CF Industries: Severely Undervalued ESG Play May Yield Hidden Alpha

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Introduction

It's time to discuss CF Industries (NYSE:CF), an ESG leader looking to provide clean energy to feed and fuel the world sustainably. Like many of the non-tech stocks in the recent rally, CF remains ~31% below all-time highs, but this trade bolsters a superior upside potential and low downside risk. CF positions itself great both in the long term and short term due to its innovation in the alternative energy space but also implementing immediate cash-generating activities to keep shareholders fed and happy. We are looking for CF to reach $112.65 due to both its fundamental foundation and technical outlook, with our range reaching as high as $144.

Who Is CF Industries?

CF Industries is the world's largest ammonia producer. Ammonia is being viewed as a source of potential energy in the future due to its hydrogen content, which can be burned for energy without emitting carbon. CF is definitely taking a long-term view on these alternative energy solutions, but in the meantime, they have found how to put that ammonia to other purposes to generate profits now. Ammonia produced by CF is also being directed to fertilizers and emissions control, with hydrogen fertilizers being responsible for 50% of the world's food supply.

International ammonia sales are expected to scale from $71.98 billion in 2021 to $110.93 billion in 2028.

CF has found a way to monetize this product now and in the future which we can see in the numbers that we will go into next.

Financials

As we mentioned the risk to reward on CF is exceptional, they consistently deliver positive economic reporting, consistently beating out expected EPS. EPS currently ranks above $10/share, with it going north of $18 in 2022. The Weighted Average Cost of Capital has maintained around 5% since 2018, with ROIC pushing as high as 40% in 2022 and now coming a bit back to earth at 25%. They are able to provide large returns on their invested capital base which I attribute to their forward-looking outlook and resourceful output.

All of their financials are green, while the market is down and price is still suppressed, the backbone of this company is very strong. EBITDA figures are up $954 million, up almost 2x what they were the quarter prior. If we are incorrect and CF has to endure some harder times before seeing sunlight, they are prepared to do so, their capital structure allows it. Interest coverage is 15.91, with companies that are attempting to push the envelope on innovation we do not often see interest coverage coming in at these numbers. As of March of this year, another leader in the Process Industries Sector gBIOX had an interest coverage of only 3.89.

CF ranks 4th in Process Industries Sector / Chemicals: Agricultural and trades currently at a 6.79 Price To Earnings, comparing that to the 3rd ranking, BIOX trades at 42.98 P/E and 2nd American Vanguard (AVD) trades at 32.02 P/E. Even below rankings such as #6 in the sector, Corteva (CTVA) trades at 40.62 P/E. Needless to say, CF is trading below where it should be and we expect it to catch up to its industry peers to trade at a much higher price-to-earnings ratio.

According to Tony Will, President and Chief Executive Officer, CF Industries Holdings, Inc. Here is his take on the long-term outlook of the company:

"Longer term, forward global energy curves continue to suggest attractive margin opportunities for our cost-advantaged network well into the foreseeable future. As a result, we expect to continue to drive strong cash generation and create long-term shareholder value through disciplined investments in growth opportunities and returning substantial capital to shareholders."

Looking at its financial performance over the past years, especially 2022 into 2023, CF Industries has consistently delivered exceptional results. Their trailing twelve months show net cash from operating activities totaling $3.23 billion, with FCF (free cash flow) of $2.12 billion.

But the enthusiasm doesn't stop there. CF Industries has also displayed its commitment to growth by repurchasing 2 million shares for $130 million during the second quarter of 2023. With such a strong financial foundation and a clear dedication to strategic investments, CF Industries is poised for an exciting and prosperous future, making it an attractive prospect for investors seeking growth potential. For the cherry on top, the Seeking Alpha Rating Summary and Factor Grades are green across the board.

Industry Outlook

Naturally, we are optimists so the idea of green power is exciting. As the R&D of hydrogen-based fuel sources moves forward, innovation continues to prosper. We are seeing multiple car brands selling hydrogen-based cars, for example, the Toyota Mirai or NAMX HUV.

We are even seeing CF looking to power ships with Green Ammonia. CF is in discussions about selling this Green Ammonia which can be used as a fuel source to Mitsubishi Corp who will break it down into hydrogen to use for their transportation sector. The previous arguments regarding Hydrogen as a fuel source were based on large greenhouse emissions, with the new Ammonia extraction process with CF, reduces those greenhouse emissions exponentially. This is shown by CF taking such a large position on their ESG rating at .85 / 1. The first thing you notice on their website is their stance on making sure their approach is environmentally sustainable. According to thyssenkrupp.com, if fertilizers are based on Green Ammonia the carbon footprint per kilo of product is among the lowest of any fertilizer currently on the market. According to the World Energy Outlook, the global demand for energy will continue to rise by 1.3% each year as a result of a growing population, advances in technology, and overall economic growth globally. Fossil fuels are not going anywhere, but renewable energy sources will take the main stage, and according to "Hydrogen Production Technologies: From Fossil Fuels toward Renewable Sources. A Mini Review" that will happen soon. Pedro J. Megía, Arturo J. Vizcaíno, José A. Calles, and Alicia Carrero expect that renewables use and innovation will spike rapidly between 2020-2030 and continue this upward trajectory to overtake petroleum and other liquids by 2045.

While the fuel industry takes over, we know CF has focused its immediate cash generation on hydrogen-based fertilizers. Hydrogen is already being used in all stages of the farming process, such as fertilizers, grain cooling, and drying, as well as being used in farming machinery to reduce carbon emissions and improve overall energy efficiency. If hydrogen use is used already in every stage of the farming process we can only expect this usage to grow. We still by CFs current financials are able to generate a healthy profit with their current extraction process in selling hydrogen-based fertilizers. We believe, even with a healthy skepticism it appears CF will continue to expand its fertilizer business and thrive there while it waits for the hydrogen fuel-based market to expand, and it will be ready to act when that time arrives.

Technicals

From the way we look at things, we need the fundamentals to light the way, but the technicals to tell us when is the right time to enter, what our take profits are, and where our ideology is invalidated and will need to be reevaluated. We prefer to use Elliot Wave Theory as our primary method of technical analysis. We believe EWT provides a framework for human herd-based thinking and showcases clear risk parameters that can be implemented effectively. We then try to combine our Elliot wave theory outlook with other technical analysis tools as you can see in this example we have our Impulse Wave combined with an Inverse Head & Shoulders pattern as well as a clean break or previous support which has flipped into resistance. We then look for confirmation that all of these indicators can be in confluence with one another. CF has some excellent-looking price action, below is a 1 Day chart.

We are looking at a very straightforward corrective pattern off of the all-time highs back in September of 2022. There is a clear Zig-Zag corrective pattern which is exactly what we look for in Elliot Wave Theory to point us to a new impulse wave. To confirm that impulse wave, there is a higher probability of waiting for Wave 1 and 2 to form, which we see may have just occurred.

Entry Thesis & Price Targets

We believe right now is a good entry point on CF, and are targeting a move back to the resistance and 1.618 fib extension of $112.65 all the way to the prior all-time highs of ~$118. We use the Fibonacci extensions as these are ways of measuring an expected move based on previous waves. This 1.618 Fibonacci extension is based on the wave from the June low to the August high. It is worth mentioning that due to the fundamental factors here and the long-term growth perspective, this is just a shorter-term price target that could be hit in the next couple of months. For the higher timeframes, we have a price target of $144, but this could take years as the transition to clean fuel sources takes the main stage. These price targets put us much closer to the industry average Price/Earnings ratios we have discussed earlier, and what we believe to be the true value of CF.

Invalidation Points

For this shorter-term play to be invalidated, we can look for a breakdown of the recent low of $71.80. For the higher timeframe conviction play, there is not necessarily a technical point of invalidation. If the financials start to decline we will reevaluate.

Considerations /Risks

Despite the great technicals and even better fundamentals, no play is guaranteed as we are all aware. We must stay vigilant and respect the price as this market can take us anywhere while there are a number of potential exogenous threats in the world currently. Risks involved in this trade on the technical side involve a rejection of support, invalidation of the H&S pattern, and the invalidation of our Elliott wave theory which was just covered in the paragraph above. There is not a point that we will become bearish here unless the company fundamentals capsize entirely, there are only points in which we would temporarily de-risk our position and wait until the buyers show they are back in charge. As of right now they are, and we believe it will stay that way. If the company abandons its technological advancements or if the industry pivots due to even newer emerging technology, we will have to reevaluate our thesis entirely, but we believe this is very unlikely.

Conclusion

Overall, if CF can continue to expand their current production and can make sure they combats the market's precautionary attitude on carbon emissions in the space we can rest easy. CF is currently partnering with investment firms globally to finance new production methods which should lower their carbon footprint even further. If for some reason the price of CF remains to be suppressed in relation to its peers and underlying financials, we can be ready for an adverse movement. There is a lot of conviction in this play as the framework is very strong and the stock is clearly undervalued. At the time of this writing, OA does not own any shares in CF but plans on accumulating more than 72 hours of publishing as we wait on our technicals to validate this trade.