Both companies are big producers of nitrogen fertilizer--CF in North America and Yara more globally, but with a European focus.
The global nitrogen cost curve has shifted in recent years with the North American shale gas revolution. Producers close to cheap U.S. natural gas, the primary nitrogen feedstock, now sit at the low end of the cost curve. As a result, CF has enjoyed robust margins over the past couple years, while Yara's have languished. Yara has been looking to add capacity in regions with lower gas costs, and this merger would represent a significant move down the cost curve for Yara. For CF, it would be the opposite.
We caution that regional gas dynamics are likely to fluctuate, which is why we are hesitant to award CF a narrow economic moat rating, despite its current enviable cost position. Our no-moat rating for CF is unlikely to change if this deal happens.
We think CF Industries is overvalued. The market is probably factoring in lower long-term natural gas prices in North America than our forecast of $5.40/mmBtu. Additionally, we have a bearish outlook for the price of Chinese coal, which represents the top end of the urea industry cost curve. Our fair value estimate for CF is unchanged.
