CF Industries Holdings (CF) released solid Q4 2011 earnings after the market close, exceeding street analyst average estimates for adjusted EPS and revenues.
Headline EPS of $6.66 per share was below the $6.82 consensus.
CF shares were up $1.28 to $179.18 during regular market trading, but lost over $6 in after market hours due to the headline shortfall.
But adding back non-cash mark to market derivative losses of 47 cents resulted in underlying adjusted EPS of $7.13. Revenues totalled $1.718 billion versus $1.65 estimates. CF shares firmed up to $174.75 after the session close after hitting $172 and change.
75.3% owned subsidiary Terra Nitrogen Company, L.P. (TNH) reported Q4 revenues of $201 million and net income attributable to common units of $3.87, versus our estimate of $217 million and $3.75 per common unit, made on October 26 here.
Terra Nitrogen units have been on a wild upwards trajectory after crossing $200 just two weeks ago, reaching a high of $239.793 around midday today. The units closed down $10.19 at $213.97 on heavy 224K volume, an intraday reversal of almost $26.
CF benefited from a large order book for nitrogen fertilizers delivered at attractive prices during into the quarter, with an extended ammonia application season due to hot summer conditions and an early harvest in the US corn belt. Soft market conditions in November and December therefore, had little impact on revenues.
Nitrogen sales were 3.3 million short tons and flat compared to Q4 2010, but prices were up substantially for ammonia (40%), urea (40.5%), UAN (71.8%) and ammonium nitrate (22.3%). Revenues were $1,463 million, up 46%, with a gross margin of $786 million or 53.7% of sales versus $1,003 million and gross margin of $421 million or 42% of sales.
Similarly, Terra Nitrogen, which CF manages, also produced decent, but not extraordinary nitrogen sales which were marginally down versus Q4 2010 in volume but up in price for ammonia (20.7%) and UAN (78.7%).
It should be noted that CF's average prices include shipping whereas TNH's are plant gate, so you can't compare CF's $633 quarterly average ammonia price with TNH's $530, for example.
On the phosphate side, CF successfully sold into the export markets (45% of sales) and avoided a weaker domestic market as US farmers sat on their hands in late 2011. Combined volumes were down 8% versus Q4 2010 but average prices realized were higher for DAP (18%) and MAP (21%) over last year's final quarter. Q4 phosphate revenues were $255.3 million or 9% higher than last year. Note that CF did not curtail phosphate production as did peer The Mosaic Company (MOS).
Both nitrogen and phosphate plants operated at high rates, with nitrogen plants at a collective and impressive 100% of name plate capacity and phosphate plant at 94%.
Rather than forward book fertilizers at the depressed prices of nitrogen and phosphate available at the end of the year, CF allowed the forward sales book to run off, which caused customer advance balances to fall by $621 million, eating into cash flow. Backing out working capital uses, CF produced $624.4 million in cash flow, or an impressive $9.475 per share, well in excess of my $475 million estimate.
CF ended the quarter with $1.2 billion in cash in spite of the runoff, an impressive amount. Net of $1.618 billion in funded debt and $257 in remaining customer advances, leaves CF in a low leverage $668 million net debt position.
Terra Nitrogen also ended the quarter with a high cash balance of $179.8 million, and no debt, but rather, a working capital position of $180.6 million.
Terra Nitrogen goes "ex" a $4.53 final distribution tomorrow. This Q4 distribution exceeds Q4 earnings per common unit which came in at $3.87. Therefore, a reduction in working capital balances must have occurred to allow the overpayment.
We do not expect Terra Nitrogen to be able to duplicate this distribution level after Q1 2012, especially because the LP must reserve for a $60-80 million turnaround expense in the second half of the year. This would cut into annual distributions to common unitholders by about $1.62-$2.16.
One negative to CF's release was the admission that the company had hedged 65% of its 2011 natural gas requirements by the end of 2011. Normally the company only hedges nitrogen fertilizer natural gas requirements for the quarter, or 25% of the expected future consumption.
As of Sep 30 CF was down $24.5 million on 45.8 million natural gas units (mmBTU) out of about 270 million consumed per annum.
As of Dec 31, 65% would mean 175 million units hedged. And the pre-tax loss was $49.7 million.
Another 60 cents would add $105 million more unrealized pre-tax loss to date, or over $1 per share.
It is likely Terra Nitrogen has also hedged a large part of its 2012 natural gas requirement, and is running a proportionate loss.
Recently in my comments, I warned that TNH's unit price rise above $210 was probably unsustainable. Even if we add 50 cents per unit to our expected 2012 distribution rate for lower natural gas costs, TNH is trading at 16 times cash flow.
TNH unit price is now trading at a $55 plus premium to parent CF, after trading near its price for most of 2011. There are structural reasons for TNH's outperformance, notably, a lack of sellers attracted to yield at any cost, as well as tax reasons.
If CF were trading at 16 times 2011 CFPS of $31, the stock would be at $496, or about 185% over the current stock price!
The question should be, is CF heavily undervalued, or is TNH overvalued?
In my view, it is a combination of both. However, I would not institute a spread trade (buy CF/short TNH), because TNH is a dangerous unit to short, with very little public float.
There is always a danger, however low, that CF might choose to sell down its interest in TNH as CVR Energy (CVI) has stated it will do for nitrogen MLP CVR Partners (UAN).
In this case, the low liquidity of TNH could cause a serious decline in the unit price.
My seasonal target for CF has been reduced from $210 to $196 due to the effects of the natural gas hedge announced today, based on a 7 times multiple of our $28.00 2012 estimated cash flow per share.
Disclosure: I am long CF.
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