CF Industries - Still Bullish As Crop Prices Rise
Feb. 14, 2021 11:48 AM ETCF Industries Holdings, Inc. (CF)11 Comments9 Likes
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Leo Nelissen
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Summary
As I expected, agricultural commodities have started a steep uptrend backed by favorable supply/demand developments and a weaker dollar.
CF Industries has benefited tremendously as its stock price is up more than 50% compared to the COVID lows.
Regardless, the stock is far from being overvalued and I believe that the company will report higher than expected sales and margins in 2021.
I bought CF Industries (CF) in 2020 as I was looking for basic material stocks in the agriculture sector. CF Industries has a fantastic track record when it comes to capital gains during agricultural upswings, offers an attractive dividend yield, and does not expose its investors to high balance sheet risks. Even more important, my bullish agriculture call turned out to be right as we are currently witnessing a steep increase in agriculture prices. In this article, I am going to update my call and tell you why CF Industries remains a fantastic long-term investment.
Source: CF Industries
What I Expected & What Happened
Basically, what I expected was a new agriculture bull market supported by a number of factors:
Higher economic growth, resulting in increased energy demand. This, generally speaking, supports ethanol prices (corn).
A weaker dollar, which almost always ends up pushing inflation higher
A mix of higher demand and supply issues
There are many ways to measure energy demand. On one hand, we have a long-term uptrend in energy use when it comes to emerging market demand with India adding 50% to its demand until 2040. On the other hand, we have a short-term decline due to lockdowns that limit the use of on-road and air travel. During the first lockdown in 2020, refinery utilization in the United States hit a low slightly below 70%. This number, while still subdued, has recovered to 83%.
Source: Twitter (Based on Statista data)
The third point is a bit more complicated as explaining the global agriculture supply/demand situation is extremely complex.
Basically, what we are dealing with is a situation of subdued supply as we are dealing with factors like worse (expected) weather, supply issues in Brazil, and fewer corn acres planted. Meanwhile, demand is rising as we are dealing with the reopening of the economy, China rebuilding its hog herd, and an overall growing population.
World food prices are rising – for the eighth month in a row. The pandemic-related food shortages this spring may have been the most bullish thing to occur for agriculture in decades! This spring, 330 million American consumers realized what it was like to NOT have food products they wanted on grocery shelves. And so did food executives: Just-in-time inventory for food (a necessity for most humans about 3 times per day) might now be ancient history. This means we could use 120% to 130% of raw product in the 2021 year for many products (less stocks left over).
- Agriculture.com
This is what happened to crop prices recently:
Source: TradingView (Corn (black) and soybeans)
While corn has sold off a bit after a short-term bearish WASD report, it is still close to multi-year highs after going vertical since the summer of 2020. Note that corn uses a lot of nitrogen as I discussed in my previous article. Given that CF Industries is a main supplier of nitrogen, it makes higher corn prices the biggest bull case investors could have asked for.
As a result, it is no surprise that urea prices have accelerated (see graph below).
More than 90% of world industrial production of urea is destined for use as a nitrogen-release fertilizer. Urea has the highest nitrogen content of all solid nitrogenous fertilizers in common use. Therefore, it has a low transportation costs per unit of nitrogen nutrient.
- Ullmann's Encyclopedia of Industrial Chemistry
Source: TradingView
Based on this context, CF Industries (and its peers) has two major things going in its favor:
Crop prices are rising, providing farmers with more cash to invest in machinery and fertilizer
Higher fertilizer prices, which allows the company to increase its margins.
So, both higher volumes and higher margins.
Why I'm Adding To CF Industries
As far as analyst estimates go, 2020 is expected to be slower than 2019 as the year started off weak for obvious reasons. However, thanks to higher prices and higher volumes, 2021 is expected to see sales close to $4.4 billion. I believe the company will exceed its 2019 sales peak as I believe that analysts have not priced in a further surge in agriculture prices. This also means that I expect at least $1.6 billion in 2021 EBITDA.
Source: TIKR.com
Additionally, free cash flow is expected to remain close to $1.0 billion until at least the end of 2021. This offers a lot of possibilities even if we are not seeing any growth yet. On a twelve-month trailing basis, the company has paid $260 million in dividends and spent $200 million on stock buybacks. Unfortunately, dividends have been kept since 2015 at $1.20 per share (implies a 2.8% yield).
ChartData by YCharts
Cash flow after dividends and buybacks has been spent on debt reduction, which has resulted in a very healthy balance sheet. As of 3Q20, net debt has been reduced to $3.7 billion, which is just 2.8x expected 2020 EBITDA. Total liabilities are 54% of total assets and further deleveraging is more than likely given the company's stubbornness when it comes to raising dividends.
Source: TIKR.com
Additionally, when adding a market cap of $9.3 billion, we end up with an enterprise value of $13 billion. Based on the 2021 expected EBITDA of $1.45 billion, this gives us a valuation of 9.0x. Given the company's historical valuation range, it is hard to make the case that CF Industries is overvalued - even after adding roughly 50% since the COVID sell-off.
ChartData by YCharts
Takeaway
I like CF Industries. Even after a 50% price increase, the stock is far from being overvalued. While analysts only expect a gradual increase in sales and EBITDA, it does allow the company to further reduce its already low debt load and to maintain share buybacks.
Unfortunately, CF Industries has not been a dividend "champion" as investors haven't gotten a raise in more than five years - which bothers me a little bit.
However, as I expect that sales, EBITDA, and margins will be higher than expected in 2021 (and likely beyond), I think that the company will use its cash to increase dividend distributions as the past five years have not seen a significant increase in inflation and agricultural commodities - that is currently changing.
So, long story short, if you are not long already, I believe that the stock still offers enough upside for investors to start buying now. I will be adding a few shares this month as I bought most of my position last year.
Let me know what you think!
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