Let me preface this article by saying that I'm not a stock analyst. However, I've been investigating Terra Nitrogen (TNH) because, at first glance, there is so much to love about this stock in terms of dividend yield. Of course, I think this stock would be perfect for my Superyield Portfolio. But, TNH is at an all time high, so this gives me pause for thought. Why does it seem to act a bit like a growth stock but pay such a good dividend? Understanding this company's variables should help give investors some indication about when to get in and when to get out.
Here are the variables as I see them:
1) Ammonia is the key ingredient in producing TNH's fertilizer, and 90% of the cost of producing Ammonia is the natural gas used, which is converted into ammonia. Therefore, the price of natural gas may be a leading indicator of profitability for TNH. I would propose that if there is a spike in natural gas prices then one quarter later you would see a price drop in TNH as investors don't get expected returns.
Let's look at an example: In July 2008, there was a sharp price spike in natural gas (to $10.79/thousand cubic feet) after a steady rise of natural gas prices. From May 2008 to October 2008,TNH stock price went from an all time high of about $160/share to $60/share in October 2008. Currently, natural gas is $4.12/thousand cubic feet. In my humble opinion, it appears that TNH would lose price support if natural gas got to about $8 if variable #2 stayed static. What is variable #2?
2) Variable #2 is the price of fertilizer sold to farmers gathered from historical priced data compiled in table #7 from the USDA Economic Research Service. Fertilizer price is obviously a complex agglomeration of economic forces resulting in a number agreed upon between buyer and seller. That is, price is easy to see but difficult to interpret. At face value, the price of fertilizers went up dramatically in 2011. For instance, the price of anhydrous ammonia, one of TNH's main products, has increased by 66% from 2010 to 2011. So, as natural gas prices have remained low fertilizer prices have increased, which leads me to assume great profit margin potential.
Conversely, this level of price instability may make farmers re-evaluate their ability to absorb input costs and lower their use of TNH product.
My conclusion is that if price fluctuations become less volatile and natural gas prices also stay relatively stable then TNH will continue to remain a stable and valuable stock. If, however natural gas prices soar, or other price influencing factors take hold such as lowered demand, then there wil be some stock price erosion.
For more on the future of the fertilizer market as a whole see the IFA's Market Outlooks summary 2011.
Disclosure: I am long TNH. I'm an architect and not a stock analyst, therefore please review my assumptions carefully before making an investment decision.