Rentech Nitrogen Partners IPO: Fairly Valued

| About: Rentech Nitrogen (RNF)

This analysis of Rentech Nitrogen Partners (NYSE:RNF) was provided to TradingIPOs subscribers in advance of its IPO. On November 3 the company announced that its initial public offering of 15 million shares was priced at $20 per share.

Rentech Nitrogen Partners (RNF) plans on offering 17.25 million units at a range of $19-$21. Morgan Stanley and Credit Suisse are leading the deal, Citi, RBC, Imperial, Brean Murray, Dahlman Rose and Chardan are co-managing. Post-IPO RNF will have 38.25 million units outstanding for a market cap of $765 million on a pricing of $20. IPO proceeds will go to parent Rentech (NYSEMKT:RTK), the majority of which will go to repay debt.

RTK will own all non-floated units as well as the general partnership management of RNF. At first glance, it appears to be a bit of a head scratcher here. RTK's ownership interest in RNF would be valued at $420 million which is more than RTK's current market cap of $360 million. RTK will be able to clean up their debt as well on this IPO. The reason appears to be that a) RTK itself has been relying on RNF's core business as their revenue driver as they evolve their clean energy segment. Post-RNF IPO, RTK's main revenue driver will be their stake in RNF as they continue to attempt to turn their clean fuels segment towards commercialization.

It should be noted here that RNF's parent operation is an unusually weak parent for limited partnership structure. This IPO is being modeled after the CVR Energy (NYSE:CVI) spinoff of CVR Partners (NYSE:UAN). CVI has a core refining operation, while here RTK doesn't appear to have much else. I am skeptical of this deal here because of the weak parent company whose track record is spotty at best. This deal feels a bit like a shaky company attempting to take advantage of a strong fertilizer pricing environment.

From the prospectus:

We are a Delaware limited partnership formed in July 2011 by Rentech, a publicly traded provider of clean energy solutions and nitrogen fertilizer, to own, operate and grow our nitrogen fertilizer business.

Nitrogen fertilizer facility is located in East Dubuque, IL. Ammonia and UAN with natural gas are used as primary feedstock. Much like UAN, Terra Nitrogen (NYSE:TNH) and CF Industries (NYSE:CF) substantially all products are nitrogen based.

The deal is structured as a pass-through partnership similar to UAN and TNH. RNF will distribute to unitholders all cash available each quarter.

The company's location is right in the middle of the 'corn belt' IL/IA/WI. The core market is located within a 200 mile radius from the facility. RNF estimates that the ammonia consumed in these states is 4 times the amount produced and the UAN used is 1.4 times the amount produced.

RNF does not maintain a fleet of trucks or rail cars. They sell their fertilizers at their plant with customers responsible for shipping. RNF believes this helps lower their fixed costs and allows higher margins than larger competitors.

Post-IPO, the company will have 66% of the ammonia production capacity produced by public companies.

It will have a capacity of 830 tons of ammonia per day with the capacity to upgrade up to 450 tons of ammonia to produce 1,100 ton of UAN per day.

Please note that RNF plans to spend $100 million to upgrade capacity. Without the cash on hand post-IPO, expect either an equity, debt or a combination offering sometime within first year it goes public.

Sector Overview- Much like the UAN IPO, RNF is going public due to a strong pricing environment for domestic nitrogen based fertilizer. Nitrogen, phosphate and potassium are the three essential nutrients plants need to grow for which there are no substitutes. Global demand is driven by population growth, dietary changes and consumption of bio-fuels. Global fertilizer demand is projected to increase by 45% between 2005 and 2030, or just a shade under 2% annually. UAN fertilizer has grown 8.5% over the past decade. Why? Unlike ammonia, UAN can be applied throughout the growing season. UAN fertilizer is costly to transport therefore locking out foreign competition.

Corn - Corn crops consume more nitrogen fertilizer than any other domestic crop. Iowa and Illinois are largest nitrogen fertilizer consuming states in the US. Mid corn belt ammonia prices have tripled over the past 10 years while UAN prices have quadrupled. Ammonia use has increased 18% in core corn markets the past five years.

Sales prices - Due to lack of transportation and storage costs, RNF claims the highest sales price per ton compared to the two pure play comparables TNH and UAN. Natural gas, RNF's prime feedstock, represents 80% of the cost to produce ammonia. Capacity utilization rate averaged 92% over last three fiscal years. Note that historically this has been a very cyclical market with the past 3-4 years representing the strongest cycle run in 30 years.

Risks - Plentiful here as RNF is going public in the mdist of a long and strong pricing cycle. Nitrogen fertilizer being driven by ethanol production. If ethanol production declines, corn volumes may decline as well. In addition, a rise in the price of natural gas can negatively impact margins. This is a deal in which projections are more tenuous than the average midstream MLP ipo.

Financials- $1 per unit in cash post-IPO, no debt. Fiscal year ends 9/30 annually. FY '11 ended 9/30/11. 273 tons of ammonia produced in FY '11, 312 tons of UAN.

Seasonality - Most deliveries are made in the 6/30 and 12/31 quarters during spring planting and fall harvest.

FY '11 - $179 million in revenues. 42% gross margins, 39% operating margins. As a pass through, tax burden will be on unit holders. $1.83 in EPS.

FY '12 - Really all that matters here is projected cash available for distribution. $204 million in revenues with $2.31 in net EPS.

RNF is forecasting $2.34 per unit in distributions for FY '12. Approximately $0.20 of that is technically cash from the ipo. On a pricing of $20, RNF would yield 11.7% annually. Strong yield here.

Let's look at RNF and two pure comparables TNH and UAN:

RNF - 11.7% projected yield with strong balance sheet. ***Note that based on FY '11 numbers yield would be 9%. RNF is projecting a stronger cash flow(and yield increase in FY '12 than either of their two pure play competitors. If they can pull it off, deal should work mid-term.

UAN - $1.84 billion market cap, some debt on the books. Yielding 8.9% currently.

TNH - $3.07 billion market cap, good balance sheet. Yielding 9% currently.

Conclusion - Yield-wise, based on 2011 going public right at a payout ratio of two pure comparables, UAN and TNH, RNF is the weakest of the three. However, with a smaller output/facility and a much weaker parent, RNF is forecasting a pretty aggressive increase in yield in FY '12, much stronger than either UAN or TNH. The key to whether this deal works mid-term from a $19-$21 pricing depends on whether they can execute. As it looks right now, pretty fairly valued at $19-$21 based on its recent quarter.