CF Industries Holdings

CF Industries reported strong second-quarter results, with adjusted EBITDA of $1.2 billion coming in below FactSet consensus estimates of $1.4 billion.

Why it matters: CF shares were down 1% at the time of writing on Aug. 6 as the market reacted to CF's results. Management does not provide annual guidance, so the market tends to react to the most recent results combined with current nitrogen prices. Higher nitrogen prices were driven by the Middle-East-conflict-related supply shock to both nitrogen and natural gas prices in Europe and Asia. Natural gas is the feedstock to produce nitrogen in most of the world. Nitrogen prices peaked in April before falling substantially over the following three months, based on World Bank data. We expect prices will continue to remain above preconflict levels into 2027, as we do not see global supply fully recovering in the near term.

The bottom line: We maintain our $140 fair value estimate for narrow-moat CF Industries as we updated our cost forecast for two changes that largely offset one another. Our long-term nitrogen price forecast is unchanged. CF is implementing cost reduction initiatives, which should boost the company's midcycle profits from higher capacity utilization and lower overhead costs. Separately, we updated our US natural gas input cost forecast to a midcycle level of $3.70 per million British thermal units from $3.30. We view CF shares as undervalued, with the stock trading over 15% below our fair value estimate. We maintain our Exemplary Capital Allocation Rating. Management continues to invest in share repurchases, which we view as value-accretive since the stock trades below our fair value estimate.

We maintain our CF fair value estimate of $140 following the company's second-quarter earnings. We assume a weighted average cost of capital of around 8%.

Our long-term price forecast is based on the marginal cost of urea production. Historically, Chinese coal-based or European natural gas-based nitrogen producers have been the marginal-cost players, and we expect this to remain the case. As farmer demand remains strong, we expect nitrogen prices to rise. In the longer term, European natural gas prices are expected to stabilize and fall to our midcycle assumptions, setting the marginal cost of urea production at $375 per metric ton in 2026 real terms.

In 2026, we forecast urea prices will average $600 per metric ton, over 40% higher than 2025. This is in line with the average through the first seven months of the year based on World Bank data. Prices likely peaked in the early second quarter but have been moderating since as the Middle East supply shock begins to alleviate. Over the long term, CF’s unit costs should remain low relative to other producers globally as natural gas prices fall to our midcycle forecast of $3.70 per million British thermal units (Henry Hub) in 2026 real terms. Based on our price and cost forecasts, we expect CF to produce average operating margins in the high-20% range in a midcycle environment, well above the 4% generated in 2016 but below the 48% margin generated in 2022.

We also assume CF expands its blue and green ammonia production over the next decade to over 15% of the total output, which includes the greenfield ammonia project joint venture with JERA and Mitsui, where CF will own 40%. We assume the joint venture project begins construction this year and enters production by 2029, in line with management's timeline. We assume CF is able to capture a premium for this carbon-free ammonia, thereby boosting its profits.

Given the wide range of long-term nitrogen prices, we have created additional valuation scenarios. In an upside case, we assume nitrogen prices stay higher for longer as strong demand growth requires higher-cost supply to enter production. In this scenario, our fair value estimate would rise to $200 per share.

In a downside case, we assume nitrogen prices rapidly fall and remain below our base-case midcycle forecast amid weakening demand as new GM seed and biological technologies sharply reduce the amount of nitrogen fertilizer required. We also see persistent oversupply in this scenario. Our fair value estimate would fall to $70 per share.

We award a narrow economic moat rating to CF Industries due to the company's cost-advantaged nitrogen production.

For nitrogen producers, feedstock cost is the most important determinant of a producer’s cost position. Nitrogen is generally made from natural gas, with some Chinese producers also using anthracite coal. Globally, the lowest-cost natural gas has been produced in North America and the Middle East. In response to the Middle East conflict, some natural gas and nitrogen fertilizer production in the Middle East has been temporarily shut down, temporarily steepening the global nitrogen cost curve.

In recent years, natural gas prices have risen in Europe as the EU works to reduce its reliance on Russian natural gas, a trend we expect will continue under midcycle conditions. For nitrogen production, European producers are generally the marginal-cost producers due to a higher natural gas cost. Given our outlook for European natural gas prices to remain well above North American natural gas prices, we think this steepening of the cost curve will result in higher midcycle nitrogen prices, which should benefit low-cost North American producers, including CF.

Over 90% of CF's nitrogen is produced using low-cost North American natural gas, which provides the company with a strong cost-advantaged nitrogen operation. Additionally, the company’s plants allow it to produce multiple nitrogen products; this allows CF to change its production based on demand and price differentials of the various nitrogen fertilizers, versus peers that are only able to make ammonia or urea. Regardless, CF’s position at the low end of the global nitrogen cost curve is ultimately the largest driver, in our view, of its durable cost advantage. As a result of higher midcycle nitrogen prices, we are confident that CF is more likely than not to generate excess returns on invested capital through a cycle and for at least the next decade.

High shipping and storage costs for importers of nitrogen fertilizer limit the competition CF faces in North American markets from outside regions with low natural gas costs.

Using low-cost US natural gas as a feedstock, CF's nitrogen operations currently sit at the low end of the global nitrogen cost curve.

CF's investments in blue and green ammonia will create value for shareholders as demand for these premium-priced products grows.

Soybeans, which do not require nitrogen fertilizer, have seen a growing share of planted acres in North America, hurting nitrogen fertilizer demand.

In nitrogen, CF competes with many companies that are state-owned or government-subsidized. Government-controlled firms are more likely to produce quantities in excess of demand, disrupting supply/demand balances.

CF's investments in blue and green ammonia will destroy value for shareholders if demand for these products fails to materialize or if the greenfield project runs into cost overruns.