Watch Out:This Stock Could Hit a New High Next Week

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I am a big fan of this stock. Every time I wrote on it in the past three months, I made strong buy calls. Boy, I hit a home run each time. CF Industries (NYSE: CF) has gained a neat 15% since mid-November last year, and no, it’s not over yet. There’s tremendous room for upside as the fertilizer major readies to suit up with numbers next week that could easily trample Street estimates, and stares at another strong year riding on favoring trends.

On the Record

CF’s numbers have been a pleasure to watch in recent quarters, even as peers battled slowdown concerns. For the nine months ended Sep. 30, 2012, every important bit of CF’s profit and loss statement flaunted record highs. From revenue to operating profits to earnings per share, it was one heck of a performance. Revenue was up 5%, gross margin marched to 53% from 46% in the comparable period last year, and net income surged 25%. EPS looked even better having put on 38% thanks to the fervent buybacks CF indulged in. To pull it all off in a year that was one of the most challenging ones for any agriculture company, CF deserves a huge round of applause.

So one thing’s guaranteed (yes, there’s no question of doubt here): the headlines on Feb.19 will have the words ‘record year’ all over them. I am not ruling out chances of a ‘record quarter’ either, though analysts seem to think otherwise. They expect a 3% dip in CF’s fourth-quarter EPS year-on-year, and an 8% fall in its top line. That’s primarily because unlike 2011 when nutrient prices were exploding, they remained pretty subdued over the past few months. PotashCorp’s (NYSE: POT) recent numbers proved it. Sale of its nitrogen products was flattish in the last quarter, but considerably lower prices pulled its margins down. Yet, CF could still be better off than PotashCorp, reason being its locational advantage.

Saving money on gas

How much a company earns out of nitrogen depends largely on prices of key input, natural gas. PotashCorp is finding it tough to sustain margins because it depends on Trinidad for gas supplies, unlike CF which is more of a Midwest producer. Recent gas interruptions from Trinidad have been a huge setback for PotashCorp, hurting its prospects significantly. As a result, gap between gas costs from the two regions have only widened, much to PotashCorp’s dismay.

To give you an idea of what a huge difference that can be, I’ve picked out gas costs for both companies in their respective third quarters. While CF paid an average of $3.34 per MMBtu, PotashCorp shelled out $6.76 per MMBtu in its third quarter – that’s more than double what CF paid! Moreover, while CF’s cost were 25% lower from 2011, PotashCorp’s were 10% higher. What’s two-fold gain for CF is a whammy on PotashCorp. Naturally, CF’s gross margin is bound to be better. Expect the trend to continue into its fourth quarter, and beyond.

What lies ahead

If there’s something that could take the sheen out of CF’s numbers, it will be phosphates. The deadly combination of low volumes and prices pulled PotashCorp’s phosphates division’s gross margin down by a staggering 28% in its fourth quarter. Likewise, Mosaic’s (NYSE: MOS) last-quarter net phosphate sales slumped 19% as its average selling prices took an 11% hit. Yet, nitrogen has always offset any weakness in phosphates for CF, and it is likely to be so again in the fourth quarter. Moreover, phosphates is less than 20% of CF’s total sales, so it isn’t as big a worry for CF as it is for PotashCorp or Mosaic.

Anyway, what lies ahead matters more than what’s past. Agrium’s (NYSE: AGU) latest market report shows a significant uptick in phosphate shipments this year compared to last year, as well as slight improvement in prices. As per its reports, urea prices too are rallying. Agrium cites cutback in gas supply from Egypt ahead of the U.S. spring season and increased demand from important markets like India as boosters.

It’s a win-win

To think of it, what Agrium says has greater relevance for CF investors because nitrogen is also its primary product. The fact that the company upped its full-year earnings outlook days before release (mark Feb. 22 on your calendars) thanks to an extended fall season only raises the bar for CF. I have earlier detailed why leading the nitrogen space is a win-win situation for CF. It notched the top North American nitrogen producer’s crown after acquiring Terra Nitrogen (NYSE: TNH) a couple of years back. Owning 75% of Terra means CF benefits directly if it does well. Terra’s net earnings were up about 9% for the first nine months of 2012 despite sales gaining only 4%. Yes, you guessed it right: it was gas that boosted its bottom line. Terra’s gas costs per MMBtu were 25% lower compared to same period in 2011. CF investors might consider Terra as well if they want to supplement value with income (Terra yields a handsome 6.7% dividend).

The Foolish bottom line

Every major agricultural company, including CF, is pegging for another solid spring planting season in the U.S. this year. Nitrogen is not only the most important nutrient for corn, but also has to be re-applied every planting season unlike potash or phosphate, traces of which remain in the soil.

It should be another profitable year for CF, and it’s likely the stock will outperform again in 2013. Watch out for two critical updates in CF’s forthcoming earnings call: how it plans to pan out its $3.8 billion worth of growth plans announced sometime back, and the status of its Viterra acquisition, which once completed will give CF a major headway in the Canadian market.

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Neha Chamaria has no position in any stocks mentioned. 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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