Terra Nitrogen (TNH) is a $2.6 billion market capitalization Master Limited Partnership (MLP) that yields 10.79% based on its last quarterly distribution of $3.75/unit and a closing price of $139/share. TNH is benefitting from strong agricultural commodity price inflation, rising corn prices, and growing emerging market demand for corn, beef and pork. Rising prices are driving farmers to increase corn and other agricultural plantings, which drive demand for fertilizer. Additionally, the macro-demographic effect of 1.4 billion Chinese and Indians moving from subsistence lifestyles to those of the middle class in newly industrializing economies, will lead to improved diets, higher meat consumption, and rising demand for feedstock to feed pork and cattle in the future.
TNH and CF Industries (CF) are enjoying the benefits of its corporate merger two years ago when CF Industries bought Terra Industries, forming one of the largest fertilizer manufacturers in the United States. Earnings have been very strong at both CF Industries and TNH, and those trends we see continuing. CF Industries reported earnings last quarter [see transcript] up 364%--“$487.4 million in the second quarter of 2011 compared to net earnings of $105.1 million in the same quarter of 2010.” CF Industries also announced that it would quadruple its dividend and buy back its own shares. We believe that the recent weakness in CF Industries also provides an attractive entry point for CF.
Insiders have recently bought TNH shares (the phantom units) as high as 188 per share, according to SEC filings, which would seem odd if CF Industries were to execute a “take under” as might be inferred by the Seeking Alpha article that appears to have caused this irrational decline. If CF Industries were to attempt an opportunistic acquisition, that behavior would violate CF Industries' Code of Ethics, in my opinion. More importantly, it makes no economic sense. CF Industries already gets 85% of TNH’s cash flows. Why would CF want to buy out the MLP which gives it tax advantages and allows CF Industries to better leverage its capital structure?
Thursday’s surprising decline appears to be the result of an article from Seeking Alpha.com, a website which posts varied equity ideas for investors and the day trading community. The particular article, written by individual investor Todd Johnson, recommends selling TNH due to its parent CF Industries’ ability to buy out TNH. Buyout for terms for TNH, as of the September 22, 2011 close, would imply a price of $188 per share versus the closing price of $139, per share. This is based on the last 20 trading days' closing price of TNH. That would imply a 35% takeout premium, if it were to happen, which we doubt.
There is nothing unique about the fact that TNH limited partner unit holders have little say with regard to the control or influence relative to their General Partners' desires. This has been the case for MLPs for over two decades. However, the tax benefits of the MLP structure and financial incentives have kept MLP unit holders accruing attractive distributions and created one of the top performing asset classes in both the 1990s and this millennium. Additionally, when MLPs have been bought by their GP, it has typically been at attractive prices, and not in some self interested transaction as one might infer from the way the Seeking Alpha article might lead one to conclude.
The MLP space is complicated and one needs to understand the subtleties of the structure and history to not get misled by a scary presentation of the facts by a writer who is recommending selling the shares. TNH has no Wall Street research coverage, so panic can be especially damaging. TNH has had a parabolic run and is coming into the seasonally weaker half of the year. A pullback was not unexpected as sequential distributions may taper off in the next two quarters. Regardless, with a 10.7% distribution, positive long term fundamentals, a potential takeover premium of 30% or more, and a tax advantaged growing distribution story for the next several years, TNH is a very attractive income investment for taxable entities. TNH, like all MLPs, is subject to UBTI and should not be purchased in retirement plans. Retirement plans should buy CF alternatively, though its dividend yield is not as attractive as TNH’s.
We like CVR Industries (UAN), which is a new fertilizer MLP. However, given the recent decline in TNH, we would not sell TNH to buy UAN. At September 21, 2011’s closing prices, we would sell UAN to buy TNH, for a trade. We believe both stocks should benefit from future agricultural commodity growth and provide attractive tax advantaged yields to investors who lack attractive income investments with fundamentally sound operating trends.
Disclosure: I am long TNH, CF.
Additional disclosure: Income Growth Advisors are long TNH, and consequently, I am long indirectly. We are buying TNH and CF for precisely the investment rationale described in our article. We bought the stock before during and after publication of this article.
Disclaimer: The information expressed in this note and on our website is based upon the interpretation of available data. The data being presented was obtained or derived from sources believed to be accurate, but Tyson Halsey, CFA and Income Growth Advisors, LLC cannot and does not guarantee the accuracy of these sources which may be incomplete and/or condensed. The data and information presented is provided for informational purposes only, and is not offered as a basis for trading in securities nor is it offered for that purpose. Readers and potential investors should conduct their own independent investigation before making any investment or business decisions with respect to Terra Nitrogen, C F Industries, CVR Industries, or other securities presented on this website. Nothing contained herein should be construed as a recommendation to buy or sell any securities.