Each industry carries its original KPI (key performance indicator), where real estate investors may worry about vacancy and cap rates. Agricultural stock investors may find answers to the current crop cycle by looking at the global stocks-to-use ratio. CF Industries (NYSE: CF) reported its first quarter 2023 earnings Monday after the markets closed and, within its presentation, stated management readings for the critical agricultural indicator.
CF management stated that the stocks-to-use ratio stood near 10% for the first quarter, reaching the cyclical low last seen in 2013. A low ratio may indicate that demand is outpacing supply and current production, thus the need to produce more crops and harvest enough inventory in time to bring this ratio to the cyclical highs of 14-16% seen in 2017.
Connecting the Dots
CF chart shows that the stock had hit a low price of $21.50 in the second half of 2016 when the stock-to-use ratio was at its 14-16% cyclical high reading, subsequently when the ratio lowered into today's 10%, CF stock rose by a monstrous 456% in the second half of 2022 just six years later. Looking further back, the last time this ratio reached 10% was in 2013 when, thereafter, a rising stock-to-use ratio benefited stockholders by advancing CF stock by 110% to its 2015 high of $70.
Fundamentally, CF financials point to a revenue slowdown and margin compression during the 2013-2015 ratio expansion period. Considering that CF revenues rose by 71.1% for 2022 and subsequently suffered a 29.8% decline in the 12 months of the first quarter of 2022, history will likely repeat itself in this second rising cycle for the stocks-to-use ratio.
As gross margins fell from 59.2% in 2022 to 42.9% in 2023, earnings per share also suffered an alarming 32% decline to end the first quarter of 2023 at $2.84 per share. Perhaps some investors familiar with this cycle kept the stock from moving after earnings, as the price remained flat once the closing bell rang.
Looking further into the press release details for CF's earnings, the declines in revenue came from a suppressed price of nitrogen in the open market, coupled with lower volumes for some of their products, like ammonium nitrate. First, a quick agriculture lesson, granular urea is typically used in the pre-seeding stage of farming, whereas ammonium nitrate is generally used in the post-seeding setting when the crop has emerged. This is important to know because volumes of granular urea rose by 227 tons in the first quarter, whereas ammonium nitrate volumes fell by 54 tons.
The volume divergence between the pre-seed and post-seed chemicals speaks to where the customer demand stems. For example, rising pre-seed granular urea volumes indicate the need to increase crop production to normalize the compressed stocks-to-use ratio; however, when these seedings emerge as crops, there will be a massive demand for ammonium nitrate from CF.
Surfing Waves, Catching bigger ones
As volumes rose for granular urea, it becomes easier to understand how such action will help to normalize the stocks-to-use ratio. Knowing the nature of the cycle and what stage comes next, management finished the acquisition of the Waggaman Ammonia production facility from Incitec Pivot Limited in March. This acquisition will supply an additional 200,000 tons of ammonia per year for CF, accruing its current volumes of 652 tons. Only an aggressive demand expectation could be held accountable for looking to increase volumes by at least twice the magnitude, and the stocks-to-use ratio agrees; as the seeding takes place with granular urea, there will be a ton of demand for ammonium nitrate products.
Despite some warning signs of a cyclical slowdown looking to rhyme its history, management has shown investors reason to believe that the ammonium nitrate demand and increased capacity would be enough to consider this stock cheap. Thirteen million shares were repurchased from the open market during 2022 and the first quarter of 2023, which makes sense considering that CF currently holds a book value per share of $41.09.
What can motivate investors who may worry about the inevitable cycle is the relationship between price and book value during these swings. In the 2013-2015 period, where nitrogen demand - and prices - fell and thus hurt CF margins and volumes, book value traded at a 3.5x to 4.0x multiple, while 2013 saw a 2.0x to a 2.5x multiple. What this means for investors is that, as the ratio approaches 2013 levels, so is the P/B multiple falling even lower to 1.75x. A bearish breach of the P/B multiple is coupled with CF dividend yields reaching the upper historical levels, implying that undervaluation may be present soon.