Third Point exited a 4.49% position in CF Industries Holdings (CF), a manufacturer and distributor of nitrogen and phosphate fertilizer products in North America. According to Third Point’s investor letter, the position was initiated in 2Q 2013.
The 2Q 2013 letter highlighted the investment thesis by saying, “CF Industries is North America’s largest nitrogen fertilizer manufacturer and one of the lowest-cost producers globally. CF currently trades at an unwarranted discount to fertilizer and commodity chemical peers. We believe its structural cash flow generation strength is misunderstood and that management should deliver a much larger dividend to its shareholders. Such a dividend would highlight the sustainability of its cash flow generation and lead to a substantial re-rating.”
The letter further said “CF’s access to low-cost North American natural gas – the primary input in nitrogen fertilizer production – gives the company a structural, sustainable margin capture relative to global peers with higher input costs. CF has been underperforming recently despite the emergence of several positive indicators, including reduced Chinese plant operating rates, reports of capacity idling in Eastern Europe, and the shelving of two plant expansions in North America. This underperformance reinforces our view that a dividend strategy based on CF’s stable cash flow stream would lead investors to reassess the company’s valuation.”
The company recently reported a decline in net earnings for 4Q 2013 to $325.8 million, or $5.71 per share, from $470.7 million, or $7.40 per share a year earlier. Nitrogen segment sales fell 4% due to a decline in overall average selling prices, partially offset by an increase in tons of product sold. Gross margin decreased due to lower revenues and an increase in natural gas costs. Despite the difficult challenging environment with the nitrogen and global urea prices down significantly, CF Industries said it was able to generate a significant level of EBITDA thanks to the structural advantage provided by low cost North American natural gas and the company’s extensive network of plant and logistical assets.
The company said it’s progressing on evaluating options for optimizing its capital structure and converting existing operating facilities “into a master limited partnership structure does not look terribly compelling to other alternatives such as additional low cost debt.”
During 4Q 2013, the company announced strategic agreements with the Mosaic Company including an agreement to sell the phosphate business for $1.4 billion and a long-term ammonia supply contract. Subsequent to the quarter end, the company also announced a long-term agreement with Orica to supply ammonium nitrate products. CF said both of these contracts provide it with a defined margin independent of gas costs, and increase confidence in the cash flow profile associated with a portion of the company’s production capacity. The company also reached several milestones on its capacity expansion projects, which will increase its annual nitrogen production capacity by 25% when the plants come on-stream in 2015 and 2016.
The company has a positive outlook for 2014. CF said global nitrogen prices have improved significantly since November. Nitrogen floor prices are expected to continue to be the cash cost of Chinese urea producers. Upside to nitrogen prices has recently developed due to the close of the Chinese low-tariff export season, low retailer and distributor inventory levels in important agricultural regions including Europe and North America, and emergence of normal seasonal demand.
The company further added that North America is expected to have robust ammonia demand through the first half of 2014, assuming normal weather conditions; however, prices may be constrained due to high levels of producer inventory carried over from 2013.
Prices of urea and urea ammonium nitrate (UAN) in North America have increased and are expected to remain firm through the spring application season in order to attract imports required to fill 22 million nutrient tons of expected full year nitrogen demand. This is well in excess of the 15 million nutrient tons of expected North American production. Imports of urea and UAN have been lower than year ago levels, while strong spring demand is expected in association with 92 million acres of corn anticipated to be planted.
CF increased dividend 150% to $1.00 per share per quarter in October and repurchased 1.5 million shares during 4Q 2013. The company said it intends to raise up to $1.5 billion of additional long-term debt in early 2014. These new borrowings, plus cash from operations and proceeds from the sale of the phosphate business, will fund the company’s capital expenditures, working capital, dividends and additional share repurchases. The company currently has $1.4 billion remaining on its existing $3.0 billion share buyback authorization.