10-K Tuesdays: CF Industries

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We are taking a look at CF Industries this week, a name that popped up in Avondale’s proprietary quantitative value screen.  The screen looks at historical financial data to potentially identify high quality companies trading at low valuations.  The screen is an important part of Avondale’s investment process, but this post should not be taken as an investment recommendation.

Fundamental Data

Price: $213.64
Market Cap: $12.2 B

Revenue: $6.1 B
Gross Profit: $3.1 B
EBIT: $2.95 B
D&A: $420 M
Net Income: $1.8 B

Cash: $2.3 B
Total Assets: $10.1 B
Debt: $1.6 B

Notes from the 10-K (Filed 2/27/13)

We are one of the largest manufacturers and distributors of nitrogen and phosphate fertilizer products in the world.

two business segments:

1) nitrogen segment (13 m tons, $2.9 B gross profit): ammonia, granular urea, urea ammonium nitrate solution, or UAN, and ammonium nitrate, or AN

2) phosphate segment (2 m tons, $200 m gross profit): diammonium phosphate, or DAP, and monoammonium phosphate, or MAP

Assets:

five nitrogen fertilizer manufacturing facilities
75.3% interest in Terra Nitrogen Company, L.P.
a 66% economic interest in the largest nitrogen fertilizer complex in Canada
one of the largest integrated ammonium phosphate fertilizer complexes in the United States
recently constructed phosphate rock mine
an extensive system of terminals and associated transportation equipment
joint venture investments that we account for under the equity method

History:

founded in 1946 as a fertilizer brokerage operation by a group of regional agricultural cooperatives.

operated as a traditional manufacturing and supply cooperative until 2002, when we adopted a new business model that established financial performance as our principal objective, rather than assured supply to our owners.

2005, we completed our initial public offering

2010, we acquired Terra Industries Inc. (Terra), a leading North American producer and marketer of nitrogen fertilizer products for a purchase price of $4.6 billion

Nitrogen Segment

We operate seven nitrogen fertilizer production facilities in North America… the combined production capacity of these seven facilities represented approximately 39%, 34%, 47% and 22% of North American ammonia, granular urea, UAN and ammonium nitrate production capacity, respectively. Each of our nitrogen fertilizer production facilities in North America has on-site storage to provide flexibility to manage the flow of outbound shipments without impacting production.

Sales and Production Data

Production

Nitrogen Segment Financials

Capacity

Nitrogen Capacity

Implied capacity utilization: Gross ammonia: 87.5%, UAN: 92.6%, Urea: 93.3%, AN: 48.9%

Total cost of sales in our nitrogen segment averaged approximately $168 per ton

Expenditures on natural gas, including realized gains and losses, comprised approximately 39% of the total cost of sales for our nitrogen fertilizer products in 2012 down from 45% in 2011. Natural gas costs represented a higher percentage of cash production costs (total production costs less depreciation and amortization)

A $1.00 per MMBtu change in the price of natural gas would change the cost to produce a ton of ammonia, granular urea and UAN (32%) by approximately $33, $22 and $14, respectively

The Donaldsonville nitrogen fertilizer complex is the largest nitrogen fertilizer production facility in North America. It has five world-scale ammonia plants, four urea plants, three nitric acid plants and two UAN plants.

Our nitrogen fertilizer production facilities have access to multiple transportation modes by which we ship fertilizer to terminals, warehouses and customers…truck and rail…The North American waterway system is also used extensively…also have access to pipelines for the transportation of ammonia.

In our nitrogen segment, our primary North American-based competitors include Agrium and Koch Nitrogen. There is also significant competition from products sourced from other regions of the world, including some with lower natural gas costs.

Phosphate Segment

Sales and Production DataPhosphate Production

Phosphate Segment Financials

Phosphate Capacity

Phosphate Capacity

 

Implied capacity utilization: 99.5% of the mine, 90.8% of sulfuric acid, 92.4% of Phosphoric acid, 90.1% of DAP/MAP

Phosphate segment cost of sales averaged $397

Our Plant City phosphate fertilizer complex is one of the largest phosphate fertilizer facilities in North America. At one million tons per year, its phosphoric acid capacity represents approximately 10% of the total U.S. capacity.

All of Plant City’s phosphoric acid is converted into ammonium phosphates (DAP and MAP), representing approximately 13% of U.S. capacity for ammonium phosphate fertilizer products in 2012.

Phosphate rock is the basic nutrient source for phosphate fertilizers. Approximately 3.5 tons of phosphate rock are needed to produce one ton of P2O5

Plant City phosphate fertilizer complex typically consumes in excess of three million tons of rock annually.

As of December 31, 2012, our Hardee rock mine had 76.9 m tons total reserves.

Sulfur is used to produce sulfuric acid, which is combined with phosphate rock to produce phosphoric acid. Approximately three quarters of a long ton of sulfur is needed to produce one ton of P2O5. Our Plant City phosphate fertilizer complex uses approximately 800,000 long tons of sulfur annually when operating at capacity. We obtain molten sulfur from several domestic and foreign producers under contracts of varied duration. In 2012, Martin Sulphur, our largest molten sulfur supplier, supplied approximately 61% of the molten sulfur used at Plant City

In our phosphate segment, our primary North American-based competitors include Agrium, Mosaic, Potash Corp. and Simplot. The domestic phosphate industry is tied to the global market through its position as the world’s largest exporter of DAP/MAP.

Notes

The principal customers for our nitrogen and phosphate fertilizers are cooperatives and independent fertilizer distributors. CHS Inc. was our largest customer in 2012 and accounted for ten percent of our consolidated net sales. Sales are generated by our internal marketing and sales force.

In the fourth quarter of 2012, we announced plans to invest $1.7 billion in an expansion project at our Port Neal, Iowa facility which is projected to be completed by 2016. When completed, this project will increase our annual capacity of ammonia by approximately 0.8 million tons and granular urea by approximately 1.3 million tons.

In November 2012, we announced plans to construct new ammonia and urea/UAN plants at our Donaldsonville, Louisiana complex and new ammonia and urea plants at our Port Neal, Iowa complex. Our Board of Directors authorized expenditures of $3.8 billion for these projects. In combination, these two new facilities will be able to produce 2.1 million tons of gross ammonia per year and upgraded products ranging from 2.0 to 2.7 million tons of granular urea per year and up to 1.8 million tons of UAN 32% solution per year, depending on product mix. The $3.8 billion cost estimate includes: engineering and design; equipment procurement; construction; associated infrastructure including natural gas connections, power supply; and product storage and handling systems.

approximately $886.0 million of our consolidated cash and cash equivalents balance of $2.3 billion was held by our Canadian subsidiaries

we had $1.6 billion of senior notes outstanding in two series of $800 million each. The first series carries an interest rate of 6.875% and is due in the aggregate in 2018. The second series carries an interest rate of 7.125% and is due in the aggregate in 2020.

We manage the risk of changes in natural gas prices primarily through the use of derivative financial instruments covering periods of generally less than 18 months. The derivative instruments that we use currently are natural gas swaps and options.

Back of the Envelope Math

Nitrogen Capacity:

Total average selling price per ton: $393
Cost of sales per ton: $168, 39% of cost is natural gas => implies $102.5 in fixed cost per ton
Costs increase by ~$23/ton for $1 increase in price of nat gas => Implies ~$193 cost per ton at $4.50 nat gas

Hold selling price constant, 14.2m tons of capacity yield $5.5 B annual rev => $2.8 B gross profit at $4.50 nat gas

Nitrogen price sensitivity (bearish fertilizer price scenario):

Assume LT gross margin falls to 20%, costs at $193 per ton ($4.50 gas) => implies selling price per ton of $241

=> $241 price per ton yields $48 gross profit per ton => $48 gross profit per ton yields $681 m gross profit on 14.2 m tons of capacity

Replacement Cost:

Company disclosed two capex projects:

$1.7 B in capex for 2.1 million tons of incremental capacity => $809 per ton

$3.8B in capex for 6.3 million tons of incremental capacity => $622 per ton

At midpoint capex per ton ($715), 14.2 m tons worth $10.2 B

Phosphate Segment:

Value of company’s phosphate rock reserves:

20 years of reserves: 76m tons of rock => 22 m tons of Phosphoric acid => 44m tons DAP/MAP => $21.7 B rev => $4.3 B gross profit over 20 years at current margins

Value Relative to Current Price:

Company currently trades at 12.2 B market cap.  What is that discounting?

17 m tons of fertilizer capacity across whole business (nitrogen & phosphate) => implies $717 per ton of capacity

If you assume that company sells for 10x normalized EBIT, normalized EBIT would be ~$1.2 B, which is equal to $70 in operating profit per ton of capacity.  If you assume $198 cost per ton, back into long term average fertilizer price per ton in $268 range, 26% operating margin.