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BREAKING- CF Industries Spikes Higher as Dan Loeb Announces Long Position (CF)

Update: The letter said this about CF:

CF Industries is North America’s largest nitrogen fertilizer manufacturer and one of the lowest-cost producers globally. CF currently trades at an unwarranted discount to fertilizer 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 fertilizer 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 fertilizer 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 fertilizer 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. Additionally, when the nitrogen price rises above the “cost floor,” which often happens when demand exceeds supply (2012 average price $408/ton), CF generates cash flows incremental to the stable cash flows discussed above.

Even using a 4x cash flow multiple for this more volatile earnings stream suggests an additional $15 of value per share for every $25 change in nitrogen price above the cost floor. Finally, we believe that executing the remaining $2.25 billion of CF’s share buyback authorization could be ~20% accretive to the estimates detailed above. CF has been underperforming recently despite the emergence of several positive indicators, including reduced Chinese plant operating rates, reports of capacity idling in Eastern Europe, and the shelving of two plant expansions in North America. This underperformance reinforces our view that a dividend strategy based on CF’s stable cash flow stream would lead investors to reassess the company’s valuation.

Shares of CF Industries (NYSE: CF) spiked higher around 2:50 p.m. EDT after it was Dan Loeb revealed in a letter to investors that he had started a new position in the company.

In the letter, he said, that the stock trades at “an unwarranted discount to fertilizer and commodity chemical pees. The letter also recommends that CF pay a “much larger” dividend than its current 0.9 percent yield.

The letter is also said to discuss positions in Sony (NYSE: SNE) and Yahoo (NASDAQ: YHOO).

We will update this story as more information comes available.

[stock-tools exchange="NYSE" symbol="CF" image_height="230" image_width="350"]

Disclosure: At the time of this writing, the author had no position in the company mentioned.

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