UAN-a Grow Your Portfolio?

Maxxwell A.R. is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The world population is expected to rise to 7.5 billion by 2020. The United Nations predicts those extra 500 million mouths – plus larger appetites in emerging markets – will increase food prices up to 40%. While that figure may be disputed, one thing is certain: the world’s farms will need to plant and harvest increasing numbers of crops to keep pace. The industry that has the most to gain from the inevitable trend is fertilizer producers, particularly nitrogen-infused fertilizer producers. My favorite company in this space is CVR Partners LP (NYSE: UAN).

Feedstock advantage

All nitrogen producers stand to benefit from short term trends. Thanks to the record drought this year, domestic corn inventories are severely depleted. Throw in a shortage in U.S. nitrogen supply – 54% (10.79 million tons) of consumption was imported in 2011 – and it isn’t difficult to see why fertilizer prices will appreciate.

The difference in margins enjoyed throughout the industry could be decided by which feedstock a company uses. Currently, most of the industry uses low-cost natural gas. Lower prices in 2012 lead to positive earnings growth for CF Industries (NYSE: CF) and Terra Nitrogren (NYSE: TNH), which are much, much larger than CVR Partners.

Eventually, however, natural gas prices will increase and slash margins throughout the fertilizer industry. That won’t affect CVR Partners, however, which instead uses pet coke supplied mostly (70%) from the adjacent facilities of its parent CVR Energy (NYSE: CVI). Even today, pet coke is cheaper than natural gas on an energy basis and is in constant supply as a byproduct of oil refineries. Better yet, year over year prices fell 30% to $30 per ton. Take that, natural gas!

<img src="/media/images/user_6293/uanprocess_large_1_large.PNG" />

This is CVR Partners’ process for making urea-ammonium-nitrate (UAN). See the full animation here. Source: CVR Partners

It’s that time of (every two) year again…

CVR Partners shut down their facility for roughly 3 weeks in October for a planned biannual turnaround, which is scheduled maintenance to restore process streams back to full uptime. Management planned ahead for the downtime by increasing inventory 36.8% since January. However, with only one facility in operation, the company will suffer from having no production for 23.1% of the fourth quarter.

Fertilizer giant Agrium (NYSE: AGU) recently missed EPS estimates by 39% after experiencing significant downtime and market headwinds. Luckily, analysts are factoring that in by only calling for CVR to hit $0.22 EPS for 4Q 2012 – a sharp drop from last year’s $0.56. The good news for investors is that the next turnaround won’t occur until 4Q 2014.

When good isn’t good enough

The upside to only having one production facility is that the only way to go is up! The company has spent $130 million on an expansion project that will come online at the beginning of next year. CVR will be able to produce 50% more product and be able to convert all ammonia into higher-valued urea-ammonium-nitrate (UAN). In 2011 the company converted only 72% of its ammonia into UAN (1 ton ammonia = 2.42 tons UAN). The nearly $60 million in additional annual net income that will come from the expansion makes the $130 million investment look like a no-brainer.

Seizing future opportunities

With the plant expansion nearly behind it the company is seeking to grow its business by diversifying revenue sources. One product being considered is Diesel Exhaust Fluid (DEF), which consists of 32.5% urea. The additive reduces NOx emissions and increases fuel efficiency – a major agenda item for the White House and the EPA. In fact, the North American DEF market is expected to grow to 1.2 billion tons by 2019, making it the largest in the world. CVR Partners estimates that the accessible local market for DEF is between 75,000 and 100,000 tons per year – a $49 million to $65 million opportunity.

Optimizing selling prices is also a priority for management. The company recently completed an off-site storage distribution facility in Phillpsburg, Kansas that will be available for orders in 1Q 2013. This site, and future planned sites, will take advantage of differences in fertilizer prices between regions. For instance, nitrogen prices per ton are nearly $25 (8.6%) more in the Corn Belt than in the Gulf Coast region.

Foolish bottom line

The management team goes above and beyond to fulfill its fiscal responsibility to shareholders by:

  1. Maintaining a healthy balance sheet. The company finished 3Q 2012 with $180.3 million in cash and $125 million in debt. While cash decreased by 29.5% ($75.22 million) since 3Q 2011, shareholder equity has only slipped 4.8% ($23.33 million). Most of the cash spent can be traced back to the plant expansion, which has yet to generate income. Patient investors should be rewarded.
  2. Growing its annual distribution. Although it has had a short life on the public market, CVR’s focus on growth will lead to increases of share price and distribution payouts. Shareholders could enjoy an increase of $0.50 (27%) to the 2013 distribution as a result of the expanded capacity and absence of a turnaround. Record low corn inventory at the end of 2012 could continue to push fertilizer prices upwards as another record crop is expected in 2013, which would lift the distribution even higher.

In short, I believe this is one of the best-managed companies you can possibly own. I started a small position ($1,000) at $20.46 per share shortly after the IPO. I will be looking to add another $2,000 to my portfolio in the first half of next year. 

Follow me on Twitter to keep up with my future posts on energy, sustainable chemicals, and undervalued growth companies @BlacknGoldFool.

Make better investments with science.


BlacknGold owns shares of CVR Partners, LP. The Motley Fool owns shares of CF Industries Holdings. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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