Why This Fertilizer Stock Could Zoom Next Week

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After record first and second quarters, will CF Industries (NYSE: CF) have an encore in its third? Analysts are expecting CF’s third-quarter sales to dip by around 4% from the same quarter a year ago, as the period is typically the weakest for agriculture companies because the U.S. planting season is still several months away, and purchases from Latin America don’t really pick up before October.

Yet, I believe CF could well stump the Street next week when it chimes in with its numbers, despite Mosaic (NYSE: MOS) and PotashCorp (NYSE: POT) burning estimates to ashes.

Price gains all the way

For the six months ending June, CF’s average selling price for urea was 29% higher from the comparable period last year; and according to Agrium’s (NYSE: AGU) monthly market reports, prices of urea remained relatively stable between July to September, even gaining a bit in between. Which means even if we assume unchanged prices from June, CF would still realize at least 20% higher prices for urea during the third quarter, compared to same period last year.

At the same time, demand for urea is likely to have firmed up as farmers stock up for fall and next spring season in the U.S. Urea is also required for winter wheat planting. To top that, demand has been particularly strong from Latin America, which is bracing for a record planting season. PotashCorp shipped more potash to the market in its last quarter than it did during the same time last year. Agrium is also expecting ‘one heck’ of a spring in Brazil.

Flexing to advantage

CF’s flexibility is an added advantage, as it can adjust production of nutrients according to what the situation demand. During the first half of the year, it produced more urea to take advantage of higher prices while scaling back production of urea ammonium nitrate (UAN), prices of which did not appreciate. But demand for UAN is picking up as well, and volumes are likely to have firmed in this past quarter. A key reason for this is that in situations where rainfall is scanty, UAN proves to be a useful nutrient as it gets absorbed better. This could also be one reason why UAN specialist CVR Partners (NYSE: UAN) remains upbeat about fall demand for the nutrient. The company will check in with its numbers in the first week of November.

High Fall

If things look good for urea, it could be even better for ammonia. PotashCorp’s nitrogen division emerged as the top performer during its third quarter, thanks to solid ammonia prices -- it realized 8% higher prices for ammonia compared to last year, which helped push its nine months gross profits to record high.

Robust demand by farmers preparing for the next spring season, coupled with tight supply, has pushed ammonia prices up in recent months. So if CF realized around 7% higher prices for ammonia year-over-year during its second quarter, the percentage jump could be higher in its third. As for demand, expectations are high, mainly because high ammonia application in the first half of the year has resulted in extremely low inventory levels with farmers. So not only would they need to stock up for fall, but also for the next spring season. In fact, CVR gave us hints of how strong pre-fall demand was when it reportedly booked orders for almost all the ammonia to be produced in second half of 2012 by June itself. Small wonder then that the company stuck to its full-year earnings guidance of $1.65 to $1.85 per share, which is an 11% jump from 2011 even at its lower end.

Nitrogen on top

If demand for fall was so good, one then might argue why last-quarter's numbers from fertilizer majors like Mosaic or PotashCorp were nothing to write home about. Mosaic whiffed on earnings with 19% and 18% drop, respectively, in sales and net profits from the same period a year ago. Likewise, PotashCorp’s third-quarter sales and earnings were down around 8% and 21%, respectively.

The answer lies in nitrogen. While Mosaic doesn’t deal in it, PotashCorp’s derives a relatively small chunk of revenue from the nutrient. Nitrogen is one nutrient that needs to be re-applied to the soil every planting season. That’s because while soils might retain potash or phosphate, nitrogen gets absorbed quickly, making it necessary for farmers to spray a fresh coat for the next crop. This obviously keeps nitrogen in high demand unlike other nutrients, a factor that works wonderfully in favor of nitrogen king CF.

Damp, but no worry

So the only dent in CF’s numbers could come from phosphates, and you already know why. Both Mosaic and PotashCorp realized around 10% lower phosphate prices from the year-ago period in this past quarter, which together with sluggish volumes hit their margins hard.

Yet, CF shouldn’t worry much, as it dominates the nitrogen market. Overall, considering the factors mentioned above, I find analyst estimates of a 4% dip in sales muted. PotashCorp’s strong nitrogen division performance raises the bar, and I won’t be surprised if CF crushes Street estimates next week.

Bottoming up on gas

What should further perk up CF’s margins are low natural gas prices. As a key input for nitrogen fertilizer, gas forms a major chunk of costs for nitrogen companies. Both CF and Agrium reported outstanding gross profits for their respective nitrogen divisions in the second quarter. While CF’s nitrogen division gross profits surged a whopping 52% from the year-ago period, Agrium’s gross profits from its nitrogen business shot up 33%.

Although gas prices have recovered a bit in recent months (PotashCorp thus expects costs to move up in the next quarter), they are still significantly lower from last year’s levels. I feel gross profits should continue to remain strong for both CF and Agrium. CF had hedged nearly 60% of its projected gas requirement for the second half of the year by June, which means it should still enjoy the benefits of lower costs for the third and fourth quarters. This also explains why analysts are expecting CF’s third-quarter bottom line to be up around 11% from last year despite lower sales.

The Foolish bottom line

I don’t think CF should disappoint us next week. Its stock is hanging up well over the $200 mark, and a good third-quarter might just spark a move upwards. To be one of the first to know how CF fares, click here to add CF to your personalized stock watchlist.

Nehams has no positions in the stocks mentioned above. The Motley Fool owns shares of CF Industries Holdings. 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.

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