Saturday, April 18, 2009

Volume 3, Issue #29

Also in Today's Issue...

Terra Nitrogen (NYSE: TNH) produces ammonia and nitrates used in agricultural crop fertilizers. Its assets consist of a nitrogen plant in Oklahoma and storage terminals in Nebraska and Illinois. Products are sold wholesale to chemical firms, farm dealers, and national retail chains in the central and southern US. Structured as a master limited partnership, TNH is managed and capitalized by global fertilizer-maker Terra Industries (NYSE: TRA), which owns 75.3% of the units (MLP shares).

As an MLP, Terra Nitrogen is legally required to pass along at least 90% of its taxable income to partners (MLP shareholders) to avoid paying corporate income taxes. In addition, the partnership agreement with the general partner requires the company to distribute 100% of available cash to partners. The amount of income and cash varies from quarter to quarter, and so do total payouts. Still, over the past five years, payouts have grown a remarkable +762% from $1.75 a unit in 2004 to $15.08 a unit in 2008.

In the last four quarters, TNH's distribution varied from $4.20 per unit, to $3.63, to $2.80, back up to $2.97. That equates to $13.60 per unit annually and gives an historical yield of 10.3%. Annualizing the last payment of $2.97 gives almost as rich a current yield of 9.0%.

Most of the payout consists of cash flow, which counts as tax deferred return of capital. The income portion as taxable at your ordinary income tax rate and so is the cash portion but not until you sell the units. However, MLPs are best held outside a tax-deferred IRA type of account due to certain tax complexities. There's no dividend reinvestment plan for TNH.

The company has profited from low natural gas prices and high nitrogen fertilizer prices. In 2007, the price of natural gas, used in making TNH's nitrogen fertilizer products, accounted for some 64% of total expenses. The selling price of the company's nitrogen fertilizer products, which is influenced by global supply/demand balance, also affects profits. Full-year 2008 earnings rose +37% over the previous year to $14.90 per unit, mainly on higher selling prices. 

In the coming year, we expect the trends that emerged over the past year to remain largely in place but the global economic slowdown may prove a mixed blessing. It will likely create some weakness in nitrogen demand that could pressure sales volumes and selling prices while also keeping a lid on natural gas costs.

A more immediate headwind, however, relates to the three-way battle between parent Terra Industries and rival fertilizer makers CF Industries (NYSE: CF) and Agrium (NYSE: AGU). In January, CF made a hostile all-stock take-over bid for Terra valued at around $20 per share. Terra directors unanimously voted against the deal and urged investors to reject the offer. Reportedly, under Iowa laws, CF can't close an acquisition of Iowa-based Terra without approval from Terra's board.

A month later, rival fertilizer maker Agrium (NYSE: AGU) made a competing bid for CF Industries. CF's board rejected the bid and on March 9th, CF upped the ante for Terra, offering between $25.42 and $27.94 per Terra share, based on Terra's closing share prices. The final outcome may or may not be favorable for Terra Nitrogen, but so far investors appear unfazed. The units have more than doubled in value, rising from their October low of $65.20 to today's price of $132.04

Good Investing!

--Carla Pasternak
Editor
High-Yield Investing
 

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