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From the Small and Mid-Cap Edition: Terra Nitrogen Company, L.P.
Terra Nitrogen Company, L.P. (TNH) is a master limited partnership that produces nitrogen-based fertilizer at one large plant in Verdigris, OK. Formerly controlled by Terra Industries, Inc., the company was acquired by CF Industries (CF) in April 2010 when CF bought Terra Industries. CF owns 75.3% of Terra Nitrogen’s common units and manages the partnership, which has no employees of its own. CF is the largest producer of nitrogen fertilizers in North America and the second-biggest worldwide.
Terra Nitrogen produces anhydrous ammonia (ammonia) and urea ammonium nitrate solutions. Both products are used primarily to improve the yield and quality of crops. Although they are often interchangeable, each has specific attributes, and farmers’ choices vary according to the crop, soil, and weather, among other factors. Since the beginning of 2011, the partnership has sold all its product to a division of CF Industries under a general services and offtake agreement. In 2011, Terra Nitrogen sold 2.4 million tons of fertilizer, amounting to about one-sixth of CF’s total output. The company’s main raw material is natural gas, which it obtains from a ONEOK Partners, L.P. (OKS) pipeline. With U.S. domestic production of natural gas rising, we think TNH will have no trouble getting more gas as its fertilizer production expands.
As a limited partnership, Terra Nitrogen distributes quarterly all cash available for distribution, as defined in its partnership agreement. This generally means all of cash profits, plus or minus changes in current assets, less a small reserve for future operating and capital needs. The August cash distribution was $4.16 per unit, or an annual rate of about 7.9%. (Distributions reflect results in the immediately preceding quarter.) But distributions depend on both farmer demand for fertilizer and the price of gas and have been extremely volatile in recent years. Terra Nitrogen paid $4.45 a unit in the first quarter of 2008, dropping to $1.25 a unit by the second quarter of 2010, before bouncing back. Moreover, earnings and distributions are somewhat seasonal and weather dependent; that is, fertilizer shipments and profits can move between quarters according to weather, which affects the timing of fertilizer application. One pattern, though, has been quite consistent: the fourth-quarter distribution has declined noticeably from the August payout in four of the last five years. Given that seasonality and the fact that natural gas prices have risen since the June quarter, the November distribution will probably be around $3 a unit or even less. That would generate a yield of around 7% for 2012, at the units’ recent quotation.
Beside the volatility of cash distributions, investors should weigh two other factors in assessing TNH units. First, CF Industries has the right to buy all the publicly held TNH units as long as CF owns at least 75% of the total, which it does now. That could lead to a forced sale at a loss, if the units’ price declines in the face of possible weaker industry fundamentals or higher gas prices. While CF has said little about its specific plans for TNH, we doubt that it will exercise its option. The parent is about to spend about $940 million on an acquisition, and its capital program calls for investing a further $2 billion in expansions over the next three years. That, and a new stock repurchase authorization, should consume much of CF’s investable cash.
Another consideration is capacity growth at Terra Nitrogen. As the partnership does not retain earnings for growth, it must raise new capital to expand significantly. TNH has no debt, so it could borrow significantly for growth. But CF has said little about its growth plans for TNH.
The U.S. nitrogen fundamentals look quite good. After a bad drought in 2012, corn stocks are down, and farmers will likely plant more acres in 2013. While natural gas prices are up from a recent 10-year low last winter, they are still well down from prior levels, and rising gas production from many shale deposits will likely prevent gas from rising significantly anytime soon. Too, around 40% of U.S. nitrogen fertilizer demand is met by imports, giving the domestic industry a chance to grow by taking share from overseas suppliers, which may face rising raw materials costs.
Despite the concerns discussed above, we think Terra Nitrogen distributions will rise over time, and the units could interest investors who can put up with some volatility.
At the time of this article’s writing, the author did not have positions in any stocks mentioned.