Fertile Future? CF Industries, Terra Nitrogen And CVR Partners Q3 Summary

Includes: CF, CVI, NTR, TNH, UAN
by: Chris Damas

Three popular nitrogen fertilizer producers have reported Q3 2011 earnings: CF Industries Holdings (NYSE:CF) and 75.3%-owned subsidiary Terra Nitrogen Company, L.P. (NYSE:TNH) after the close Tuesday, and CVR Partners, LP (NYSE:UAN) Monday.

CF Industries

Q3 ending September 30 is normally the second weakest of the year for CF Industries, but results were impressive (Q2 is the strongest period followed by Q4 falll application for US cornbelt fertilizer sales and profits). CF's revenues came in at $1.404 billion close to in line with $1.43 billion average analyst expectations, but earnings of $330.9 million and adjusted EPS of $5.04 beat the $4.79 consensus handily.

The headline EPS of $4.79 I adjusted upwards by $35.1 million or 31 cents for a charge from the closing of the methanol production unit at the Woodward nitrogen plant.

The company also reported a natural gas derivatives non-cash mark to market loss of $14.1 million or 12 cents, but I consider this an operating item as it's their policy to hedge quarterly sales forward in the swap market at all times. Hence, it isn't a one-off. Natural gas costs for CF, a critical cost, were $4.45 per mmBTU in Q3, substantially higher than the spot market and higher than Q2 2011 at $4.32.

The nitrogen segment performed well in Q3, as buoyant urea and UAN upgraded fertilizer product prices and sales offset weaker ammonia and steady industrial ammonium nitrate prices and volumes. Nitrogen gross margin was 49.4% on $1.12 billion in revenues versus 19.2% on $735 million in Q3 2010 and 52.0% on $1.5 billion in Q2. A total of 3.04 million tons of nitrogen products were sold versus 2.98 million in Q3 2010 and 3.77 million tons in Q2 2011.

The phosphate segment produced $285.8 million in revenues with 30.1% gross margin versus $182 million and 15.6% margin in Q3 2010 and 28.6% margin on $296.6 million revenues in Q2 2011.

DAP and MAP prices at $566 and $567/short ton were up from Q2's $555 and $544 and combined sales volumes were slightly down from Q2 at 505,000 tons versus 538,000. Export volumes of 240,000 were flat and counterbalanced the seasonal decline in domestic volumes from 298,000 in Q2 to 265,000 in Q3.

We saw some cost pressure from rising sulphuric acid prices in PotashCorp (POT) Q3 phosphate results last week. It would appear CF has maintained its phosphate gross margins as it buys and rails molten sulphur directly from the US Gulf Coast oil refiners.

We'll have more information on the various operations in CF on the conference call tomorrow, including the JVs in the UK and Trinidad, and the sales of DEF (diesel exhaust fluid) urea additive. Top of mind are issues such as the natural gas shortages affecting Trinidad ammonia exports, where CF inherited a 50% interest in the Point Lisas ammonia complex when it bought Terra in April 2010. It is estimated that natural gas shortages have shaved over 1 million tons of ammonia from the over 5 million tons of annual production on the island, impacting CF, Koch, PCS, Yara and Methanol Holdings.

My favorite commodity stock metric is Cash Flow before Working Capital Changes and I had expected a number in the high $400 million range but was prepared to be disappointed as CF's seasonally high portion of cost plus industrial ammonia sales often drag down margins in Q3.

CF cash flow came in at $522.4 million or $7.29 per 71.753 million shares, the number outstanding last quarter. A bonus was the news that CF had bought back 5.6 million shares during the quarter with another 900 million settling after quarter end. Therefore, the average number of CF shares outstanding will be 9% reduced next quarter to 65.2 million and all things being equal, EPS and CFPS numbers will rise 9%.

Therefore, based on the good Q3 results and the reduced share count, I am upgrading my Q4 2011 CF estimate to $1.981 billion, and Q4 CFPS from $5.93 to $6.52. Full year CF CFPS is now estimated at $28.22 on $5.73 billion in sales. 2012 estimates will have to be raised by 9% as well.

The company spent $1 billion on the share buyback which was announced to be "up to $1.5 billion" at the Q2 release on August 4. The average buyback price was $153.49 and since almost a million shares are settling in early October, CF must have taken advantage of the drop in the price in late September.

CF closed today at $158.63 and therefore is trading at 5.6 times my 2011 cash flow per share estimate. Note that during much worse times for the ag sector in 2009 and early 2010, CF and Terra were being valued by their suitors - Agrium (AGU) and CF respectively - at EBITDA multiples between 7 and 8 times.

CF's 2011 EBITDA would be its cash flow before working capital changes plus interest and cash taxes. The interest payments on the $1.6 billion in notes outstanding is $112 million. I expect cash taxes to come in say $700 based on the year to date tax level and recognizing some of these are provisions for off-shore JV's that aren't cash in nature. Therefore 2011 EBITDA is estimated at $1.981+0.11+.70=$2.79 billion.

This would imply an Enterprise Value of $20.9 billion at 7.5 times 2011 EBITDA and since quarter end net debt was $1.07 billion, this leaves a fair value market equity capitalization of $19.85 billion. This equates to a CF fair value stock price of $304.50 given the share count has been reduced to 65.2 million.

Granted this is more like a takeover multiple and being a Delaware corporation, no takeover of CF could proceed without the board's blessing. Plus it is unlikely anyone would want to buy nitrogen assets when prices are historically high.

But structural, lasting changes have occurred in the US nitrogen fertilizer market and someone with deep pockets may recognize this and that CF has become a cash flow machine, with the largest share of the pie. CF stock is a "value buy" but is volatile. You need to have a high volatility tolerance to own it, and a trick I use is to push the decimal place to the left so when CF is at $158, I pretend it is $15.80. That way I don't get spooked when it drops $10 and I make sure I don't buy too much. I like to take advantage of the high volatility to make trading profits.

Terra Nitrogen

I've recently written a report valuing Terra Nitrogen and you can see the article here.

Terra Nitrogen reported $128.4 million in Q3 total net earnings on $203.3 million in sales. More importantly, net income allocable to common units came in at $72.4 million or $3.94 per unit and Terra Nitrogen declared a Q3 distribution of $3.91 payable November 29 with an "ex" date of November 10.

Our estimates for Terra Nitrogen's Q3 results were very close to actuals but slightly on the conservative side. We had net income for the units at $68.8 million or $3.72 per unit with a $3.75 distribution. Revenues were less than our $$216 million estimate as ammonia prices at $455 were lower than our $500 estimate and UAN prices at $295 were slightly lower than our $300 estimate. Volumes came in exactly as predicted for UAN (525,000) but 7,000 tons higher on ammonia.

Gross margin was higher than expected at $137.6 million versus our estimate of $129.6 million. but charging the LP for affliliate services from CF in the amount of $4.9 million.Total profits including the General Partner's share of $56 million was $128.6 million and exceeded our $125 million estimate because CF accounts for its relationship with Terra Nitrogen differently as of January 1, 2011.

Terra's natural gas cost was $4.51/mmBTU versus $4.19 in Q2.

TNH closed at $164.12 and at our revised 2011 net income per unit of $15.21 is trading at a 10.8 times multiple. If TNH can pull off another $3.75 distribution for the final Q4 (payable in early 2012), the total 2011 year distribution rate would be $16.30/unit and discounting TNH for th near-term payment, is trading at a 10.18% yield, albeit on a trailing basis.

We do not yet have a view on the 2012 distribution rate. A key consideration for TNH unitholders going forward will be not only the price of fertilizers and the cost of natural gas, but also the timing of the next plant maintenance turnaround at the Verdegris nitrogen complex. CAPEX bites into available cash for distribution and can reduce payout going forward.

CF Industries, the controlling TNH unitholder and General Partner, does not disclose these biennial turnarounds in advance but we can guess as to their timing from CAPEX spending.

CAPEX spending by TNH was only $4.2 million in the first half of 2011, so it would appear one should coming up soon. In 2009 TNH CAPEX was $30.4 million and in 2010 it was $26.5 million.

Our recommendation on TNH units is that they continue to be a hold, due to the subdued natural gas price curve for winter 2011-2012, and strong Spring nitrogen fertilizer refill demand with slightly rising prices in the near-term.

However, upside appreciation on TNH from here is balanced by the downside risk of owning a single plant investment and the relative illiquidity of the units, due to the small public float. The trading spread (difference betwen the bid and the ask) on TNH units is quite often a $1.50 or more, and prices can fall or rise fast.

CVR Partners

Although we haven't finished an in-depth review of the relatively new nitrogen Master Limited Partnership CVR Partners and its Coffeyville, Kansas nitrogen fertilizer plant, we found their Q3 earnings released yesterday to be generally up to our expectations.

CVR reported $77.2 million in Q3 revenues and $36.3 million in net income, sor 50 cents per unit, slightly weaker than the seasonally stronger Q2 revenues of $80.7 million and $38.2 million net income, or 52.3 cents per unit.

External sales revenues weakened because realized merchant ammonia ($568/st) and UAN ($294/st) prices were both down $6/short ton versus Q2 levels even though benchmark prices were up $15 and $35 over Q2 respectively. As is typical in the industry, the Partnership pre-books orders several months in advance so current revenues were determined when prices were lower but only realized when shipped.

Progressively higher spot prices are only now being realized for Q4 2010 and Q1 2011. During the conference call, the CEO Byron Kelly indicated that UAN sales were being made at $315/ton for Q4 2011 and at $330 for Q1 2012.

Offsetting the Q3 price and revenue weakness was an increase in UAN sales from 179,400 short tons in Q2 to 185,800 in Q3. Ammonia sales however, were 25,900 short tons or 2,300 less than Q2.

Raw hydrogen sold by the Partnership to the CVR Energy (NYSE:CVI) affiliated refinery is to assist them with sulphur reduction capability to produce low sulphur fuels during plant urnarounds. The costs and revenues are established under a "keep whole" provision of a feedstock and shared services agreement. The hydrogen sales in Q3 represented 8,703 lost tons of ammonia for the partnership, which the Partnership was compensated for at an ammonia equivalent price of $654.90 per ton. Q3 hydrogen revenues were $5.7 million versus $6.1 milliion in Q2. A key requirement for the success of the Partnership's UAN upgrading expansion project (see below) will be the ability and willingness of the refinery to sell the Partnership enough excess hydrogen, rather than vice versa.

Last week CVR pre-announced a 57.2 cent distribution for Q3 payable on November 14 with an "ex" date on Thursday, November 3. The Partnership paid an initial 40.7 cent distribution for the Q2 beginning April 13 post the unit IPO.

The CEO reaffirmed the Partnership would pay (I assume a minimum) $1.92 per unit for the twelve months ending March 31, 2012, including the shortened payment for the Q2. This implies a 48 cent payment for Q4 2011 and Q1 2012.

CVR cash flow available for distribution has been improved slightly due to business insurance recovery payments of $3.4 million year-to-date stemming from the UAN explosion on September 30, 2010. Excluding these items, but due to the higher price realizations expected, we think a 55 cent distribution rate for CVR per quarter is a good estimate, with a $2.20 adjusted annual rate applicable until Spring 2012.

During 2012, CVR will increase spending on its fully-funded 400,000 ton per year UAN expansion, with estimated completion for start-up beginning in Q1 2013.

Cash available for distribution will increase in 2013, all things being equal.

At the closing price of $25.20, UAN is trading at 13.8 times our estimated 2011 cash available for distribution of $1.83 per unit and 11.45 times our estimated $2.20 rate based on the past two quarters and the next two quarters. The current CVR yield based on the estimated $2.20 distribution rate and excluding the nearterm 57.2 cent payment, is 8.93%.

This multiple is higher and the yield is lower than that of fellow fertilizer MLP Terra Nitrogen, but given the better growth plans for UAN production and lack of sensitivity to natural gas prices with low feedstock costs, the multiple may be warranted. We'll have a more in-depth look at CVR's cost structure and risk profile in a future report.

Sustaining CAPEX spending for general maintenance was a relatively subdued $0.8 million in Q3 and $3.0 million in Q2. Major CAPEX spending of $68 million on the UAN upgrade project has already been funded with $125 million in debt, and CVR ended the third quarter with $229.8 million in cash on the balance sheet.

The CVR Partners policy is to pay out all available cash flow after CAPEX requirements and in spite of the cash on the balance sheet, its distribution is sensitive to price realizations and volumes of fertilizer sold, as well as significant direct operating costs to operate the gasification units. The CVR business model includes a low cost of product sold based on cheap petroleum coke feedstocks available from the affiliated refinery, with little sensitivity to natural gas prices.

Disclosure: I am long UAN, CF.

Disclaimer: The information above was disseminated to clients and subscribers of The BCMI Report and/or The BCMI Flash anywhere from 12-48 hours before appearing on Seeking Alpha.