Should You Buy CF Industries Or OCI? – Seeking Alpha

Introduction

Although fertilizer prices remain relatively weak, I do agree with the assessment of CF Industries' (NYSE:CF) management, which expects things to improve in 2018. This could indicate it's the right time to position yourself into the fertilizer companies in anticipation of higher prices. Whilst most American investors focus on the well-known mammoth companies like CF Industries, Agrium (NYSE:AGU) and Potash Corp. (NYSE:POT), I'd like to highlight one European fertilizer company as well, OCI (OTC:OCINF) (OTCQX:OCINY).

Some readers will remember the name, as CF Industries originally wanted to merge with this company and re-domicile itself in the UK and subsequently the Netherlands, but the deal ultimately fell through and CF Industries had to pay OCI a break fee.

CF Year to Date Price Returns (Daily) data by YCharts. OCI's main listing is on Euronext Amsterdam, where it's trading with OCI as its ticker symbol. The average daily trading volume is in excess of 600,000 shares for a dollar volume of approximately $14M. The current market capitalization is 4.61B EUR.

A brief overview of CF Industries' Q1

CF Industries saw its revenue increase by 3% to $1.04B, but unfortunately, its gross margin and operating income came in substantially lower as the pressure on its margins continued. This shouldn't be a surprise and even the net loss of $23 million (or 10 cents per share) was pretty much expected.

But just as in my previous articles I wrote about CF Industries, you should care more about the company's cash flows rather than the income statement as the depreciation rate ($205M in Q1) is substantially higher than the sustaining capex ($94M) to keep the plant and equipment in good shape.

Source: SEC filings

So whereas the company reported a net loss, its cash flow statements were actually showing a positive free cash flow. The adjusted operating cash flow was $234M, and after deducting the $94M in capex and the $54M distributed to non-controlling interests, the adjusted free cash flow was approximately $86M. Granted, that's still not great, but a FCF/share of $0.37 is definitely better than the net loss of 10 cents per share.

And what's perhaps even more important is the fact that the quarterly dividend was fully covered by the free cash flow in the first quarter. And that has been a while!

OCI only released a 'trading update', but the 2017 outlook is what matters

Dutch companies are only required to file financial reports on a half-year basis, so OCI only released a brief trading update, which actually sounded pretty positive. The utilization rate of its Egyptian urea facilities was approximately 100%, and the sales prices are increasing again compared to Q4.

This bodes well for the company's revenues, and as the new Iowa fertilizer plant has started to produce nitrogen and is the first greenfield factory built in almost three decades, I expect to see a substantial pick-up in the total sales volumes and revenue from the current quarter on, as this is the very first quarter wherein the new Iowa plant will start to contribute to the total result.

Source: OCI press release

Indeed, the company's capital expenditures will drop sharply to just $150-200M from this year on. Even if I would use the upper end of this guidance, OCI's free cash flow will increase tremendously from FY 2017 on, and I think the company will surprise a lot of investors. The recent strength in its share price shouldn't be a surprise, as the market is anticipating a windfall of cash flow in the 2017-2020 era, even at below-average fertilizer prices.

Comparing the metrics based on the 2016 results

Let's now put everything in perspective and compare some of the most important metrics of both companies. As OCI hasn't provided detailed financials after its first quarter, unfortunately, I will have to use the annual results of both companies. All amounts and numbers are in US Dollars.

As you can see, CF Industries scores better than OCI on the net debt/EBITDA metrics as well as the operating cash flow margin. However, I do expect OCI's EBITDA and operating cash flow to increase faster in 2017-2018, as the company has completed its Iowa nitrogen facility and is in the final construction phase of the Natgasoline site (methanol) which should be completed by the end of this year.

On top of that, OCI's board has sanctioned the re-start of the second production line at BioMCN to increase its methanol production even further. This shouldn't be surprising as the methanol price has been booming lately, as you can see in the next image:

Source: OCI Trading update

The 430,000 tonnes of Methanol in Europe will add at least $150M to the revenue, whilst the 875,000 tonnes of methanol produced in Texas at the Natgasoline facility will add an additional $310-340M per year. This means OCI will see its revenue increase by $500M based on these projects alone, and this could push the EBITDA to in excess of $600M (this still excludes the contribution from the new Iowa plant, the higher commodity prices and the lower interest expenses). Throw in the $100M in annual cost savings that has been identified, and OCI is ready to flex its muscles.

Investment thesis

So whilst CF Industries seemed to be scoring better based on the 2016 results, investing is about looking to the future. I'm particularly pleased to see that OCI is now planning to use pretty much its entire free cash flow to reduce its net debt in order to obtain an investment grade rating by 2018-2019. I would expect the net debt to drop below $4B by the end of this year, and to less than $3.5B by the end of 2018.

Considering OCI's cost of debt is really high (it's a non-investment grade issuer) at 5.25% ($242M in interest expenses divided by $4.6B gross debt), reducing the net debt will have a huge impact on its interest bill and free cash flow. A positive snowball effect, that's for sure.

Investing in CF Industries and in OCI isn't a mutually exclusive scenario, and a combination of both companies might cover your needs. CF Industries will act as the dividend payer whilst OCI is focusing on repairing its balance sheet to get an investment grade rating. It still is a pity the merger didn't go through, as the combination of both companies and OCI's renewed investments in Methanol would have resulted in a strong conglomerate.

And before we leave: Consider joining European Small-Cap Ideas to gain exclusive access to actionable research on appealing European-focused investment opportunities, and to the real-time chat function to discuss ideas with similar-minded investors!

Disclosure: I am/we are long CF, AGU, OCINF.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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Should You Buy CF Industries Or OCI? - Seeking Alpha