CF Industries stock leaves competitors in the dust

Key Points

• The agricultural industry is at a cyclical low, but there are signs that it is on a path to turning back around.
• Analysts could quickly realize that CF Industries is the best stock to consider for the space; markets seem ahead of the curb this time.
• No competitor comes close to how markets reward CF in its valuations, and there's a reason why.

When picking the right stocks for your portfolio, you can follow market price action or gauge a stock's current valuation against competitors in the same sector. But how do you pick the right one out of all industries?

You can shamelessly copy what the big players do. Names like The Goldman Sachs Group NYSE: GS have been in business for over a century, bringing increasing profits from their trading activities. 

How do these traders pick where they will place their bets? Typically, it starts with a process called "top-down" analysis. 

Now that the Federal Reserve (the Fed) will cut interest rates by the second half of 2024, markets are preparing to embark on a money shift to take advantage of the changes the new policy will bring. The fertilizer chemicals industry could soon be one of the hottest for reasons. CF Industries NYSE: CF quickly becomes a price suspect for this new breakout.

Focus on what matters

To land on the best industry and put the odds in your favor, you must get there before the rest of the market realizes where the party is. Regarding the manufacturing sector, which includes industrial names like chemicals and fertilizers, the party hasn't quite begun, but it's starting.

Understanding why these industries may be the place to look into is easier said than done. Still, you can start by following the trends in the ISM manufacturing PMI reports. Over the past quarter, the chemical and agricultural sectors have shown signs of contraction until they broke out in an explosive expansion last month.

The story doesn't end there because Goldman Sachs analysts expect a breakout in the broader manufacturing sector of the U.S. economy; you can rest assured that big money is waiting on the sidelines to get into the best stocks. You can read more about their opinion in this 2024 macro outlook report.

When the Fed lowers interest rates, the strength of the dollar (which follows the level of interest rates) could also come down. A weaker dollar could make American exports (such as crops) more attractive to foreign nations, which is where CF Industries comes in.

According to their third quarter 2023 earnings presentation, The Mosaic Company NYSE: MOS reports that the current stocks-to-use ratio, a measure of where the supply and demand trends lie in the agricultural space, is at a cyclical low. In other words, there is too much inventory and insufficient demand.

Now, that can place a significant headwind on profitability for these companies. Still, as you now know, the cycle could quickly turn around, especially now that the big guys are broadcasting their interest in a sector breakout. Consider looking now, as the industry can potentially continue to expand on its newfound expansion.

Why CF?

What could make you land on CF stock rather than other names? Remember the two factors of price action and market pricing above? Here is what they say about CF.

While competitors like Mosaic and Scotts Miracle-Gro Company NYSE: SMG trade at 52% and 63% of their 52-week highs, CF stock has traded at an industry-leading 86% of its 52-week high price. There must be a reason markets are willing to drive the price up like this.

Scotts Miracle-Gro stock jumped roughly four points when they announced their quarterly earnings a couple of weeks ago; that's a pop of roughly 7.4%. As this company provides chemicals and fertilizers similar to CF, its earnings can also foreshadow what could await CF shareholders in their upcoming earnings announcement.

While analysts think that both Mosaic and CF will see earnings per share contractions of 13.5% and 18.7%, respectively, markets are starting to bet that these projections could bump up to reflect incoming growth. At least, that's the case for CF.

The chemicals and fertilizers industry trades at an average forward P/E of 10.6x and an average P/B ratio of 1.0x. Mosaic brings a slight discount to both these measures, a 3% for P/E and a 16% for P/B. Remember the saying, "It must be cheap for a reason," your portfolio shouldn't stick around to find the reason.

CF stock commands a premium valuation on these measures to differ from Mosaic. A 13.5x forward P/E represents a 28% premium to the industry, its 1.8x P/B a massive 78% premium, and the opposite saying, "It must be expensive for a reason," also applies here.

That reason could vary with the coming crop demands. Still, knowing what you know now, it's easier to expect a decent rally in this stock, considering that it aligns with the story for a breakout in the sector.