Shares of nitrogen and phosphate fertiliser manufacturer CF Industries are ripping after Dan Loeb’s Third Point LLC said in an investment letter that it had taken a stake.
From the letter:
Equity Position: CF Industries 6
CF Industries is North America’s largest nitrogen fertiliser manufacturer and one of the lowest-cost producers globally. CF currently trades at an unwarranted discount to fertiliser 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.
CF’s access to low-cost North American natural gas – the primary input in nitrogen fertiliser production – gives the company a structural, sustainable margin capture relative to global peers with higher input costs. These same competitors provide a floor for the nitrogen fertiliser price, because they idle production when the price nears their cost (“the cost floor”). The spread between CF’s production cost and that of the higher cost producers is a sustainable stream of cash flow for CF, with limited volatility. Using an onerous set of assumptions for this spread ($5 Henry Hub/natural gas input cost and $275 per ton nitrogen fertiliser price),we estimate that this cash flow stream would be ~$1.2 billion annually (operating free cash flow less maintenance CapEx, post expansion). On today’s equity value, that would mean CF is currently trading at an 11% free cash flow yield using these onerous assumptions. Given the low-risk profile of this portion of CF’s cash flow, it should receive a bond-like multiple (e.g. 7 – 8% yield), which alone implies significant upside to the current share price.
CF management has the ability to highlight the value of this stable cash flow stream by paying a significant portion of it as a dividend. A high dividend payout would still leave CF’s leverage well below the 3x debt to EBITDA criteria that Moody’s recently established as adequate to maintain their current debt rating of Baa2.
The stock was last trading up around 7%.
Check out the stock’s reaction following the news.
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