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Coverage Initiation: CVR Partners (UAN)
Value Line has initiated coverage of CVR Partners (UAN), a Limited Partnership that produces nitrogen fertilizer. An important distinction between this company and others is that it’s structured as a limited partnership. As a limited partnership, unit holders receive distributions that have certain tax advantages, including the ability to individually benefit from depletion and depreciation to shield distributions from taxation. That said, the tax structure that allows for this often results in complicated tax preparation requirements. It might be advisable to consult a tax professional before making a commitment to a limited partnership to ensure a better understanding of the ramifications of ownership.
CVR Partners was formed in mid-2007 by CVR Energy (CVI) to own and operate its nitrogen fertilizer business. A portion of CVR Partners units were sold to the public in the first half of 2010. CVR Partners’ facility is located adjacent to CVR Energy's refinery in Coffeyville, Kansas. This is beneficial for both companies. One gets easy access to an integral ingredient (natural gas) and the other has a loyal customer that is, literally, right next door.
Note, however, that CVR Energy controls CVR Partners because it owns over 70% of the limited partnership units and is the general partner (the entity that actually runs day-to-day operations). The close relationship could pose risks to CVR Partners unit holders, but, since CVR Energy owns a material amount of the same units, what is good for it will also likely be good for other unit holders. As with any situation in which two interdependent companies are controlled by one of the two firms, this is an issue to monitor.
CVR Partners utilizes a petroleum coke, or pet coke, gasification process to produce nitrogen fertilizer. The facility includes a 1,225 ton-per-day ammonia unit, a 2,025 ton-per-day urea ammonium nitrate (UAN) unit, and a “gasifier complex” with a capacity of 84 million standard cubic feet per day. The partnership upgrades a majority of the ammonia it produces to higher margined UAN fertilizer, an aqueous solution of urea and ammonium nitrate that management notes has historically commanded a premium price over ammonia.
One of the primary differences between CVR Partners and other fertilizer producers is that it uses pet coke, which is produced during the crude oil refining process. Most other companies use natural gas as their primary input. Management is quick to point out that pet coke has historically been less expensive than natural gas on a per ton of fertilizer produced basis and that pet coke prices have been more stable than natural gas prices. The partnership believes that its nitrogen fertilizer business is the lowest cost producer and marketer of ammonia and UAN fertilizers in North America. This is clearly a benefit, but one that relies on historical trends continuing into the future—CVR Partners would be at a competitive disadvantage if producing fertilizer with natural gas became cheaper than its process.
Upon completion of its initial public offering, the partnership began the process of expanding its capacity by up to 50% by early-to-mid-2013. This provides the potential for increased revenues since it will have more product to sell. Still, this upgrade increases risk somewhat because the partnership is updating its sole existing facility. The impact could be material if anything were to happen to this one property. Having just one facility also increases the risk of a supply shock from other significant input suppliers, such as the adjacent company that provides oxygen, nitrogen and compressed dry air to CVR Partners’ facility. Should anything happen to a major supplier, the partnerships’ facility would likely be affected.
CVR Partners is also subject to various regulations that can affected its business. These include controls on the substances it produces, the byproducts of its production processes, its production processes themselves, and the safety of its employees. Changes in any of the regulations to which it is subject could have a material impact on operating results.
Longer-term the partnership appears poised to benefit from the expected growth in demand for fertilizers driven by the growing populations and increasing wealth in many of the developing nations of the world. As a pure play nitrogen provider, CVR Partners believes it has a higher growth profile than many of its more diversified competitors because nitrogen is a primary determinant of crop yield. Moreover, nitrogen fertilizer production is a higher margined business with more stable demand compared to the production of the two other essential crop nutrients, potassium and phosphate, because nitrogen must be reapplied annually.
As noted above, one of the benefits of the limited partnership structure is that it is a pass-through entity that allows unit holders to receive often-material distributions. Many limited partnerships pay stable dividends, often with a contractual floor. This is not the case for CVR Partners, which intends to pay out substantially all of the cash it generates each quarter. As such, distributions are likely to be volatile from quarter to quarter (farming is an inherently cyclical business) and may be volatile from year to year, as well. This is particularly true because prices in this industry have a history of being cyclical—even though there appears to be a long-term demand trend presently taking shape, income-oriented investors should carefully consider the potential for distribution volatility before making an investment.
Paying out so much of the partnerships cashflow will also limit its ability to grow its business via acquisition. As such, secondary offerings of shares or the sale of additional debt will likely be used to finance such strategic initiatives. Such security sales could have a negative effect on current unit holders if the acquisitions do not generate the expected returns. Looking at this from a different perspective, however, the need to sell additional securities to fund acquisitions can provide a check and balance on management which must, essentially, get a vote of confidence from investors in order to fund its growth strategy.
Subscribers interested in this pure play fertilizer partnership can monitor Value Line’s quarterly reports in The Value Line Investment Survey, while keeping an eye out for Supplemental reports covering late-breaking news.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.