OCI is the world’s 4th largest producer of nitrogen products after Yara, CF Industries and Potash Corp. The nitrogen market (urea is the most common nitrogen product) is currently facing a cyclical low. Prices crashed over the last 4 years and are set to recover going forward as the market tightens. OCI invested heavily and added substantial capacity over the last few years and its capacity has increased by 50% from 2015 to 2018E, but it has not seen the benefit of this as its share price has collapsed by 50% since 2014 as nitrogen/urea prices have collapsed. Global urea prices fell from $450 to around $210 year to date and I forecast them to recover to $300 by 2020. Because of the increased operating and financial leverage, OCI’s EBITDA will expand from $750m in 2017E to $2,058 by 2019E. OCI will already have a 10% FCF Yield in 2017, rising to 37% in 2019. On a 7.0x multiple in 2019, this will result in a 2 year target price for OCI for 2019 of €49.1, from €20.1 currently, a return of 144%.
Nitrogen (N) is a fundamental building block of plant proteins that improve crop yield and quality. It is also essential for proper animal nutrition and maturation. Synthesized from natural gas or coal, ammonia (NH3) is a concentrated source of nitrogen and the basic feedstock for all upgraded nitrogen products. It is also used to make industrial products and as a direct-application fertilizer.
The most commonly used nitrogen fertilizer is urea, which is also the feedstock for industrial products such as plastics, resins, adhesives and increasingly for emissions control. Liquid forms of urea and ammonium nitrate are combined into UAN solution, which is used in agriculture. Urea is also the only form that’s traded globally and hence sets the price for other nitrogen fertilizers as well.
Most of the urea globally is produced and consumed locally, with the largest production and consumption in China. China has rapidly expanded capacity over the last decade and has been a net exporter over the last few years. Meanwhile US, Europe and India are all net importers of urea with the Middle East being the biggest exporting region.
While the rest of the world uses natural gas to produce urea, China has been producing urea from coal. The price of the fuel can represent more than half the cash costs of urea production, and the global cost curve is effectively based on fuel costs in the respective regions, with Middle East and US shale based natural gas being the lowest cost, while Russian urea has to incur significant freight costs despite also having a low fuel cost advantage. Chinese coal based urea represents the high end of the cost curve. Hence the marginal cost of urea in the market was being set by the Chinese coal price. The coal used for urea production in China is a mix of anthracite coal and thermal coal. Since the US market is a net importer of urea, and local production is much cheaper than the global marginal producer (coal based Chinese players), the local US price is set by the import price and hence global prices, and the local producers can benefit from the higher profits.