Buy Into This Golden Opportunity Before It Slips Away!

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

CF Industries(NYSE: CF) shares have lost 17% value in the past three months. I can sense only one reason behind the bloodbath – rising natural gas prices. Gas prices are sitting pretty at a 20-month high currently. Why should CF investors worry? Well, natural gas is also the key input for nitrogen nutrient which in turn is CF’s bread and butter. Naturally, rising input costs can never be good news for a company.

But is it really as bad as the market perceives it to be? Maybe not. I think it’s time you grab CF’s shares before they start jumping round. If anyone disagrees with you, tell them you have more reasons than one to do so.

The gas won't hurt much

CF consumes huge amounts of natural gas, but it also has in place a hedging strategy that could come in handy. CF had already booked 90% of its projected gas requirement though April 2013 by February this year. I’m sure you know that the gas also gained the most in the past couple of months. That means CF’s first-quarter report, which is due in some weeks’ time, shouldn't carry any major gas blow. I am expecting its gas cost to be well under $4 for the quarter. Going by CF’s trend, it should have also booked most of its gas needs for the coming months in advance, insulating itself from hard gas shocks. Its forthcoming earnings call will tell better.

Others hedge as well, but aren't as aggressive as CF. Take the case of smaller nitrogen player Rentech Nitrogen (NYSE: RNF). The market’s fear about rising gas costs has caught Rentech in its web – its stock has shed a whopping 31% in the past three months. Half of Rentech’s cost comprises natural gas, and it booked 37% of its 2013 gas requirement at $3.87 per MMBtu during its last quarter. That still leaves Rentech largely at the mercy of spot gas prices, which are hovering over the $4 mark currently.

That’s not to say that rising gas prices won’t hit CF’s margin. Year-on-year comparisons could particularly look morbid as costs rise. Yet, the pessimism seems factored in CF’s stock price now. Apart from the concern of rising input costs, there’s no problem with CF. Even when gas prices were high, CF maintained margins at decent levels. I strongly feel the trend is here to stay.

Wind at its back

The inelastic demand for its core product, nitrogen should keep CF going. As the most widely applied nutrient, nitrogen surpasses potash and phosphate in terms of both usage volumes and prices. More important, nitrogen is the lifeline for the essential crop, corn. Farmers in the U.S. are gearing up for record spring planting this year. Monsanto (NYSE: MON) confirmed this in its recently reported second-quarter numbers. The largest seed company in the world is a good comparison here because corn seeds and traits made up 70% of its total seed sales during the quarter. Monsanto reported a 15% rise in revenue year-on-year backed almost entirely by robust corn seed sales. The company has even upped its full-year earnings guidance on expectations of record corn volumes for the year. Small wonder, then, that Monsanto’s stock is flirting with its 52-week high.

As the largest nitrogen producer in North America and the second biggest in the world, CF should do well. Rising sales of nitrogen should also help offset rising gas prices. Long-term trends indicate that farmers are also increasingly substituting nitrogen for potash and phosphate. From 37% share in total fertilizers consumed in the U.S. in 1960, nitrogen today is 60% of the total. So CF gains at the cost of peers like PotashCorp (NYSE: POT) and Mosaic (NYSE: MOS) which have little to do with nitrogen. That also explains why CF’s operational metrics look much better than these two, which of course is another reason why you should consider buying CF now.

Undisputed leader

Revenue for both PotashCorp and Mosaic dipped around 9% each last year as global markets cut down their potash and phosphate consumption. Mosaic was worse off because it doesn’t deal in nitrogen unlike PotashCorp which generates nearly 30% revenue from the nutrient. Mosaic’s gross and net profit margins for the trailing twelve months was 34% and 19%, respectively. PotashCorp earned 50% and 28% in gross and net margins, respectively, over the same time frame. CF leads with a 58% gross margin and a 30% net margin. Rentech boasts a 41% net profit margin but loses out to CF when it comes to the balance sheet.

CF’s unbelievably good financials is the third reason you should consider buying it. It is one of the few companies that generate greater free cash flow than net income – a great sign of internal strength. CF’s cash and equivalents have grown manifold in the past few years, currently chugging ahead of the long-term debt it shoulders. A long-term debt-to-equity ratio of 27% is supported by a handsome operating margin of around 48% (TTM). Rentech’s long-term debt-to-equity stands at 170%.

The Foolish bottom line

For all this, CF looks darn cheap at 6 times earnings. Rentech still trades at 11 times earnings. Even weaklings like Mosaic and PotashCorp sport double-digit P/Es. Only, both of them have better dividend yields than CF – Mosaic’s is at 1.7% and PotashCorp boasts 2.8% yield while CF languishes at just 0.8%. But who knows? Given CF’s warchest, a possible dividend hike can’t be ruled out. Meanwhile, it is buying back shares to treat shareholders.

Such opportunities don’t knock your door too often. I think agriculture is a sector every investor should have some exposure to, and CF is one of the best plays out there. You might not want to wait till the company smashes Street estimates in some time. I am not ruling out the probability. 


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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