier proved to be more profitable than most nitrogen products, cautious buyer behavior early in the year resulted in softer demand, and thus flattish prices. At the same time, urea prices remained steady, rising 34% from the year-ago period. Accordingly, CF boosted its urea production during the second quarter while cutting back on UAN.
Lower than expected profitability is also probably why UAN specialist CVR upgraded lower amounts of ammonia to UAN during its second quarter. Being a much smaller player, CVR doesn’t enjoy the flexibility CF does.
But demand for UAN is bouncing back, and these companies remain upbeat about the nutrient. So much so that CF recently started converting larger amounts of ammonia to UAN, and CVR is actually looking at 100% conversion soon. In fact, in situations of scanty rainfall (like the one likely this year), UAN is a preferred nutrient. Studies have shown how it gets distributed more evenly and absorbed better through leaves even in dry conditions. With CF’s flexibility, it becomes easier.
The other area where CF scores high is its strong distribution network, which enables its products to reach out to customers as and when needed. As an example, CF moved thrice the amount of ammonia it normally stores at one of its terminals in the past two months to keep pace with high demand, pulling off the feat easily. This, I feel, is a key strength the fertilizer giant can bank on, an ‘asset’ as it rightly says.
Gaining on gas
When CF hedged a good chunk of this year’s natural gas (key input) requirement at high prices last year, it thought it will lose a lot as prices fall. But things seem to have turned now, thanks to the extraordinary spring planting season, which translated into high production and input consumption. Unlike the first quarter, CF surprisingly made gains on its natural gas derivative contracts during the second quarter, and its realized gas cost was just $3.13 per MMBtu compared to $4.32 in the year-ago quarter. As long as gas prices remain low, CF will benefit.
Value for all
CF is a great example of how to put cash to all-round use, balancing growth and return generation well. When a company buys back shares, it generally wants to tell the market that its shares are undervalued. CF proved to be one such case. As it completed its $1.5 billion buyback program (in flat 10 months) in this past quarter, its average repurchase price came to $156.8 per share. Currently, CF’s shares are trading above the $210 mark.
The company will embark on a fresh $3 billion worth of buyback program that will continue through the end of 2016. Interestingly, CF finds share buybacks a better way of returning value to shareholders than dividends, and is not too keen on increasing its meager payout of 6%. But I feel the company should pay attention to boosting its low dividend yield of 0.8% -- one of the few areas it lags.
While rewarding shareholders, CF also took a step forward in its expansion initiatives by inking a deal to acquire remaining stake of Canadian Fertilizers from Viterra for $915 million, for cash. With this acquisition, CF will become the owner of Canada’s largest nitrogen complex in Canada. The company has also lined up ambitious brownfield expansion programs in North America for the next 4-5 years that could increase its ammonia capacity by 1 million tons and that of urea and UAN combined by 3.5 million tons. CF’s ultimate target? A greenfield project a few years down the line.
Into the second half of the year now, CF remains upbeat. Demand for ammonia is likely to remain high for two reasons: One, unusually high application this spring has resulted in ‘historically low’ inventory levels, raising the need to replenish stocks. Two, nitrogen needs to be re-applied every season to perk up the nutrient level in soil ahead of the forthcoming planting season.
No wonder PotashCorp (NYSE: POT) expects ‘significant fall fertilizer applications’ for nitrogen. The nutrient proved to be a savior in the company’s second quarter when other nutrients failed to deliver. CVR too remains bullish, having booked orders for nearly all of its expected ammonia production for the next two months. Rentech has even raised its full-year earnings guidance on the back of high demand and low natural gas costs, and Agrium (NYSE: AGU) feels soft demand for nitrogen in fall, if any, will be made up by next spring.
CF is also not the only one expecting an uptick in demand for phosphates. Both PotashCorp and Agrium emphasized the depleting levels of the nutrient in soil. They also expect demand from Latin America, which is entering its planting season, to remain strong.
CF is poised to grow bigger with time, is an excellent stock to own, and definitely deserves a spot on your watchlist. Click here to add it.
Neha Chamaria 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.