Why there’s not Much Room for Upside in this Fertilizer Stock
Neha is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The fertilizer industry is proving to be one of the most resilient of all. But when most players are churning out impressive numbers one after the other, there’s one company that isn’t really going to the dance despite dealing in top nutrient nitrogen—CVR Partners (NYSE: UAN).
Revenue remained almost flat at around $81 million, while net profit slipped 8% from the year-ago quarter as production costs and operating expenses rose.
Demand is not a problem for the company, as it is able to sell off almost all that it produces. So while other players are raking in the moola, why is CVR lagging behind? I see two reasons behind it—one, CVR is unable to take advantage of low input costs unlike peers; and two, being a much smaller player, CVR’s production volume is nowhere near to what a nitrogen king like CF Industries (NYSE: CF) can attain.
Gain or pain?
How things can change in a matter of months! What looked like a definite advantage for CVR till last year is now eating into its profits. CVR is the only North American company that uses pet coke as feedstock instead of natural gas. Pet coke has historically been a cheaper alternative to gas, protecting the company from wild gas price swings. But as natural gas prices dipped, the charm faded.
While peers are making the most of cheap gas costs, CVR is actually shelling out more for coke than it did last year. PotashCorp’s (NYSE: POT) nitrogen division’s gross margin hit record high during its second quarter driven by low gas prices. Similarly, gross margins in CF’s nitrogen division jumped from 52% a year ago to 66% in its second quarter thanks to the gas advantage. Sadly, CVR has no such story to tell. Pet coke cost it $1 more during the second quarter compared to last year. Only the gap wasn’t as pronounced as it was in the first quarter when CVR paid nearly thrice of what it had last year.
Prices of pet coke seem to be easing though—while CVR paid $42 per ton in the first quarter, it was $31 per ton in the second. This is good news no doubt, but not as great because peers will have the advantage as long as gas prices remain low. Things get worse for CVR as it is a relatively new entrant to the market and cannot afford to lose competitiveness when making a mark is what it wants to do.
Better days in 2013
The second half of the year shouldn’t be tough for CVR as far as sales are concerned. The company apparently has already booked orders for almost all that it will produce in the next two quarters. Yet sales volumes are likely to be ‘pretty similar’ to that of last year, which doesn’t sound too encouraging.
I am expecting production at CVR to buck up from next year onwards once its urea ammonium nitrate expansion project is complete. It’s a critical project that should add significant value to CVR’s business. Once completed, the company will be able to convert almost the entire ammonia it produces to the more profitable nutrient UAN, taking its total annual UAN capacity up by almost 50%.
Shifting focus to UAN probably makes sense, as other players are doing it too. CF recently started upgrading an additional 200,000 tons of ammonia annually to UAN, and might consider more on this front. On similar lines, pure nitrogen play Rentech Nitrogen Partners (NYSE: RNF) too seems to be paying more attention to converting ammonia to UAN due to increase profitability. It upgraded 44% of it during the first quarter.
As for CVR, it is already upgrading nearly 70% currently, and as mentioned earlier, is targeting 100% conversion rates in the long run. With prices of UAN much higher than other nutrients like ammonia, this move should result in higher profits and thus higher dividend distributions. Hopefully, we should be able to see this coming through next year.
The Foolish bottom line
As of now, there doesn’t seem to be much room for an upside in CVR’s business or its stock prices. Trading at a trailing P/E of 15, a forward P/E of around 14.5 indicates much of the expected future growth has already been factored in its share prices.
If anyone wants to gain from corn at this point of time, CF is definitely a much better bet on all fronts—it dominates the nitrogen market and is currently trading at a P/E that’s almost half that of CVR. The only brownie point CVR earns over CF is for its awesome dividend yield of 9.8%, way above CF’s measly yield of 0.8% and even more than CF's subsidiary Terra Nitrogen’s (NYSE: TNH) yield of 7%. Both CVR and Terra are master limited partnership structures that enable them to pass on any taxable income directly to shareholders in the form of dividends. But remember—such high dividends might not be sustainable in the longer run.
Keep following me for updates, analysis and news on CVR Partners and its peers as they get bigger and better.
Neha Chamaria has no positions in the stocks mentioned above. The Motley Fool owns shares of CF Industries Holdings. Motley Fool newsletter services recommend PotashCorp. 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.