(Published by Bob Ciura on June 9)
The price of agricultural commodities boomed in the immediate aftermath of the Great Recession. The boom quickly turned into a bust, though, leaving many agriculture stocks in the dirt.
From 20132016, agricultural commodities collapsed. While this has been a boost to consumers, in the form of low grocery prices, it has been a source of great pain for agricultural producers.
Lower farm incomes have suppressed demand for everything from farming equipment to fertilizer.
This has notably affected Terra Nitrogen LP (TNH, Financial), a Master Limited Partnership engaged in the production of nitrogen fertilizer products.
After hitting a high of $268 in April 2012, Terra Nitrogen has steadily fallen since then to its current level of $81.
The upside is that Terra Nitrogen may be a buying opportunity on valuation and dividend income. It is one of 416 stocks with a 5%-plus dividend yield trading on major U.S. stock exchanges.
You can see the full list of established 5%-plus yielding stocks by clicking here.
Business overview
Terra Nitrogen is structured as a Master Limited Partnership. This means it has a general partner, which is Terra Nitrogen GP Inc.
The general partner is a wholly owned subsidiary of CF Industries (CF, Financial). As of Dec. 31, 2016, CF Industries owned 75% of Terra Nitrogen’s outstanding common units.
Terra Nitrogen’s principal products are ammonia and urea ammonium nitrate. These products are used primarily by farmers to improve crop yield and quality.
It has production capacity of 1.9 million tons of urea ammonium nitrate solutions and 1.1 million tons of ammonia each year.
In 2016, Terra Nitrogen sold 2.2 million tons of nitrogen fertilizer with net sales of $418.3 million and net earnings of $209.3 million.
Falling nitrogen fertilizer prices have taken a steep toll on the company over the past three years, and rising ammonia production has been only a modest offset.
Source: 2016 Annual Report, page 6
Unfortunately, low commodity prices can have the effect of a vicious cycle on producers. When prices fall, many operators try to increase production to help offset the impact of weak pricing.
Of course, expanding supply into an already oversupplied market only exacerbates the problem.
2016 was another difficult year for the company. Sales and earnings per share declined 28% and 25% from 2015.
Fertilizer pricing worsened over the course of the year. In the fourth quarter, ammonia and UAN average selling prices decreased by 43% and 40%.
Making matters worse is that lower fertilizer prices have been met by higher natural gas prices, a main feedstock cost. Terra Nitrogen incurred 12% higher natural gas prices in the fourth quarter.
This explains the huge drop in Terra Nitrogen’s share price over the past three years.
On a positive note, there could be light at the end of the tunnel. Global supply could drop toward the end of 2017 and into 2018, which might finally help boost fertilizer prices.
Growth prospects
The biggest growth catalyst for Terra Nitrogen would be a return to higher fertilizer prices. One of the main reasons why fertilizer prices crashed in 2013 and 2014 – and have remained low –Â is because of a deluge of exports from China.
However, the good news for Terra Nitrogen is that many Chinese producers are operating at a much higher cost structure. Persistently low prices are forcing significant shutdowns in China.
Source: CF Investor Presentation, page 14
Over time, these shutdowns could help normalize prices once again as global production falls. This would be a huge boost to U.S. producers.
There are promising signs that this is already starting to happen.
Terra Nitrogen’s first-quarter revenue increased 10% to $119. The company kept the pedal to the metal on production –Â sales volumes for ammonia and UAN soared 40% and 47% from the same quarter last year.
Earnings per unit jumped 46% to $2.10.
Going forward, there is a good chance Terra Nitrogen’s fortunes are finally about to turn.
On CF Industries’ last quarterly earnings call with analysts, management stated that Chinese urea exports were 1.2 million metric tons during the first quarter, down significantly from 3 million metric tons year over year.
Expectations are for Chinese exports to total 5 million to 6 million metric tons this year, which would be a heavy reduction from recent years.
It seems that the fundamental laws of economics are finally catching up to exporters of cheap goods with high cost structures.
CF management expects new projects to slow as well. As a result, the global supply-demand picture could balance over the next few years, which would be great news for Terra Nitrogen.
Valuation and expected total returns
Terra Nitrogen stock has been hammered over the past few years but could now be a value opportunity.
The units trade for a price-earnings (P/E) ratio of 10.7, based on 2016 financial results. If the pricing environment improves and earnings rise once again, a higher valuation multiple is definitely possible.
An expanding P/E ratio alone could yield huge returns. For example, if Terra Nitrogen stock rose to a P/E ratio of 15, the shares would return approximately 40%.
Plus earnings growth and dividends will provide additional returns.
Not surprisingly, dividends will be a major source of investor returns, although Terra Nitrogen’s dividend is harder to predict than most companies.
Terra Nitrogen employs a variable dividend policy. Its distributions depend on many factors, including the financial performance of the company and the outlook for the fertilizer industry.
Due to the turbulent industry conditions over the past few years, Terra Nitrogen’s distributions have been all over the map.
Source: Investor Relations
Deteriorating conditions led to a disappointing distribution of 97 cents per unit in the first quarter.
Aside from a skipped distribution in 2010 resulting from a temporary manufacturing shutdown, last quarter’s distribution was Terra Nitrogen’s lowest payout since 2007.
Still, even with reduced payouts, Terra Nitrogen still distributed $6.54 per unit in the past four quarters. Based on its current share price, this represents an 8% yield.
Final thoughts
Times are tough in the fertilizer industry. Weak pricing has weighed on Terra Nitrogen, and its distributions have fallen as of late.
But there are signs that the economics are improving.
Terra Nitrogen’s dividend hit a low point last quarter, but there is huge upside potential. Consider that from 2011 to 2014 the company distributed at least $10 per year.
As a result, value and income investors looking for a buy-low candidate should give Terra Nitrogen a closer look.
Disclosure: I am not long any of the stocks mentioned in this article.
