Terra Nitrogen: This 8%-Yielding Small Cap Agriculture Stock Should Be On Your Radar

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 |  About: Terra Nitrogen Co. LP (TNH), Includes: CF
by: Bob Ciura

Summary

Agriculture is an industry with strong long-term economics.

Terra Nitrogen was been hit by a poor application season last fall, the effects of which are lingering this year.

The upcoming application season may be better. In the meantime, investors are treated to an 8% annualized distribution.

Small-cap stocks often fly under investors' radars. But that would be a mistake, especially when a small-cap operates in an industry with strong long-term economics. When that company is cheap and sports a huge yield, it's an even more attractive scenario.

That's why investors who love to receive hefty yields from their investments should consider Terra Nitrogen LP (NYSE:TNH), a $2.7 billion company by market capitalization.

Terra Nitrogen is struggling through a tough period for its business. But its operating problems may be short-term, as there are glimmers of hope appearing across the industry. While its challenges have served to crush its unit price over the past several months, this sets up a great opportunity going forward.

With a very modest valuation and high yield, Terra Nitrogen should be on your radar.

Go long on agriculture

Terra Nitrogen is a master limited partnership engaged in nitrogen fertilizer production. It is a subsidiary of CF Industries Holdings (NYSE:CF). Terra Nitrogen's focus is on nitrogen fertilizer, which helps boost farming productivity. CF Industries also has a more diversified business model than Terra Nitrogen. In addition to a large nitrogen business, CF Industries is also involved with phosphate fertilizer. This diversity helps blunt the impact of a single product area under-performing.

Terra Nitrogen is a much smaller company than CF, which holds a $13 billion market capitalization. Moreover, its assets are comprised mostly of one primary manufacturing facility in Oklahoma. Because of all this, it's reasonable to expect more volatility from Terra Nitrogen, which indeed has been the case.

Its volatility has been even more pronounced because the operating climate surrounding nitrogen fertilizer is challenged. As the company states in its SEC filings, its production depends on many factors, including soil and weather conditions as well as changes in regional farming practices. Fluctuations on a harvest-to-harvest basis result in volatility in the company's financial performance.

Terra Nitrogen's sales and earnings per unit fell 25% and 34%, respectively, in the first quarter. The leading contributor is falling ammonia prices. Ammonia is the basic ingredient for nitrogen fertilizer, as well as many industrial products. Prices declined because of higher inventories.

The fall application season last year was a poor one, based on cold weather that reduced the application period. This resulted in higher inventory levels to begin 2014, causing ammonia prices to decline.

Things didn't get much better in the second quarter, as sales and earnings per unit declined 22% and 30%, respectively. While this certainly isn't good performance on the surface, it represents an improvement from the previous quarter.

Another sign of improvement is that parent company CF Industries enjoyed record ammonia shipments in the most recent quarter, perhaps implying a better application season this fall.

Lastly, Terra Nitrogen investors should be optimistic because the company increased its distribution by 3% from the prior quarter.

Here's why Terra Nitrogen has more to offer than CF Industries:

Annualized Yield

Enterprise Value/EBITDA

Terra Nitrogen

8.4%

5.6

CF Industries

2.3%

5.6

Click to enlarge

As you can see, both Terra Nitrogen and CF Industries are fairly cheap stocks. They are modestly valued on an operating cash flow basis. Both trade for just 5 times enterprise value (which is market capitalization plus net debt) to EBITDA, or earnings before interest, taxes, depreciation, and amortization.

The reason why Terra Nitrogen is such an attractive play is its huge distribution yield, which stands at 8.4% annualized. Despite the volatility in its underlying financial performance, it's required to distribute the vast majority of its cash flow through to investors. Terra Nitrogen is classified as a Limited Partnership, which means it enjoys a favorable tax structure but must distribute most of its cash flow.

To be sure, Terra Nitrogen is not without its risks. It is a fairly small company that focuses only on nitrogen. It holds only one production facility. And its units have reflected this risk, swinging wildly over the past year.

Nevertheless, if you can stomach the higher level of risk, the rewards could be very compelling if the climate for nitrogen application improves, and there are signs that this is occurring. Until then, Terra Nitrogen's 8% yield offers a very comforting margin of safety.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.