Key Points
- North American shortages in nitrogen fertilizers have created a demand gap to be filled. Ammonia is an essential chemical in allowing nitrogen to act in crop yield dynamics; thus, the foundational block chemical is seeing additional demand pressure.
- CF industries finds itself in the middle of this supply and demand exchange, seeing the highest capacity utilization in the industry as a result of record demand for ammonia. Such high demand has prompted management to acquire facilities accruing 22% to existing ammonia production capacity.
- This capacity increase, along with cyclical low stock-to-use ratios in grain crops, imply that CF may benefit from a typical three to five-year bullish cycle in ammonia demand.
- Analysts have assigned a $104.30 price target to the stock as a result of the cyclical upside, and investors may be able to pick the company up near a strong support level.
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When turbulence hits the financial markets and the countless assets that compose them, investors typically turn to industries that seem to carry that "stable" factor, as in products or services that will be in demand whether markets and global economies are in a bull cycle or bear cycle.
Naturally, the businesses that operate in such industries as agriculture stocks will showcase stability in their financials, returns on capital invested, cash flow deployed toward paying down debts, and subsequent share repurchases or dividend payouts.
The constant variable in these industries comes down to which peer group carries the better, healthier cash flow during any extreme of the economic cycle.
It has been the case lately that the global food supply chain finds itself in a pinch regarding sustainable supply chains and finding the right components for sustainable output. For example, north American farmers reported increasing shortages of nitrogen fertilizers in 2022 which eventually added to the inflation input within food prices, as the fear of an ensuing food shortage drove prices higher.
Investors who anticipated the effects of a nitrogen fertilizer shortage saw the initial benefits of money flowing into the names responsible for providing the necessary components to make these needed fertilizers; however, that does not mean that everyday investors are left out of the game as there is still significant upside to this trend.
Record Year At CF Industries
CF Industries (NYSE:CF) has seen a record-breaking year in 2022, stemming from massive momentum born in the shortage peak in nitrogen fertilizers. CF Industries is, in essence, an ammonia producer.
Although ammonia is one of the essential chemicals that allows nitrogen to take on its fertilizer properties, nitrogen is not available for plant growth, so it must be converted to ammonium nitrate to produce the yields and farming practices of the modern day.
Nitrogen is the essential chemical supporting fertilizers; a fertilizer shortage would represent an even more significant shortage in ammonia, which is good for CF's business.
A way to measure the need for fertilizers worldwide is to look at the "stock-to-use" ratio. A higher percentage would imply sufficient supply-to-demand balances and a lower proportion of insufficient supply than demand.
According to CF's latest presentation, taking information from the USDA, stock-to-use ratios are at a ten-year low. Thus, the current need to supply ammonia for nitrogen fertilizers may stand to benefit from a typical three to five-year cycle until stocks rise to meet the standard of global demand.
This expectation of continued demand has prompted management to address the current high utilization rate within the company's capacity, which was approximately 96%, according to the 2022 annual report.
A 96% capacity utilization rate placed CF well above North American and global peers. It posed the urgency to increase capacity immediately to sustain the continued demand expected from the cyclically low stock-to-use ratios.
Expansion and Investor Scale
CF Industries announced the purchase of the Waggaman ammonia production facility from Incitec Pivot Limited as of March 2023. This acquisition represents an additional 880,000 tons of net ammonia production, accruing a nearly 22% increase in the overall net ammonia capacity reported by CF industries in their 2022 annual report.
This decision to increase capacity significantly through a plug-in acquisition rather than organically can give investors insight into the current state of affairs in the ammonia market. Apart from looking to expand capacity for ammonia production, CF's balance sheet as of February 2023 saw a 16.2% increase in total inventories held, accompanied by the highest inventory turnover ratio (cost of sales divided by inventories) since 2020.
The described inventory dynamic showcases a direct correlation to the stock-to-use ratios presented by the USDA, as higher inventory turnovers mirrored lower stock-to-use ratios.
The stage is set for CF to enjoy a reasonable double-digit boost in sales and sustained free cash flow retention, which is why management has approved a USD 3 billion share repurchase plan to be carried out through 2025, which comes on top of a current 2% dividend yield which may also benefit from a boost in free cash flow retained by the firm.
The company retired over 10% of its outstanding shares in 2019-2022, where free cash flow generation was a fraction of what investors are experiencing today. As a result, it is reasonable to believe that share repurchases will be accelerated.
Harvesting Upside
Analysts agree with the momentum sustainability in CF's economics, so they have assigned a consensus $104.30 price target to the stock, showcasing bullish divergences in indicators such as weekly RSI and Stochastics. In addition, a substantial support range of $65-$70 provides investors with a reasonable budget when adding CF to their watchlist.
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