Short Idea: Terra Nitrogen

(Got this from a Notable Calls Network member and thought to share:)

Terra Nitrogen (NYSE:TNH) reported its earnings and its distribution this morning. More importantly they reported the “threshold “ level where a massive profit split change (negative for TNH) will kick in. It goes from 99:1 split to 50:50 (after the first $1.045).

First, TNH is ridiculously overpriced. It's the classic case of an unknown/unfollowed stock that stumbles out of the dark ages into a hot sector and has very little float or intelligence. It's a daytrader's dream as folks go to chat boards searching for info.

TNH is an MLP. It was spun off by TRA back in 1994. It's a single factory that churns out nitrogen based fertilizer product (UAN and ammonia byproduct). Terra Industries (NYSE:TRA) retains 75% ownership (needed to control an MLP vs 50.1% for a corp) and is the general partner running TNH. Because they lost money a few years back, profit sharing dropped to just 1% until losses in past were earned back . Those losses are very getting close to being earned back and then profit sharing soars in TRA favor with the big number being 50% of everything over $1.045 cents .

Refer to their last 10-Q where TRA management reposted this ancient profit split.

It is all right here on page 9 of their last 10Q.

The Limited Partners receive 99% of the Available Cash and 1% is distributed to the General Partner, except when cumulative distributions of Available Cash exceed specified target levels above the Minimum Quarterly Distribution (“MQD”) of $0.605 per unit. Under such circumstances, the General Partner is entitled, as an incentive, to larger percentage interests. As of September 30, 2007, the cumulative shortfall on quarterly distributions to holders of Common Units that must be paid before the General Partner receives an incentive payment was $152.9 million, or $8.18 per unit.

Well, today it was announced that after the next $2.86 in distributions is paid out (next quarter), the profit split will kick back in to the old profit split levels of 50:50 after the first $1.045 cent distribution.

By way of fundamentals, TNH runs at 100% production all the time so it can't produce more and if NatGas soars , its margins can crater (yes , this $130 stock traded at $3+ 5 years ago).

I see folks on chat boards referring to TNH as a 'locked in dividend forever' and a way to cash in on the agriculture boon.

The problem of course is that TNH is no different today than it was at $3. That plant can be replicated by a competitor most anywhere NG is available.

It's a daytrader's dream but I suspect 70% have no clue of underlying fundamentals. With a YoY change in avg daily volume going from 27k shares to 638k shares, short interest ratio is under 2.

I think TNH can trade below $100 as people figure this out. I will be listening to the conference call to gauge the level of investor awareness. Been painfully short awhile on this one and I have tried a paired trade (short TNH against TRA) but there really isn't any trading correlation between the two.

Disclosure: The author is short TNH

Comments

[1ArmSteve:]

Sounds like a great idea...unfourtnately, no options outstanding and my broker (fidelity) said there is no shares to sell short - any ideas? thx

2008 Feb 07 01:56 PM

[jcrash:]

Yeah, you can't short it. Besides, it is 50/50 after the first $1 EACH QUARTER, so that means it still yields 3%+ without any split at all, easy 5% yield.

2008 Feb 07 10:35 PM

[jonnoarmo:]

You can’t open a newspaper or turn on a business channel today without noticing that both the domestic and global agriculture market is booming. Increased food demand, increased ethanol demand, increased crop prices, and a rapidly growing middle class in Asia (millions of mouths to feed) are all bullish signs that the Ag story is not over. Normally this kind of attention would indicate a top, however, fundamentals are driving this story.
This past week, THN reported their 4Q and FY 2007 earnings and blew the estimates away. It is still the sexiest fertilizer story out there with the strongest fundamentals across the board. Here are some interesting facts tying the ag story to THN's future prospects:
-TNH is almost the only fertilizer stock with NO debt. The avg debt of the big three (POT, AGU, MOS) is $1 Billion! Even its parent company TRA has 300 million in debt.
-It is the only fertilizer with a distribution. This quarter they paid out $4.45 a share. More on the distribution later...
-Highest quarterly Revenue gain in percentage terms (see IBD Mon Feb 11 2008 pg.A20).
-Highest Return on Equity of the Ag/Fertilizer (see IBD Mon Feb 11 2008 pg.A20).
-Highest pretax margin of the Ag/Fertilizer sector (see IBD Mon Feb 11 2008 pg.A20).
-The lowest PE ratio of any fertilizer or Ag stock out there!
-It takes 5 years to open a new plant and have all its production in the heart of the corn-belt like TNH.
-Seeing how it has the highest distribution (some may call it a yield/dividend) of any fertilizer stock in an low interests rate environment, TNH will still provide for a higher return than any or bond could.
-The stock along with the sector is off its highs going into a year where fertilizer demand will be just as robust as last year, makes TNH look ever cheaper.
-Also, with heavy importing of Liquid Natural Gas (LNG) expected this year, TNH stands to recognize lower Natural Gas expense. Nitrogen fertilizer companies largest expense is natural gas and TNH is no different, this is very bullish for the companies margins.
-With the U.S. heading into a recession or slow down or whatever you want to call it, Natural gas prices will fall. Natural gas was 1/3 of its current price during the last recession.
-Even during a recession people still need to eat even in an environment with low grain stocks worldwide, high grain prices, a robust global market for nitrogen, and high food demand, TNH stands to benefit.

Distribution
Now in terms of the distribution (TNH is still the only one that has one) the pay out structure is about to change if TNH stands to pay out more than $2.45 in next quarter. It will go from paying out unit holders 99% to paying out 50% of the value (You can refer to their 3Q 10-Q for the latest payout structure seeing how their 4Q 10-Q and 10-K is not available yet). Now at first this may seem bearish, but you have to consider where THN has been, where it is, and where it can go.
1)TNH will always have a minimum payment to unit holders of 0.605 per unit.
2)The split only reaches the 50/50 threshold when the company makes a significant amount of money (take into consideration that the Ag and fertilizer stocks are hitting new highs and will continue to be reflected in the coming quarters. Just look at the double, triple, and quadruple in upcoming quarterly earning projections. See IBD Mon Feb 11 2008 pg.A20).
3)If the company makes $16 per unit in 2008 (conservative estimate) the worst case scenario would be a payment of $8 to unit holders. Considering that the stock hit $168 in the early part of 2008 and using $8 per unit as the worst case scenario makes TNH is undervalued at its current levels (Earnings per unit were $10.90 for FY 2007, if earnings grow only 50% that would be $16.35 earnings per unit. Half of that is $8.175). I say this is a conservative estimate because earnings per unit from 2006 to 2007 grew by over 3X!!!
4)Understand the conservative estimate, earning growth projections of its peers, low interest rate environment, good chance of lower natural gas costs, and a booming agricultural phenomenon around the globe.

Bottom Line
Even if TNH had no distribution (hard to believe since you will still receive the 0.605 per unit minimum) it would still be the cheapest ag stock with the lowest PE and best fundamentals in the industry.

2008 Feb 10 04:26 PM

[jonnoarmo:]

For all those Shorts:

-The float is 25% of outstanding, of which 9.3% of that is held by institutions, and 3% shorted. That makes for an extremely thin float.
-Every Quarter, the shorts have to pay out the distribution, making it painfully expensive to be short this stock.
-It is a hard stock to borrow for the above mentioned reasons, and you are charged a high borrowing fee.
-My broker told me to transfer all my shares from my Margin account to my Cash account. This will make it nearly impossible to short the stock further and will result in the short stock out there being called in.

2008 Feb 10 04:30 PM

[cramermuteb...:]

Alot of what you say is already in the stock, its done, its already happened. What one needs to do is look into the future and try to assess the risks. You say it's cheap.. But I say there is a reason.

1. TNH is ONE single plant. Could there be a fire? a flood? heck.. even a black out. certainly a risk to consider.

2. TNH is hostage to natGas prices... it's 60% of their cost structure. I estimate that (holding all else equal), every 0.50MMBtu increase in natGas prices negatively affects TRA's eps by 50 cents annually. Contrary to your thoughts natGas is NOT as cyclical as oil. 24% of natGas is used for heating purposes (that portion is recession proof) as opposed to oil of which 6% is used for heating. And considering it runs at 100% capacity.. if natGas prices rise margins will have to fall.

3. Corn is the most nitogen (fertilizer) intensive crop to grow. TNH is 100% nitrogen. During the 2007 planting season corn was the ONLY grain that was ripping to new highs... but THIS YEAR we have Wheat and Soy ALSO ripping to new highs.. perhaps farmers back off corn a bit this year to diversify their land.... and wheat and soy do not use nearly as much "nitrogen" fertilizer as corn.... my bet for this planting season is a massive switch to wheat (from corn)... which would be a huge negative for nitrogen fertilizer.

4. $4000 put into this stock 5yrs ago (at $4) is now worth $130,000. Not one single thing has changed except for the demand and prices of nitrogen fertilizer that have both gone up. It is a pure commodity play and can come down sunstantially more rapidly than it went up.

This stock is priced for perfection.. and as the poster stated above.. their dividend is being cut substantially.

If I wanted exposure to fertilizer, TNH would be the last stock I would consider. Just my 2 cents.

2008 Feb 11 07:49 PM

[nosivad:]

Enjoyed the article, "Short Idea, Terra Nitrogen", but pretty much disagree with its tenor. I'm long the stock and will buy more, but do agree that it's probably not wise to put all your eggs in this basket.

Several major points: First the ZERO debt sets it apart from any competition. Secondly, the ROE was reported as 98.08 for some time. One knows that would change...last week it did and is now reported as 117.2. That puts it in a different universe. The 100% production coming from one place is not to be ignored...I assume they have insurance, but profit would still take a hit. I assume Natural Gas will fluctuate and may go up, but as with any business if costs rise one raises prices. With no debt TNH can probably suck it up a little but I don't know why they should. I see no reason why margins have to fall. Their one product, nitrogen, is definitely related to the commodity world and its cycles. Corn may be at a high, as may be wheat or even soy, but the world is short food and this puts a prettyhigh bottom on the supply/demand equation. I doubt if Canada, Australia, Argentina, Brazil and/or The Ukraine can increase production enough to drastically alter the worldwide supply/demand situation.

My guestimate as to this years earnings is $16.48 and I note that jonnoarmo puts it at $16.35. To put it as the annal retentive wouldn't like to hear, that's close enough for government work. At the current P/E, that would value the stock at over $250. I certainly wouldn't want to be shorting it. Unless, as my pappy, from the mining camps of Montana might crudely say, "you want to lose your hat, ass and overcoat".

Gringito
QJ Associates
Gringito

2008 Feb 24 05:25 PM