2023-10-25 13:59:05 ET
Summary
- FMC Corporation and Archer-Daniels-Midland have faced challenges or caused investor concern in the agriculture sector, spreading concern to CF Industries.
- CF Industries' focused business model and low-cost nitrogen production give it a competitive edge and resilience in the market.
- I believe CF Industries is expected to report strong Q3 results, highlighting its advantages in the global nitrogen fertilizer industry.
Investment Thesis
Despite challenges at agriculture peers like FMC Corporation (FMC) and the poor equity price performance from Archer-Daniels-Midland (ADM) after earnings, I expect CF Industries (CF) to report strong Q3 results showcasing its structural advantages in the global nitrogen fertilizer industry. I think this stock is a long-term buy and hold. The market is overly pessimistic about this firm given the agricultural environment.
Recent Struggles in Agriculture
On October 23 , FMC Corporation spooked investors by slashing its Q3 guidance primarily due to lower sales volumes in Latin America. FMC now expects Q3 revenue of just $982 million, compared to estimates of $1.2 billion, with adjusted EPS of $0.44 compared to estimates of $1.01. The company cited substantially lower sales volumes in Latin America, particularly destocking in Brazil as well as drought in Argentina.
FMC also reduced its full-year 2023 outlook , forecasting revenue of $4.48-$4.72 billion, well below estimates of $5.54 billion. In response to the weak near-term demand environment, FMC announced restructuring actions in Brazil and a comprehensive review of its total cost structure.
The negative update sent FMC shares plunging over 15% in two days. The selling pressure also spread to agriculture peer CF Industries, with its stock falling over 3% on October 23 in sympathy with FMC's slide. Investors are clearly concerned that FMC's challenges in Latin America could be an industry-wide issue.
Similarly, on October 24, Archer-Daniels-Midland, a grain trader and another bellwether in the agriculture commodities market, reported Q3 adjusted EPS of $1.63, beating expectations by $0.09. However, revenues of $21.7 billion missed forecasts by nearly $2 billion . ADM highlighted good performance in its Carbohydrate Solutions segment, aided by strong ethanol demand and margins. But it lagged due to lower volumes of plant-based proteins .
For Q4, ADM actually raised its full-year EPS guidance to $7.00, reflecting outperformance in segments like Carb Solutions. ADM's results showcase the variable demand environment across agriculture with some parts (carbohydrates) doing better while plant-based proteins are slower. These earnings weren't even that bad overall, but the market punished them (and other agriculture stocks) with ADM dropping over 4% on Tuesday.
CF Industries' Structural Advantages
While FMC and ADM are navigating through a complex macro environment, CF Industries' focused business model centered on low-cost nitrogen production sets it up better to maintain strong results.
CF generates over 82% of revenue in its core North American Markets ( 2022 10K ). Its concentration in reliable North American markets (where natural gas prices are lower for Nitrogen fertilizers) provides resilience amid shifting global fertilizer demand and a cost advantage that allows them more sustainable profits. In contrast, FMC and ADM have greater emerging market exposure that introduces volatility both from a currency perspective and from a local raw input cost perspective.
As a low-cost nitrogen fertilizer producer, CF enjoys a significant production cost advantage compared to marginal producers in Europe and Asia. Its North American manufacturing network benefits from abundant low-cost natural gas. This cost position buffers CF's profitability from margin compression affecting higher cost rivals. This is already affecting European producers like Yara, who are cutting production due to poor spreads between natural gas and fertilizer prices.
CF focuses intensively on selling nitrogen-based fertilizer products including anhydrous ammonia, urea, and UAN solutions ( 2022 10K ). Nitrogen is an essential crop nutrient facing relatively inelastic agricultural demand. FMC and ADM sell diversified portfolios including crop chemicals that are (I believe in this market) more vulnerable to temporary demand swings. Nitrogen fertilizer will basically always be needed in the growing cycle, it's just a question of how much. Below is a farmer fertilizer affordability graph from CF's competitor Mosaic (MOS) from May of this year. I believe farmer economics stayed favorable over the summer, allowing for strong fertilizer purchasing volumes. The natural gas price advantage should allow profits to stay robust.
Mosaic Farmer Profitability Graph May 2023 (Mosaic)
Q3 Earnings Outlook
Heading into CF's Q3 results, the street expects the company to deliver adjusted EPS of $1.01, and sales of $1.31 billion. Sales should remain healthy and profit margins strong as the El Nino effect over the summer gave farmers ample reason to use fertilizer to grow their crops and have good margins with the weather event "typically being a good thing" for North American farmers when it occurs (where CF primarily sells to).
Any positive demand signals from CF around improving affordability, forward order activity, and firm farmer economics would further support my thesis on the company's leverage to further nitrogen demand recovery. Strong Q3 results would reinforce CF's superior positioning in the global fertilizer industry. Given they also have strong buy-back plans I'm excited to see management give more cash back to shareholders.
While broader agriculture faces near-term uncertainty, CF Industries enters earnings season poised to showcase its structural cost and market advantages. I remain bullish on CF's ability to drive strong results in 2023 and beyond. I think this is a long-term buy and hold.
For further details see:
CF Industries Q3 Preview: Ignore The FMC Weakness