I recently wrote and published an article about fertilizer MLP Rentech Nitrogen Partners LP (RNF) and several comments pointed out a mistake in the article noting that CVR Partners LP (UAN) uses petroleum coke as a feedstock instead of the natural gas used by Rentech and Terra Nitrogen Partners LP (TNH). The point of the correction was that CVR Partners has a cost advantage by using pet coke instead of natural gas. My curiosity was raised, so I thought I would dig into the details to determine if and how much advantage the alternate feedstock gives to CVR Partners.
Note: MLP companies such as CVR Partners have units and pay distributions. The words stock, shares and dividends may be used here with the understanding that the rules of MLP units apply including the tax consequences of investing in MLP units.
My approach to determine whether using pet coke instead of natural gas is a significant advantage for CVR Partners compares the cost as a percentage of revenue. The challenger in this match is Terra Nitrogen, since Terra is the most established of the nitrogen fertilizer MLPs, while production and sales have been in a state of flux for Rentech Nitrogen. The data used here are from the 2012 10-K annual reports of CVR Partners and Terra Nitrogen.
Terra Nitrogen Partners
- 2011 Sales Revenue: $797.9 million
- 2011 Realized Natural Gas Cost: $180.7 million
- Natural gas costs as percentage of sales: 22.6%
- Net earnings profit margin (sales minus total expenses): 63.6%
- 2012 Sales Revenue: $776.7 million
- 2012 Realized Natural Gas Cost: $141.6 million
- Natural gas costs as percentage of sales: 18.2%
- Net earnings profit margin: 71.9%
- 2011 Sales Revenue: $302.9 million
- 2011 Pet Coke Cost: $17.1 million
- Pet coke as percentage of sales: 5.65%
- Net earnings profit margin: 51.2%
- 2012 Sales Revenue: $302.3 million
- 2012 Pet Coke Cost: $16.1 million
- Pet coke as percentage of sales: 5.3%
- Net earnings profit margin: 45.2%
Analyzing the Big Surprise
I will admit I was surprised by several items in the data outlined above. First, pet coke is really, really cheap compared to natural gas, and gas has been relatively inexpensive over the last two years. I also found out that the price CVR Partners pays CVR Refining LP (CVRR) is based on the sales price of the Partners' primary product, UAN fertilizer. If fertilizer prices drop, so will the price CVR Partners pays for pet coke. CVR Refining supplies about 70 percent of the pet coke used by CVR Partners.
The next surprise was how much higher operating expenses were for CVR Partners compared to Terra Nitrogen. Over the last two years, the income statement shows an average of $90 million for the year in "direct operating expenses - third parties" with an $8 million increase in that number for 2012. Terra Nitrogen spent about $35 million each year on services provided by the general partner and affiliates. This number appears to cover the same costs as the CVR Partners direct operating expenses.
While using pet coke saves CVR Partners a lot of money on raw materials, the company has operating expenses nearly three times the level of Terra Nitrogen on less than half the annual sales. I am not sure of the reason for these higher expenses, and a few guesses include the maturity of Terra Nitrogen as a business or there are other advantages besides cost when using natural gas to produce nitrogen fertilizers.
CVR Partners has forecast 2013 distribution guidance of $2.15 to $2.45 per unit. The $2.30 middle of the range would be a 9% yield on the current $25 share price. The Terra Nitrogen share price does a pretty good job of keeping the yield to investors in the 7% to 7.5% range, so CVR Partners carries an edge on potential distribution returns in 2013. Also, higher natural gas prices would put a squeeze on the Terra Nitrogen results while CVR would not face the same squeeze. CVR Partners is the slightly more attractive choice here, but the pet coke cost advantage is not as big of a competitive benefit as raw costs would indicate.