Are You Aware of the Big Risks Associated With This Stock?
Neha is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Numbers that missed the Street estimates, earnings projections that failed to inspire, and dividend guidance that stumped investors – Is the tide turning against Rentech Nitrogen (NYSE: RNF)? Investors cheered when the fertilizer maker’s stock crossed the $49 mark in early February. The euphoria didn't last long – The stock has lost 27% since then.
A lower dividend in 2013 is a concern, but are there bigger dangers lurking ahead for the company, and investors alike?
Waiting to back off
The big drop in Rentech’s stock price can be explained by two things. Despite being among the smallest players in its industry, Rentech outperformed peers last year. Between January and December 2012, Rentech’s stock had more than doubled. The next best, Agrium, was way behind with 40% returns. Rentech didn’t do anything magical to justify this rally. To cut the long story short, profit taking must have occupied investors’ minds.
Investors were pressed further when Rentech lowered its 2013 distribution guidance last month. Now the dividend is probably the biggest factor that draws investors to Rentech, or to any other master limited partnership structured company. Rentech expects to distribute dividends to the tune of $101 million, or $2.60 per share in 2013, citing the negative impact of scheduled plant outages as the primary reason. That compares to $3.30 per share paid out in 2012.
That’s probably the biggest risk of investing in an MLP – payouts can be volatile. With Rentech, there are other things as well investors should take note of.
Rentech generated $75 million in free cash flow over the past four quarters, but paid out $119 million as dividends. So it is actually burning cash a lot faster than it generates -- a typical yellow flag situation. Peer MLPs have similar stories to share, but one of them is in better stead. CVR Partners (NYSE: UAN) returned $112 million as dividends to shareholders in the last twelve months, but raked up just $51 million of cash flow. That takes its free cash flow payout ratio to more than 200%, which is scary. Terra Nitrogen (NYSE: TNH), on the other hand, is taking it a little easy -- Its cash payout ratio for the past year stood at 106%. Not comfortable, but not as bad as the other two either.
If most MLPs follow a policy of paying out whatever cash they generate as dividends, where does financing for growth come from? Debt is the route they usually opt for, and Rentech is doing just that.
Pressure in sight
Rentech expects maintenance at its two facilities in East Dubuque and Pasadena to together cost around $16 million this year, which will be funded out of operating cash. But to fund the remaining projected $55 million capital expenditure for the first facility and more than $30 million for the second, Rentech wants to borrow.
The problem is that following the recent acquisition of ammonium sulfate specialist Agrifos, Rentech has already added significant debt to its books. From being debt free in 2011, Rentech went on to report $193 million debt as on Dec 31, 2012. Higher debt also means increased interest burden, which ultimately reduces the cash available for distribution. Unfortunately, Rentech’s free cash flow hasn’t quite kept pace with the rise in debt. It was $66 million in 2011 and $75 million in 2012.
CVR took on heavy debt in 2011, but didn’t add anything last year. While that sounds good, Its FCF slipped 57% year over year partly because of plant outages, prompting the company to lower dividends last year. Comparatively, Terra is debt free and is also not burning down cash as fast. What truly works in Terra’s favor is that it has the solid backing of the leader in nitrogen nutrient, CF Industries (NYSE: CF). CF owns 75% of Terra, and everything that Terra produces is sold through the parent company. In return, CF provides major services including production and manufacturing planning, administrative services, accounting, investor relations, etc. So in a way, it’s CF that makes sure that Terra runs efficiently.
Need to buck up
CF itself distributed only 18% of its cash flow last year, keeping the rest for investments in growth projects. Agrium sports a better dividend yield than CF at 2% despite paying out just 14% of FCF in dividend checks last year. Stocks of both companies climbed more than 30% last year. So dividend yields can be decent even with low payouts. Agrium gets a brownie point because its FCF has grown phenomenally in recent years – From negative cash flows in 2010; it swung to $568 million FCF in 2011 and upped it further to $837 million last year.
With such bigger companies sporting better financials, Rentech’s rising debt is getting me a little jittery. Investors should also know that aside from debt, Rentech is also considering issuing additional equity. In fact, a part of the Agrifos acquisition was funded through this route. As equity gets diluted, dividends are distributed over a larger share base, leaving each shareholder with a lesser amount. If Rentech’s cash doesn’t flow strong enough to support higher debt, future dividends may find it hard to grow as well.
The Foolish bottom line
It’s great to see hefty dividend checks in your mail boxes, but whether they will keep coming is what you should carefully weigh before investing in dividend stocks. Rentech’s cash flows aren’t particularly strong, and investors already know they shouldn’t expect great dividends this year.
Though that doesn’t mean you should pull out of Rentech yet. The company has some great growth projects underway which should keep the momentum alive, provided it capitalizes on the opportunities well. Stay tuned as I tell you more about the top opportunities Rentech can bank on in the near future. To make sure you do not miss it, add Rentech Nitrogen to your stock watchlist. Click here to add it.
Neha Chamaria has no position in any stocks mentioned. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!