Why This Stock Could Explode

Neha is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Its stock has lost some wind over the past three months, but it yet again churned out one of the best numbers in its industry. That’s a tricky situation. Is CF Industries (NYSE: CF) a buy then, or is it not?

I don’t jump to conclusions till I do my own research. I spent time studying CF, and what I realized is this: this is one stock that could just explode in the near term.

Pleasant Seasons

Revenue, operating margins, net profits – all hit record highs for the first nine months of the year; and the year-over-year growth has been substantial. Operating earnings climbed 17%, gross margin gained seven percentage points to hit 53%, and the bottom line gained 25%.

I guess I don’t need to tell you why CF is set to end the year with a bang. The company is upbeat not just about the fourth quarter but the next year as well, and I see reason here. Corn harvest is almost complete, which in normal summer years goes on for at least another four weeks. This means fields are ready for dressing for the fall and the next spring earlier than usual. At the same time, rainfall is adding moisture to the soil, which is critical to facilitate application of fertilizers.

Last-quarter numbers already proved how farmers are gearing up to take advantage of the favorable environment. CF’s ammonia volumes and prices were 3% and 13% higher, respectively, from the comparable period last year.  Agrium’s (NYSE: AGU) nitrogen sales volumes were 30% higher in its last quarter. Like CF, Agrium is anticipating an extended fall application season this year. It further expects ammonia volumes as well as prices to be better in the fourth quarter sequentially.

A good fall season is welcome news for CF because if second-quarter sales depend on spring planting, the fourth quarter banks largely on the fall.

‘Invisible’ Magic

Interestingly, for CF, things don’t get tough even if sales falter. That’s because the company doesn’t have to depend only on higher sales for better margins – costs play an equally, or should I say a bigger, role now. CF didn’t have a particularly easy time emptying its shelves last quarter. Its total sales volumes were in fact 2% lower from the year-ago quarter, pulling the top line down by 3%. Yet, the nitrogen king’s gross margin touched 58%, up significantly from 49% a year ago. Naturally, costs eased. Read that as natural gas took the pressure off CF.

As a key input for nitrogen fertilizer, natural gas plays an integral role in CF's profitability. As prices fall, CF's margins have the potential to expand dramatically given nitrogen's dominant position in the company's product portfolio – the nutrient accounted for more than 80% of sales last year. For those who didn't know, CF is also the largest North American producer of nitrogen. Gas prices might have inched up a bit in recent months, but they still remain at levels profitable for fertilizer players. CF’s realized gas cost came to $3.34 per MMBtu last quarter compared to $4.45 last year. Just to give you an idea, CF’s nitrogen complex at Donaldsonville alone consumes around 240,000 MMBtu of gas every day. And that’s just one of the seven big facilities it runs. So you can imagine how profitable a $1 per MMBtu fall in gas price would be for CF. This gas benefit should continue to flow; but CF isn’t content, and wants more.

Big Aims

CF’s Donaldsonville nitrogen facility is already the largest in North America, and the company has just made sure it remains so. It plans to invest $2.1 billion on the site over the next few years to set up new ammonia and urea plants, apart from another $1.7 billion on its Port Neal complex.

Donaldsonville enjoys abundant natural gas supply from the five pipelines it is connected to, and is a flexible facility. While benefits of the first are obvious, the second is equally important, and interesting, to understand.

The Donaldsonville complex will be expanded in a way that the amount of urea and urea ammonium nitrate (UAN) produced can be adjusted as per market conditions. In simpler terms, CF can easily adjust operations to produce higher quantities of the nutrient that fetches better prices or is demanded more, which I feel, is a critical advantage.

Personally, I see this project more as CF’s way to expand UAN capacity as the nutrient has generally proved to be more profitable than other nitrogen products. So much so that UAN specialist CVR Partners (NYSE: UAN) is all set to convert 100% of ammonia produced to UAN from as early as next year when its UAN capacity increases by 50% as a result of recent expansion projects.  CF too has started converting larger amounts of ammonia to UAN since some quarters. Clearly, potential must be huge to justify such confident investments in the nutrient.

Dealing Right

I also realized how CF isn’t bothering much about the other nutrient it deals in –phosphates. Not that I am complaining. Nitrogen is more important as a fertilizer for crops, and has also been more profitable.  See CF’s third-quarter numbers for yourself. Its phosphates segment sales were down 8% and the related gross margin slipped 26% on low prices. Perhaps better proof would come from phosphate majors PotashCorp (NYSE: POT) and Mosaic (NYSE: MOS).

PotashCorp’s phosphate sales were down 20% in its last quarter as both volumes and prices fell, while Mosaic’s last-quarter phosphate sales tanked 30%. Result: Profits for both companies fell by the double digits. Agrium’s phosphate gross profits also almost halved in the last quarter. Nor is potash as a nutrient any better. Mosaic has already lowered its next quarter volumes guidance by nearly 10%, and PotashCorp is shutting down two of its mines between December and February in anticipation of sluggish demand.

Of course, CF investors can party as nitrogen won’t have to battle it out like the rest. Nitrogen remains the most important fertilizer for critical crops like corn, and USDA data has shown how demand for the nutrient consistently surpassed others by wide margins over the past two decades. So even if gas prices bounce back, CF needn’t worry much. This is probably the best reason to stay invested in CF, or even initiate a new position if you already haven’t.

The Foolish Bottom Line

CF will end the year on a record, and its $3 billion buyback program doesn’t get affected by its new spending plans. So you have a company here that’s growing as fast as it is returning value to shareholders. I think that alone makes CF one heck of a stock to own, and I am not the only one who thinks so. The stock has bagged a coveted five-star ranking in our Motley Fool CAPS community. Click here to add CF Industries to your watchlist.

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Neha Chamaria 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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