Master limited partnership Terra Nitrogen Co. LP (NYSE: TNH), a recently acquired and wholly owned subsidiary of CF Industries Holdings (NYSE: CF), manufactures and distributes the nitrogen products farmers need to grow crops that directly or indirectly feed the world. TNH is a major US producer of nitrogen fertilizer products, with its primary manufacturing facility located in Oklahoma and two terminals in Nebraska and Illinois.
TNH has the capacity to annually produce 1.1 million tons of ammonia, the basic ingredient for most nitrogen fertilizers and many industrial products. It can also produce 2 million tons of TerraSol, its proprietary brand of urea ammonium nitrate solutions (UAN), each year. UAN is the most versatile fertilizer.
The more corn, soybeans, and wheat planted, the more demand rises for nitrogen-based fertilizer. Corn and soybean planting have risen 10% or more for the past two years as ethanol mandates kicked in. So, Terra is well positioned for fast-growing demand, relatively calm manufacturing costs, and less competition from imports.
Demand for nitrogen products continually increases, as the population grows and rising standards of living increase the demand for higher-protein food. Every year that you plant corn, wheat, or other high-yield crops, you must fertilize to replace the nitrogen in the ground.
Farming experts expect strong demand for fall fertilizer programs and nitrogen prices to remain seasonally firm. Corn futures continue at levels that should encourage farmers to devote much of their planted acreage to corn next spring. That means more nitrogen-based fertilizer will be needed.
Second-quarter results for TNH were up nicely. The partnership posted net income of $66.7 million for the quarter, versus $60.8 million for the same period a year ago. They also announced a cash distribution of $2.36 per share that was paid on August 28th. The current payout ratio for TNH is 89%, which means the partnership is more than earning the amount paid out to unit holders, while having enough surplus cash to grow the business.
Despite the excessive rains in Iowa, this year’s US corn crop looks like it will break both yield and production records, according to the US Department of Agriculture’s first official estimate for 2010 in its August Crop Production Report.
But the price of natural gas is the single most important factor that affects TNH’s profitability. Natural gas costs accounted for about 64% of the partnership’s total costs and expenses, and currently 23% of their forward purchases are hedged. Natural gas prices have been in a prolonged bear market, staying below $4.00 per thousand cubic feet, thanks to overly abundant domestic reserves. Because it’s the single largest input to TNH’s business, profit margins should remain strong.
Buy TNH up to $95 to lock in a 10.12% distribution yield. I love knowing management owns 75% of the partnership. I’m looking for the stock to trade north of $120 in the next year.
As of this writing, Bryan Perry was recommending Terra Nitrogen Co. in his Cash Machine newsletter.
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