Today, Pat McKeough responds to a question from a member of his Inner Circle about astock in the fertilizer industry. Converting relatively cheap natural gas into fertilizer has become increasingly profitable, and CF Industries is making strides in this field, expanding aggressively through acquisitions and joint ventures. But while CF has established itself as a growing dividend stock, Pat prefers a Canadian stock that supplements its fertilizer production with a successful chain of retail stores.

Q: Pat: What are your thoughts on CF Industries?

A: CF Industries Holdings Inc. (symbol CF on New York; www.cfindustries.com) makes nitrogen-based fertilizers from natural gas.

The company has six plants: four in the U.S. and two in Canada. It also owns 75.3% of Terra Nitrogen, which makes nitrogen fertilizers at an Oklahoma facility, and operates fertilizer plants in the U.K. and Trinidad through joint ventures.

In March 2014, CF sold its phosphate mining and manufacturing operations to Mosaic Co., symbol MOS on New York, for $1.4 billion. That’s the main reason why its revenue declined 15.8% in the three months ended March 31, 2015, to $953.6 million from $1.1 billion a year earlier.

Earnings fell 62.9%, to $0.96 from $2.58 (all per-share amounts adjusted for a 5-for-1 stock split in June 2015). Excluding unusual items, such as a gain on the sale of the phosphate business, per-share profits were unchanged at $0.97.

CF recently agreed to pay $580 million for the 50% of a U.K.-based joint venture that it doesn’t already own. The deal will close later this year. This business accounts for 40% of the U.K.’s fertilizer market.

The company can easily afford to keep expanding. As of March 31, 2015, it held cash of $1.8 billion, or $7.55 a share. Its long-term debt of $4.6 billion is a moderate 33% of its market cap.

Shares rise on merger speculation, fall on regulatory concerns

CF’s shares jumped 10% recently on speculation that it’s planning to merge with Netherlands-based fertilizer producer OCI NV, which has a $6.2-billion market cap. The combined firm could be based in the Netherlands, which would let it take advantage of that country’s lower corporate tax rate.

In October 2014, CF ended discussions with Norway’s Yara International ASA about a merger that would have created the world’s largest maker of nitrogen-based fertilizer.

The shares have moved back down since the price jump, likely because a merger would face regulatory hurdles and political opposition. As well, the U.S. government recently changed the rules on tax-inversion deal like this, making it harder for the foreign parent company to shift funds between subsidiaries.

The stock trades at 13.7 times this year’s forecast earnings of $4.25 a share. It yields 2.1%.

Inner Circle recommendation: HOLD.

Note that for new buying of a fertilizer stock, we prefer Agrium, (symbol AGU on Toronto; www.agrium.com), a recommendation of our Successful Investor newsletter.

Agrium gets 75% of its sales and 60% of its earnings from its retail stores, which include 1,450 locations in North America, South America and Australia. These outlets sell seed, fertilizer and other products to farmers.

The remaining 25% of sales and 40% of earnings come from making nitrogen-based fertilizers from natural gas. The company also operates potash and phosphate fertilizer mines. Here is a major report we did on Agrium earlier this year: Retail sales make Agrium the top performer among Canadian potash stocks

Recommendation in The Successful Investor: BUY