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Some investors doubt whether the fertilizer giant will be able to continue its growth.


A fertilizer co-op grows its way into the Fortune 500

by Gordon Voit
March 14, 2013


CF 1

Gordon Voit/MEDILL

CF Industries has outpaced analyst expectations in three of the past four quarters.

The year was 1946 and northern Illinois’ farmers had grown weary – not from balky tractors or another backbreaking harvest, but from problems with fertilizer.

Even the famously rich soil of the Corn Belt needs a bit of help to produce its annual flood of corn and soybeans. In those days, the nitrogen, phosphate and potash the state’s growers depended on to enrich their fields was tough to track down and inconsistent in quality. To address that issue a group of Illinois’ frustrated growers banded together and set out to solve the problem.

Central Farmers Fertilizer Co. was hatched in that moment. The body of farmers plowed ahead with a collective goal: taking the guessing-game out of the Midwest farmer’s fertilizer costs.

Over time, that local cooperative became a publicly traded company. Now a Fortune 500 corporation , the operation that once served as an insurance policy for a regional farm group has gone global.

Shares of CF Industries Holdings Inc., as it’s known today, have come a long way since the company’s IPO in August of 2005, when the stock price was in the teens. Thanks to the boom in grain prices, and the subsequent jump in the number of acres that U.S. farmers plant each year, the stock now hovers around $200 a share, giving the company a market value of more than $12 billion.

But the Deerfield-based company’s future is unclear. The farm sector’s recent years of prosperity helped CF attain remarkable growth, but experts wonder how much growth is left. “We're a little worried about what CF now plans to do with that sizable cash hoard,” said Morningstar analyst Jeffrey Stafford in a research note. CF reported it had $2.27 billion in cash at the end of 2012, up 88 percent from the previous year.

“In our opinion, the North American nitrogen fertilizer market is near a cyclical peak, and this could be a bad time to sink money into additional U.S. capacity.”

The company’s network of seven nitrogen plants stretches from Ontario to Mississippi. Its plant in Donaldsonville, La. is the largest in North America.

Challenges ahead

“We think CF has limited potential to grow volumes over the coming year due to internal production constraints and to North American corn acreage that is already at a 75-year high,” said Standard and Poor’s analyst Kevin Kirkeby in a recent note to investors.

Part of the reason that analysts question CF’s ability to turn cash into investing interest is the fact American farmers simply can’t plant much more corn. Corn is coveted by fertilizer companies because it requires more nitrogen than soybeans per acre.

Ethanol is helping raise corn prices dramatically as well. In 2005 corn prices averaged $1.95 per bushel, with ethanol production coming in at 93 million barrels, according to government data. By 2011, the price of corn was approximately $6.12 per bushel, and ethanol production, spurred by government requirements that refiners blend it with gasoline, reaching 332.1 million barrels. In addition, the developing world is also consuming more animal protein, which means livestock fee, usually corn, is thriving as well.

In 2012 CF’s sales were essentially flat at $6.1 billion, with roughly 80 percent of that coming from nitrogen fertilizers.
Despite the sales plateau, CF’a earnings climbed 20 percent last year to $1.85 billion , or $28.59 per diluted share, from $1.54 billion, or $21.98 per share, in the previous year. Those numbers represent a major increase from 2010, when CF earned $349 million, or $5.34 a share. As the continent’s largest producer of nitrogen fertilizer, CF takes natural gas and other input chemicals and turns them into key components like ammonia, urea and ammonia nitrate.

CF’s first move since questions started cropping up about its cash reserves and growth opportunities came with a major announcement made recently. The company is looking to silence its critics is by investing $3.8 billion to expand its facilities in Louisiana and Iowa. Production for those facilities are scheduled to begin in 2015. With the plant adding to the global supply of fertilizer, prices could fall, but CF hopes its market share will increase.

Experts aren’t so sure the company can overcome its challenges. Kirkeby says his “sell” rating is due to an anticipated dip in sales. According to him, the fertilizer bubble created by the nation’s crippling drought this past summer caused demand to rise artificially.

Key advantages

In Stafford’s note the analyst says the CF of today still wrestles with and suffers from the very market fluctuations that caused CF to form in the first place.

“We don't think CF has any sustainable competitive advantages, with nitrogen production costs and selling prices outside of the firm's control,” he said in the note.

Natural gas’ price stability is a point of contention between CF and analysts. Wilson said during CF’s quarterly conference that he was certain gas would maintain its low prices in the U.S.

“We realize a significant and sustainable advantage as a consumer of North American natural gas,” he said. “Natural gas availability is far from assured in many regions of the world as we've seen gas curtailments impact several offshore nitrogen producers.”

Natural gas prices have been driven downward in the U.S. by the increased prevalence of the petroleum-recovery method known as “fracking.” In July of 2008 the price of gas sold to commercial consumers was $15.64 per thousand cubic feet, according to the U.S. Energy Information Administration. In December of 2012 the price had fallen by nearly half, to $8.11 per thousand cubic feet.

One way CF has aimed to protect itself against price risk is by hedging. In fact, Wilson said that 90 percent of the company’s gas purchases through April of this year have been hedged – and well below $4 per million British thermal units at that. (Currently natural gas prices range from $3.49 to $3.58 per million BTU, depending on the contract type, according to the U.S. Energy Information Administration.)

One asset in CF’s favor is its sheer size. In 2010 the company bought fellow fertilizer maker Terra Industries Inc. for $4.7 billion. The merger made CF the largest fertilizer operation in North America and it contributed to a 54 percent increase in CF sales from 2010 to 2012.

Analysts say purchasing Terra was a successful move.

“Upon a backdrop of high corn prices and low North American natural gas costs, Terra's nitrogen fertilizer assets have printed money since the purchase, and CF has been flush with cash as a result,” Stafford said.

CF has a developed network of railways, pipelines and other means of distribution that give it an advantage over other competitors like Agrium.

Another advantage CF has over its rivals is the fact that nitrogen is arguably the hardest farm chemical for growers to cut back on in tough times, according to Bank of America Corp. analyst Kevin McCarthy.
McCarthy said that if farmers were to forego nitrogen application, even for one growing season, the move “would result in more immediate and pronounced yield loss than phosphate or potash deficiency.”

Fertilizers fill an unusual niche in drought conditions, as some farmers purchase more in drought times to combat the withering effects of the climate.

CEO Steve Wilson touched on the increased need for fertilizer in the summer of 2012 – the nation’s worst drought since 1956 – while speaking at Bank of America/Merrill Lynch’s global agriculture conference last month.

“There's no excuse actually on the part of farmers to use less than the optimal amount of nutrients and it's unlikely that they would do that,” he said

Financial status

The company currently carries a price to earnings ratio of 7.05, which is lower than competitors Agrium Inc. (10.84) and Potash Corp. Saskatchewan Inc. (16.61). The S&P 500 Index currently carries a P/E ratio of around 14.

Again, CF’s future growth potential is the primary concern for analysts.

Stafford has CF rated as a “hold” due in part to the perception that CF has run out of room to grow substantially.

“We're expecting profitability will begin to decline in 2013 after spiking in 2012,” he said. “By 2015, we think CF's operating margin will dip to about 25%, from over 45% in 2012.”

Aside from weather conditions regressing to the norm, natural gas prices have begun to creep up, potentially hurting margins in the future. S&P is expecting such a price increase. CF is a major buyer of natural gas.

Analysts polled by S&P have projected $25.83 in earnings per diluted share for the current year, down from $28.59 in 2012. The following year could continue the projected downward movement, as analysts are expecting an earnings decline in 2014 of 9% to $23.51.

CF's rise to giant status has been lucrative to an extent the founders couldn’t have imagined back in 1946. For today's investors, however, the questions may be "‘is the ride over?”