The Long and Short
CF Industries debt should tighten to peers
Meredith Contente | March 31, 2023
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
CF Industries (CF) debt spreads now stand at the wides for the year, and its curve has steepened relative to peer The Mosaic Company (MOS: Baa2/BBB/BBB-(p)), despite better margins at CF and a similar credit profile. CF long bonds have widened from trading 15 bp behind MOS to roughly 30 bp back. The company’s recently announced acquisition should not affect leverage and will likely provide some immediate synergies post close, so CF spreads have the potential to collapse closer to MOS. Furthermore, MOS has refinancing needs later this year, and new issue concessions could pressure secondary spreads while CF has no refinancing needs until 2026.
CF and other North American fertilizer producers stand to benefit from increased demand as crop inventories—particularly grain—continue to hover around multi-year lows. But CF (Baa3/BBB/BBB) remains in favorable position given its geographic advantage and low-cost production assets. While growth will come off considerably from the record posted in 2022, margins and free cash flow will continue to trend above pre-pandemic levels. Furthermore, the company’s recent acquisition announcement will be funded with cash on hand, demonstrating management’s conservative financial policies while supporting its strategic focus on clean energy sources. CF’s credit profile remains strong for the current ratings with leverage expected to remain below a turn in fiscal 2023.
Exhibit 1. CF Curve vs. BBB Comps
Credit and Margin Profile Remain Very Strong for Ratings
After posting a record year in fiscal 2022, CF’s credit profile is expected to remain strong as management took advantage of robust free cash flow generation to repay debt and build cash on the balance sheet. CF ended fiscal 2022 with total debt of $2.97 billion, a decline of nearly $1.0 billion since year-end 2020. That said, CF ended the year with total leverage of 0.5x. Given the strong cash position, which totaled $2.3 billion at year-end, net leverage was 0.1x. This compares to gross and net leverage of 0.6x and 0.5x, respectively at MOS, its closest US fertilizer peer. Albemarle Corporation’s (ALB – Baa3/BBB/BBB) credit profile is slightly weaker, as it ended the year with gross leverage of roughly 1.0x and net leverage of 0.5x.
CF also boasts the largest margins relative to US peers with an adjusted EBITDA margin of 55.8% for fiscal 2022, which is over 23 points higher than MOS’ adjusted EBITDA margin of 32.4% and 730 bp higher than ALB. CF’s margin benefits from its low-cost production assets, which are located across the US Corn Belt and its access to natural gas. Natural gas accounts for approximately 85% of the cost of in producing ammonia which is the base product that CF manufactures and is used in nitrogen fertilizers.
Exhibit 2. CF Financial/Credit Profile Comparison
Cash Funded Acquisition Demonstrates Conservative Financial Policies
CF announced on March 20, 2023, that it has signed a definitive purchase agreement with Incitec Pivot Limited (IPL) for its ammonia production complex located in Louisiana. Under the terms of the agreement, CF will purchase the facility and related assets for $1.675 billion, with $425 million of the purchase price allocated to a long-term ammonia offtake agreement with a subsidiary of IPL. That said, CF will need to fund the remaining $1.25 billion of the purchase price, which it plans to do from cash on hand. The deal has been approved by the boards of directors of both companies and is subject to regulatory approvals. No time frame has been given for the close of the transaction.
The use of cash to fund the acquisition underscores management’s prudent financial policies and its commitment to maintaining lower levels of leverage through the cycle. While EBITDA is expected to contract this year across the industry, CF is estimated to maintain gross leverage below a turn. CF recently authorized a $3 billion share repurchase program through 2025, however management noted that it plans to repurchase roughly $175 million of shares per quarter. Any further share repurchases will be done opportunistically with excess free cash after reinvestment in the business. This allows for CF to continue to focus on investing in green projects and making acquisitions that fit its strategic focus of low-carbon ammonia production. Management plans on implementing CCS (carbon capture and sequestration) technologies on an accelerated basis at the IPL facility, post close. This will increase CF’s low-carbon ammonia production capabilities while earning tax credits and supporting the country’s climate goals.
Recent Upgrade to BBB
S&P upgraded CF to BBB in October 2022 noting that financial policies are appropriate for the new ratings category. While credit metrics are currently much stronger than the threshold for the ratings, S&P noted that the considerable volatility associated with the nitrogen fertilizer sector constrains the ratings. The stable outlook reflects S&Ps view that nitrogen fertilizer pricing will continue to trend above historical levels through 2024, supporting strong cash flow growth at CF and stable credit metrics. While the rating and outlook do not take into account any large M&A transactions, the use of cash to fund the IPL transaction is important for the current rating. Furthermore, management has explicitly stated that they remain committed to maintaining Investment Grade ratings through the cycle. Liquidity remains strong, even after the close of the acquisition, as CF will have at least $1.0 billion of cash on hand and an untapped $750 million credit facility. While the credit facility is secured, it is anticipated that CF will negotiate a new unsecured line of credit when the revolver comes due in 2024, given the full Investment Grade ratings.