We Sold Terra Nitrogen And CF, Bought Chesapeake Midstream

Includes: ACMP, CF, CHK, KED, TNH
by: Tyson Halsey, CFA

We sold our entire Terra Nitrogen LP (NYSE:TNH) position, as of April 30th, 2012 after 112% stock rise over the last eight months. We recommended Terra Nitrogen LP for our clients after irrational 30 point single day drop and posted our recommendation on Seeking Alpha on September 22, 2011.

TNH is a $4.9 billion market capitalization Master Limited Partnership (MLP) that yields 6.97%--based on its last quarterly distribution of $4.53/unit and a price of $260/share. Earnings appear to be growing at a decelerating pace. In the June 2011, earnings were reported at $3.95/share versus $2.22 in q2 2010--a 77.9% increase. In the December quarter 2011, earnings were reported at $3.87/share versus $2.61/share in Q4 2010-a 48% increase.

TNH earnings benefited from two extended commodity trends which aided earnings and appear to be tiring. The first commodity trend is corn prices which have been strong for nearly seven years rising from $2/bushel to $7/bushel. Now the price rise appears to be moderating as the market is anticipating a huge planting season. With the primary commodity demand driver moderating, future plantings should also moderate and suggests that we have passed an inflection point which will diminish TNH's torrid earnings ramp in the future. Additionally, the extraordinary decline of natural gas has helped increase operating margins. Natural gas recently traded below $2/million BTUs. Natural gas production cuts and moderating Canadian imports suggest that natural gas prices appear to be basing or bottoming. With the incremental benefit of declining gas prices fading this earnings driver may be ending too and should lead to a deceleration in future TNH earnings.

The two commodity price extremes appear to have been responsible for a parabolic move in Terra Nitrogen stock which traded to $298.5 on April 16th up 114% since September 21st when the stock closed at $139 and we announced our client purchases. On February 6th, TNH traded at $200 per share for the first time, before initiating a parabolic 49% move in six weeks. Due to the over weighted position we took for our MLP clients, we have been trimming our TNH position from $190 to $288 and completed our final sales this week at $268. Amazingly, TNH is a high dividend stock and provided a more attractive total return than the simple price move.

TNH is not like most MLPs we buy. It is a commodity play and its earnings visibility is highly volatile unlike midstream pipeline MLPs which historically have dominated our portfolios. Due to the exceptional volatility, cyclical earnings risk, and unusually serendipitous commodity trends in corn and natural gas that have heavily effected TNH earnings expectations, we cautiously scaled out of our positions until it became apparent that the parabolic move in TNH had become exhausted with the abating of the extreme benefits to earnings from the favorable price trends in natural gas and corn prices.

TNH had no Wall Street coverage when I wrote it up for Seeking Alpha. TNH and CF Industries (NYSE:CF) have enjoyed the benefits of their corporate merger two years ago when CF Industries bought Terra Industries, Inc. forming one of the largest fertilizer manufacturers in the United States. Because of the newness of the entity, TNH was not on the radar screen of most MLP managers or analysts. Earnings have been very strong at both CF Industries and TNH. We view the earnings trajectory to now be decelerating and have sold both TNH and CF.

We have reinvested the recent sales proceeds of TNH into Chesapeake Midstream Partners LP (CHKM), which saw some headline risk impact the stock due to the ethics and disclosure concerns regarding Aubrey McClendon's drilling program. We bought CHKM as we anticipate continued high distribution growth typical of a new MLP and benefiting from its parent Chesapeake Energy Corporation (NYSE:CHK) the second largest natural gas producer in the United States. Like most GP MLP corporate relationships, we anticipate CHK will push down significant assets into CHKM -- the MLP structure -- driving above industry growth rates leading to a high distribution yield with high levels of earnings and distribution visibility. We also used this recent negative news to buy CHK for our retirement plan MLP strategy available on Folio Institutional on Monday with proceeds of Kayne Anderson Energy Development Company (NYSE:KED) a closed end fund we bought for our retirement plan MLP strategy and whose discount to NAV had declined since our purchase.

CHK is down from 53% from $35.75 to $16.78 in part due to the Aubrey McClendon Founders Well Participation Program, which suggested potential self interest and a lack of full disclosure. We believe the company is well positioned in the natural gas, natural gas liquids, and oil business and is very inexpensive. We think the company's continuing transition to a natural gas liquids and oil focus is wise and continuing. With a possible bottom in natural gas prices, we believe there is potential upside to the near zero valuation the market currently accords CHK's natural gas holdings. Given that this is the second time Aubrey McClendon has taken very aggressive personal financial positions relating to CHK, I suspect that the company will take the necessary steps to address the governance issues and the company will recover recent losses over the coming months. This headline risk will persist, but creates the value opportunity at hand.


I am long CHKM, CHK. Our average MLP separate account is $2,000,000.

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, Chesapeake Midstream Partners, Chesapeake Energy Corporation, Kayne Anderson Energy Development Company or other securities presented on our website. Nothing contained herein should be construed as a recommendation to buy or sell any securities.