Learning from hedge funds: CF Industries' 70% outperformance (Part 4 of 7)
CF Industries’ rise
Readers might have noticed in the previous article that CF Industries’ (CF) valuation forward PE (price to next four quarters earnings per share) has come close to what Terra Nitrogen (TNH) and CVR Partners (UAN) have been valued at since 2012 in the market, that is, ~13.5 times. But CF’s dividend yield was still 0.88% as of March 2, 2014. So what were the catalysts behind CF Industries’ ~70% outperformance over TNH and UAN since June 30, 2013?
CF Industries first got a boost of 9% at the end of July 2013 when Third Point disclosed its sizable position in the company, pointing out that the management should boost dividends. Shares pulled back for a few days thereafter.
When the time is right
When the company’s second quarter earnings was released on August 6, 2013, one analyst inquired whether CF Industries will increase payouts in the coming quarters. The management said it regularly discusses the best methods of returning cash to shareholders with the board. And that it would be open to reexamining the capital returns “when good ideas are presented.”
Undervalued share price
Management didn’t want to return cash to investors in the form of dividends because it believed CF Industries was highly undervalued. A reminder that CF Industries was trading at close to 50% discount relative to Terra Nitrogen and CVR Partners in the past based on forward PE multiple. On August 6, 2013, CF Industries’ forward PE stood at 8.79. It was an improvement from 7.35 on June 30, 2013, but it still had much to go.
Shares marched higher
While CF Industries’ shares didn’t rise much after the earnings release, its shares continued to climb up over the medium term. This was perhaps on expectation that the management will eventually pay dividends in the future. As long as the valuation continued to rise, the market expected an eventual increase in the dividends, as it became more attractive to return capital to shareholders in the form of dividends as opposed to share buybacks.
(Expectation of) dividend increase
Shares got a little boost of ~3% when the company said it was going to increase dividends by 150%. It wasn’t really a lot since CF Industries paid close to zero dividends before, but it was moving in the right direction. Plus, it might have been the management’s cue that it will eventually increase dividends in the future. CF Industries also jumped ~10% in December when it said it might even consider offloading some assets into a limited partnership to benefit from tax, which increases the prospects of higher dividends.
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