Greed In Times Of Fear: The Case Of Terra Nitrogen
October 3, 2017

There is little glamour in the business of fertilizing soil. The product, whether it be ammonia or nitrate solutions, is a commodity. There are many competitors, both inside and outside of America, that demonstrate a similar industrial capacity. Buyers are known to be thrifty and bargain-hunters and over the past decade the industry has seen a higher level of scrutiny and red tape by governmental agencies. 

In short, if you are in the business of selling soil nutrients, you are most likely not bragging about it over a cocktail party. But that doesn't mean it is an unimportant industry in the present nor an unprofitable enterprise in the future.

Two are two “big picture” reasons for an expected future increase in demand. First, the more people live on planet earth, the more food will need to be extracted from the ground. Second, as developing countries become wealthier, the appetite for a protein-based diet will continue to increase.  

But capital markets see things differently. Over the past five years, the valuation of companies in the fertilizer industry have lost significant market value. Here are a few notable examples: CV Partners (UAN) declined to $3 from $26; Mosaic Company (MOS) declined to $21 from $59; Potash Corporation of Saskatchewan (POS) declined to $19 from $43 and Terra Nitrogen Company (TNH) declined to $80 from $216. 

When capital markets are fearful about an industry’s outlook is when I typically become greedy. So, last week, I decided to purchase a position a company that operates in the fertilizer industry (my dear friend, Tomer Kilchevsky, who has committed to a chemical-free-vegan-only-lifestyle would be disgusted by my decision). 

But I knew little about the industry and even less about its competitive landscape, so I decided to purchase a position using a six-rule formula. Here it is:   

1. Adequate size, greater than $100 million in market capitalization.

2. Sufficient financial condition, working capital ratio greater than 1.5 times.

3. A consistent dividend record over the past decade.

4. No earnings deficit over the past decade.

5. 10-year growth rate of at least a third.

6. No more than 15x the average three-year earnings per share 

Only Terra Nitrogen met the criteria. Market capitalization was about $1.50 billion. Current assets to current liabilities ratio was 1.90 times. The company had not skipped a beat, and paid dividends to its shareholders (or unit holders to be exact) over the past decade. 

Terra Nitrogen had positive earnings throughout the past decade and grew earnings to $9.90 (the earnings average from 2016 to 2014) compared to the three-year average earnings of $2.61 (the earnings average from years 2006 to 2004). And at current valuation of about $80 per share, I paid 11 times the 2016 earnings per share.

After purchasing a few shares of Terra Nitrogen, I read some of the public disclosures. I learned that 2016 earnings were much lower compared to earnings over the past five years. But once I included capital expenditures as an expense item, 2016, on a five-year outlook, appeared to be just an average year. 

Specifically, if you had looked back five years, the lowest earnings reported were $10.06, compared to the 2016 earnings of $7.56. But if you had looked back five years at the earnings-after-capital-expenditures, the lowest earning reported was in 2013, with $3.62 earnings per share, while in 2016, the earnings after capital expenditures were $6.57. 

Before I leave you to research the company and the industry on your own, let me comment on the use of capital expenditures. While the income statement excludes the expense with the dreary title of "additions to property, plant and equipment" (which can be found on page 38 of the 2016 annual report), in the particular case of Terra Nitrogen, capital expenditures are meaningful as they reduced – and will continue to reduce - about 30% of earnings available to common unit holders. 

On a current purchase price of $80, I expect the earnings-after-capital-expenditures yield to be about 8%, a reasonable yield in my opinion.

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After thoughts: Over the next few months, I will write more about Terra Nitrogen's income statement, balance sheet and corporate capitalization. And if you think the latter is a dull and archaic topic, I will have you know that Terra Nitrogen’s  had the same amount of shares outstanding in 2016 as it did in 2007. 

An Oscar-award-shareholder-friendly-act if there was one to dedicate to corporate decisions. If you would like to be notified when I post articles, click on the orange button at the top of this page.

In the meantime, there is plenty to read about Terra Nitrogen and the fertilizer industry on Seeking Alpha. Bob Ciura in "Terra Nitrogen: Feeding The World With Fertilizer, Feeding Investors With An 8% Dividend Yield," shares my view that capital markets may change their opinion of the firm in the future. John P. Reese, in "As Inflation Looms, These Commodity Stocks Could Shine," discusses how the relationship between a commodity price and inflation may affect companies like Terra Nitrogen.

 I would also suggest reading about the industry's primary cost component: energy. For that, I would suggest that you start your reading with the article "Energy Recap: 'Breaking Clean,'” written by Seeking Alpha's own editor, Michael Crini.

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