The Materials sector is one of the more interesting sectors of the market, because it encompasses a pretty wide range of business types. It’s also an industry that the average consumer probably doesn’t think much about, I think primarily because as consumers we tend to be aware of just the finished goods and products that we use at any given time. Stocks in the Materials sector, however, are usually the companies that provide the components that manufacturers use to create the products and goods we consume. That’s where the diversity of business types comes into play: the sector includes paper manufacturers and wood processors to chemical companies producing everything from plastics to fertilizers and more.
The COVID-19 pandemic prompted a global economic shutdown that has affected every sector of the global economy, and that is just beginning to get restarted. One of the interesting places to analyze that impact is on the demand for agricultural products like corn. Corn is a crop that is used for everything from the dinner on your plate to the production of ethanol, a fuel additive designed to make fuel consumption cleaner and more environmentally friendly. High corn demand translates to high demand for nitrogen fertilizers.
Even as the global economy restarts, however, there are concerns that ethanol production, which naturally slowed while shelter-in-place orders were in effect around the world, will be slow to recover. Favorable weather in the U.S. during the first quarter gave farmers an opportunity to start planting early, which could also contribute to expected oversupply issues on this commodity. That could act as a drag on companies in the Materials sector like CF Industries Holdings Inc (CF). This is a mid-cap producer of nitrogen and phosphate fertilizer. That makes them highly dependent on natural gas and ethanol, and subject to the variances in prices of those commodities. Despite that pressure, CF has managed to rally in the last few weeks, from a low price around $23.50 to its current level around $31, presumably on the hope that as economic activity increases, people will want to get out and travel more, which could boost demand for ethanol in general. That may or may not happen, but even while dealing with cost concerns and the broad-based uncertainty that every business has in the last few months, CF has managed to maintain a solid fundamental profile. Even with the stock’s recent increase, it also offers an excellent value proposition that just might be too good to pass up right now.
Fundamental and Value Profile
CF Industries Holdings, Inc. manufactures and distributes nitrogen fertilizer, and other nitrogen products. The Company’s nitrogen fertilizer products are ammonia, granular urea, urea ammonium nitrate solution (UAN) and ammonium nitrate (AN). Its other nitrogen products include diesel exhaust fluid (DEF), urea liquor, nitric acid and aqua ammonia, which are sold primarily to the Company’s industrial customers, and compound fertilizer products (nitrogen, phosphorus and potassium or NPKs). The Company’s segments include ammonia, granular urea, UAN, AN and other. The Company’s ammonia segment produces anhydrous ammonia (ammonia), which is concentrated nitrogen fertilizer as it contains 82% nitrogen. The granular urea segment produces granular urea, which contains 46% nitrogen. The UAN segment produces urea ammonium nitrate solution. The Other segment includes DEF, urea liquor, nitric acid and NPKs. The Company’s primary nitrogen fertilizer products are ammonia, granular urea, UAN and AN.CF has a current market cap of about $6.8 billion.
Earnings and Sales Growth: Over the last twelve months, earnings increased by 14.8%, while revenues slipped by -3%. In the last quarter, earnings increased by 24% while sales declined -7.44%. The company’s margin profile is healthy, but has narrowed in the last quarter; Net Income as a percentage of Revenues in the last quarter is 7% versus 10.33% over the last twelve months.
Free Cash Flow: CF’s free cash flow is $1.16 billion. That translates to a very attractive Free Cash Flow of a little more than 17.44%.
Debt to Equity: CF’s debt to equity is .73, a conservative number that signals the company’s conservative approach to leverage. Their balance sheet shows cash and liquid assets were $753 million in the last quarter versus $3.95 billion in long-term debt. Their operating profile indicates that they have sufficient operating income to service their debt, with adequate liquidity to add to the mix. It should be noted that at the beginning of 2020, cash was notably higher, at around $1 billion. That is likely a reflection of the challenges faced by all of corporate in the wake of the early stages of the pandemic, and it is a concern; the question moving forward is whether the company’s liquidity will continue to deteriorate, stabilize, or start to increase again.
Dividend: CF’s annual divided is $1.20 per share, which translates to a yield of about 3.88% at the stock’s current price.
Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but I like to work with a combination of Price/Book and Price/Cash Flow analysis. Together, these measurements provide a long-term, fair value target around $39.50 per share. That means that the stock is nicely undervalued, with about 28% upside from its current price.
Technical Profile
Here’s a look at the stock’s latest technical chart.
Current Price Action/Trends and Pivots: The diagonal red line traces the stock’s downward trend from July of last year to to its low point in March at around $20 per share. It also provides the baseline for the Fibonacci retracement levels shown on the right side of the chart. The stock rallied to a high around $30 in April before falling back again to a new low in mid-May around $23. It has rallied strongly from that point, and as of today’s session is driving above that April peak. Its next most likely resistance is at $33.26, where the 38.2% retracement line sits. A push above that level should give the stock to push to about $37.50, inline with the 50% retracement line. Current support should lie back around the $30 level, using the April peak resistance level, above which the stock is now breaking. A drop below that level could see the stock fall to next support between $25 and $27 based on the stock’s price action in April and May.
Near-term Keys: CF’s fundamentals are strong and have held up relatively well even with COVID-19 acting as a significant headwind. It also carries a value proposition that remains attractive despite the stock’s increase in the last few weeks. If you prefer to work with short-term trading strategies, you could use a push above $33.26 as a signal to buy the stock or to work with call options, with a near-term price target at around $37.50. If the stock’s current momentum turns bearish, you could also use a drop below $30 to consider shorting the stock or working with put options, using $27 as an initial, quick-hit profit target on a bearish trade, and $25 if downward momentum remains strong.