Terra Nitrogen (TNH) - Analysis And Thoughts

(source: dividend.com)

In a market that has run up as much as our current one it is difficult to find good investment opportunities; well priced dividend stocks are even more difficult to come across as they need to represent a good value and represent a safety net against increases in the federal funds rate. TNH is one of the best priced dividend stocks that I know of, and one my personal holdings. Below is my analysis of the company.

Business

Its really simple. They make and sell two products that have a whole bunch of nitrogen in them. The products are anhydrous ammonia (ammonia) and urea ammonium nitrate solutions (UAN), both of which are made at a plant in Oklahoma. Numerical Breakdowns of Revenues are as follows

Product	2012 Revenues	2011 Revenues	2010 Revenues
Ammonia	$204.3	$182.4	$123.7
UAN	$571.2	$613.8	$377.3

There was a tiny bit of nitric acid sold but it was under 1% of revenues every year so I am ignoring it.

Total tons of each product produced followed an identical trend: low in 2010, highest in 2011 and slightly reduced in 2012. the changes, however, are not huge (on the order of 0.5% a year or so.

Their products are sold exclusively to their parent company's affiliate, CF Industries. This is CF's MO. This adds some risk, however CF Industries is a large ($10B), very stable company and This makes TNH's revenues reasonably safe, in the author's opinion. Additionally, before 2011 TNH was very successful selling their products to more than just their parent company, so if something happened to their buyer the business would not be substantially hurt. When analyzing this it is important to remember that their product is a commodity which means that buyers simply care about price, and will buy whatever has the best price they can find.

Growth

They have two stable products and production for the moment is not going much of anywhere. So, assuming they don't any trouble selling their products, their income will be purely a function of the price of UAN and Ammonia and their inputs (primarily natural gas).

Over the past few years natural gas has tanked and crop (and thus fertilizer) prices have gone up substantially. This has put TNH in a sweet spot that has allowed revenues to grow substantially. Since 2005 revenues have risen a tidy 71% (from $455.52 Mil to $780.10 Mil). This followed about 30 years of falling food prices and this sort of growth is probably not replicable.

Neither is the collapse in natural gas prices, which fell from about $7 to $3.77 now. That sort of fall is not replicable, both because natural gas' supply boost has already been factored in and because it is pretty hard for something priced at $3.77 to fall $4.23.

What can we expect from the future? Based on the most recent annual energy outlook for natural gas from the EIA the price is expected to remain at around $4 for the next decade or so, increasing slowly. Futures based projected prices for agricultural products from the USDA shows very slight declines in price across the board for corn, soybeans and wheat.

Over the long run, supply-demand fundamentals dictate that both commodities will rise in price. For natural gas it may take some time due to the abundance of shale gas now available thanks to new technology, however we do have a limited supply of gas and an ever increasing demand for what is seen as a green fuel and a cheap, clean alternative to coal and oil in power generation across the US. Further the recent development of LNG terminals will boost international demand for domestic gas, raising the overall price. As this graphic will indicate our natural gas price is exceptionally low compared to the rest of the world so we will see some upward movement due to the balancing of prices from exports.

Agriculture will go up for one very simple reason: the addition of more people. The world population is growing. I think most people have read, or read about, the UN global population projections so I am not going to bother linking/quoting them. We also know that basically all the good quality arable land in the world is currently in agricultural production (some marginal land is still available to be used, however it is unlikely that this can boost food production significantly compared to population increases).

For a long term forecast of natural gas see the EIA link. For agriculture, good luck. If you find a quality report with any sort of accurate, intelligent predictions for the next decade or beyond, let me know.

What Is a Reasonable Value for the Company?

According to YCharts, dividend yield on TNH has been steady around 8% for the past few years. (see chart here). As per the above there is no reason for the dividend to change significantly going forward. This measure suggests the company is pretty fairly valued.

As far as growth goes the company absolutely has the ability to grow. They have a disgustingly high return on invested capital and return on assets (its about 360% now). They have no debt and every ability to grow. The only thing holding them back is management, and of course CF Industries. The management is horrendous at working to create additional shareholder value and would do well to make significant moves. They claim that they have $75m of CAPEX planned, however the majority of that is focused on increasing storage capacity and maintenance of systems, etc. The only truly growth oriented spending is to increase the size of the rail yard and their plant. That isn't exactly impressive. I think we can expect to see the company grow at a very slow pace going forward.

So far I see no reason for valuation to differ from the present value significantly.

Does Anyone See Something Different?

No analysts cover the company, so I will look to private investors for this. An article written on June 20 at SeekingAlpha goes into great detail about how the company is, in essence, owned by CF Industries. I did not mention this much as, while CF Industries owns and controls the company, and takes a lot of the profits, this is unlikely to change and laws in place state that if it does CF Industries must pay investors a fair price for the purchase of their shares. I don't see it as having a reasonable chance of affecting the stock price so I have largely ignored this fact. The author also assumes a 10% growth rate going forward, however I cannot agree with his assumption that increased storage capacity & efficiency in spending in rail lines is sufficient to drive significant growth.

Over at Motley Fool CAPS a couple highly ranked members have posted that they think demand for fertilizer will rise and the price is undervalued. I can't see any evidence of this.

What This Means

So, TNH is stuck in a zone where its major input and market are moving in similar directions at a similar time, for the foreseeable future. Should these conditions continue to hold we will need to know the magnitude and time of long term agricultural prices movements. Without this we can simply state that both products are moving in tandem and until more evidence becomes available (or TNH actually decides to grow in a serious way) it appears that TNH will be stuck in the same general price range.

Bought at the current price you would get a 7.7% dividend (based on TTM dividend payments). I am not especially excited about the company but I see it as a potential source of a fairly safe return, for the time being, with some potential upside that others see (although I do not).

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Disclosure: I am long TNH.