The Opportunity Spreads for Fertilizer

02/13/2012 12:27 pm EST


Igor Greenwald

Chief Investment Strategist, MLP Profits

Farmers set to plant the most corn in decades will soon pay through the nose for vital nitrogen, further boosting CF Holdings’ ample profits, writes senior editor Igor Greenwald.

Another month and winter will be gone. Soon after, parts of the Midwest will wake up to an unmistakable sign of spring—the stink of ammonia wafting from the corn fields.

That will smell as sweet as freshly printed currency to shareholders of nitrogen fertilizer giant CF Holdings (CF), poised to rake in the green from what’s shaping up as a record-breaking planting season.

The extent of CF’s good fortune should become clearer late Wednesday, once the $12 billion company reports fourth-quarter earnings. The fertilizer business has become incredibly lucrative, witness the consensus forecast for a profit increase of more than 150% in a year’s time.

Credit the high price of corn, the top US crop that demands huge and growing quantities of nitrogen to deliver profitable yields. CF, with its 80% concentration in nitrogen fertilizers, is particularly leveraged to high corn prices.

With drought ravaging the South American corn crop, US farmers are preparing to fill the gap with the biggest corn acreage planted in 68 years, by one reckoning. CF, which controls the premier ammonia-distribution network in the US, is especially well placed to convert all this looming demand into big profits.

Ammonia prices are up sharply year-over-year, at levels not seen since 2008. Meanwhile, the principal feedstock of nitrogen fertilizer, natural gas, is mired at historic lows.

Through the first nine months of 2011, CF had already seen nearly as much cash flow as in its prior two best years put together.

CF has provided upside earnings surprises in each of the last four quarterly reports, and is likely to do so again Wednesday, as befitting a company that lists “under-promise and over-deliver” as one of the four pillars of its corporate culture.

As for under-promising, the key tell here is last week’s report by rival Agrium (AGU), which trounced earnings estimates. The company said it expects “pent-up demand to continue to emerge” for nitrogen fertilizer.

CF shares ran to a record high in the immediate aftermath of that report, only to suffer an abrupt rejection. After a surge of 50% from the late-December lows, a pullback like this was in the cards. But on the other hand the stock is up just 4% since early November, while the business outlook is much stronger than it was at the time, or at the previous all-time stock high last August.

I expect the stock to set new records sooner than later, in part because a lot of the good news still isn’t priced in. CF shares sell for just eight times forward earnings and less than five times trailing cash flow, valuations modest even by the fertilizer industry’s low lights.

Of course, all farm booms eventually bust. And like other commodities, fertilizer is subject to big cyclical price swings in both directions. But there’s little evidence that the current cycle has peaked, with global corn stocks at their lowest levels in six years, and no guarantees that record plantings this spring will translate into a bumper crop come harvest time.

Over the longer run, rapid appreciation of agricultural land in the US (and increasingly globally as well) will only increase the incentives to work the soil to its limit, typically by trying to turbocharge corn yields with extra nitrogen. Meanwhile, shale extraction techniques are likely to keep US natural gas cheap by global standards for quite some time.

CF looks undervalued here, and poised to resume its run at any time.

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