It's Time To Buy This Seasonal Stock

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

If a drought destroys fortunes, it also builds fortunes. Last year’s drought wreaked havoc on crop yields in the U.S., after which crop prices skyrocketed. This year is turning out no differently, and weather experts predict that the dry spell could extend until summer. According to the U.S. drought monitor, recent showers have reduced the drought impact in certain states, but conditions have intensified in the central states. This suggests that crop prices could continue to head north, presenting a bullish case for fertilizer companies like CF Industries (NYSE: CF) and Agrium (NYSE: AGU).

Impact of shale gas

Natural gas is a crucial ingredient in the manufacturing of ammonia, which is later used to manufacture nitrogenous fertilizers. Thus, any fluctuation in natural gas pricing impacts the profitability of Agrium and CF Industries. Thanks to the shale gas boom in North America, the supply of natural gas is greater than its demand, even though the operational rig count is at historic lows. As a result, gross margins of CF Industries have risen by 229% over the last 10 years, and the current scenario calls for an even further margin expansion (due to falling natural gas prices).

There are three major types of potash dependent on either phosphate rock, ammonia (nitrogenous) or potassium. Since CF Industries and Agrium are the leading manufacturers of nitrogen fertilizers, both companies stand to benefit from dipping shale gas prices. While other names like Potash (NYSE: POT) and Mosaic (NYSE: MOS) are less dependent on ammonia, they would likely experience a lesser upside due to the shale gas boom.

Together, Mosiac, Potash and Agrium form Canpotex, which supplies fertilizers to farmers in India and China. Farmers in India had delayed purchasing potash fertilizers, awaiting a discount. It was only in February of this year that Canpotex agreed to sell potash at a discount in India. This would strain margins, but would also bring in nearly $470 million of operating cash flow.

That said, CF Industries mostly manufactures nitrogen-based fertilizers, which makes the company a pure play for the shale gas boom. However, Agrium, Mosaic and Potash have a diversified manufacturing mix, which would yield steady and stable returns. As a result of this operating mix, shares of CF Industries have risen by nearly 80% over the last 5 years, while shares of Agrium have risen by 53%. Meanwhile, shares of Mosaic and Potash have declined by 40% and 26%, respectively, clearly putting CF Industries ahead.

Expansive drive

To increase the lead, CF Industries is also expanding its nitrogenous fertilizer production facilities in Iowa and Louisiana, with a capital expenditure of $3.8 billion. Management stated that, once the expansion projects are complete, nitrogen volume should surge by 25% (8.5 million tonnes) by 2016. The company has already invested $480 million in the project so far, and is aiming to invest $1 - $1.3 billion this year. Thus, investors shouldn’t be surprised with higher capital expenditures (even unplanned) in the coming year.

Let’s compare the financial metrics of the mentioned companies.

Company

Forward P/E

PEG

Gross Margin

Debt/Equity

Potash Corp

8.07x

1.02x

51%

27%

Mosaic Company

11.85x

1.81x

27.65%

8%

Agrium Inc.

9.76x

1.98x

26.93%

57%

CF Industries

11.76x

2.49x

38.09%

41%

It’s not hard to see that CF Industries steals the show here. It’s not only the most undervalued fertilizer company, but also has a moderately leveraged business model with the highest margins.

Investors delight

The board of CF Industries believes in returning value to its shareholders, especially when the company is doing well financially. Although its current yield of 0.84% seems tiny when compared to Agrium’s 2.05%, CF Industries has been aggressively returning value in the form of share repurchases. Last quarter, CF Industries repurchased $1.5 billion worth of its shares, and its board recently approved another $3 billion worth of share buybacks, to be carried out by 2016. At the current price, this translates into a pending repurchase of around 15.75 million shares, or 25% of its outstanding shares, which should boost dividend yield to 1.1% at a constant payout of just 5.5%.

Wrapping it up

CF Industries has been outperforming its peers in terms of stock returns, and favorable industrial conditions suggest that its bull run could continue. Its capacity expansions, dividend hikes and share repurchases make it a great investment, and the dipping natural gas prices are icing on the cake. I think CF Industries deserves nothing short of a Buy rating.


Piyush Arora 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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