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Long Term Investing in Fertilizer: Terra Nitrogen Company, L.P. (TNH), Agrium Inc. (USA) (AGU)

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Food producers are perhaps one of the best investments anyone can make. But in my opinion, fertilizer is the second best choice, since you need it to grow that food in the first place.

Fertilizer companies are split into two main camps, the nitrogen names such as Terra Nitrogen Company, L.P. (NYSE:TNH) and Agrium Inc. (NYSE:AGU) , which are reporting record earnings thanks to continually depressed natural gas prices. Then there are the potash names, such as

Potash Corp./Saskatchewan (USA)(NYSE:POT) and Mosaic Co (NYSE:MOS), which are reporting significantly lower earnings thanks to low potash prices. (Potash companies usually have a monopoly over potash mines, since they sell their potash from these mines at lower prices they make less profit.)

Fertilizer names that rely on natural gas have been reaching record high valuations as the price of natural gas falls. The cost of natural gas can account for up to 80% of the production cost of nitrogen-based fertilizer.

Where to invest?

Based on the current market, a nitrogen-producing stock would be your best bet. In addition, nitrogen fertilizer has to be constantly re-spread, unlike potash, which can be mixed into the soil and left for an extended period. Thus, buyers will tend to buy more nitrogen-based fertilizer.

In the chart below, we’ve listed the difference in company structures because master limited partnerships must distribute 90% of their income to partners. They also come with their own set of tax issues compared to regular stocks.

Company Company structure Nitrogen/potash based Market Cap 5-yr EPS Growth P/E Yield
Terra Nitrogen Master Limited Partnership Nitrogen $4.4B 44% 14.6 6%
CF Industries (NYSE:CF) Incorporated Company Nitrogen + Potash $13B 105% 7.5 0.8%
Agrium Incorporated Company Nitrogen $16B 97% 12 0.9%
CVR Partners Master Limited Partnership Nitrogen $2B 55% 13.6 3%
PotashCorp Incorporated Company Potash $35B 17% 17 2.8%
Mosaic Incorporated Company Potash $25B 36% 14 1.7%
Average 59% 13 2.5%

Out of these six producers, I am going to look at three closely.

Terra Nitrogen Company, L.P. (NYSE:TNH) is the highest-yielding, thanks to its master limited partnership structure. The company has produced below-average EPS growth for the past five years, and is a nitrogen focused producer.

CF Industries has achieved the best EPS growth over the past five years. The company produces fertilizer from both and nitrogen and potash, and currently has the lowest P/E ratio in the group.

Agrium Inc. (USA) (NYSE:AGU) has achieved the second-highest EPS growth over the past five years. The company is the second cheapest in the group by P/E ratio, and is another nitrogen-based producer.

Margins

The three companies I am looking at are all nitrogen-based producers. One of the reasons they have been so successful over the past five years is because of their profit margins and highly cash-generative nature.

Terra Nitrogen Company, L.P. (NYSE:TNH) has achieved the best profit margins over the past few years. The gradual decline in the price of natural gas since 2009 has meant that net margins have grown every year consistently since 2009.

As the smallest of the three, Terra Nitrogen Company, L.P. (NYSE:TNH) has the lowest costs, translating directly into larger profits. In comparison, Agrium Inc. (USA) (NYSE:AGU), the largest of the three, has the lowest net profit margin, due to higher admin and sales costs.

TNH
$US Millions 2009 2010 2011 Q1 2012 Q2 2012 Q3 2012
Revenue 508 565 799 197 196 181
Gross profit 178 231 556 152 159 139
Margin 35.00% 40.90% 69.63% 77.20% 81.40% 76.90%
Net Profit 144 200 505 124 153 131
Margin 28.40% 35.40% 63.28% 63.10% 78.40% 72.10%

The table shows the profit margins that Terra Nitrogen Company, L.P. (NYSE:TNH) is managing to achieve, partly thanks to its relatively small size and partly thanks to low natural gas prices. Terra’s margins have steadily increased since 2009 as the price of natural gas fell. Indeed, these high gross margins have flowed through onto the company’s net margin making Terra by far the most efficient company of the group.

AGRIUM
$US Millions 2009 2010 2011 Q1 2012 Q2 2012 Q3 2012
Revenue 10,411 10,836 15245 3,634 6,907 2,949
Gross profit 2,250 2,942 4654 892 2,002 920
Margin 21.60% 27.10% 30.88% 24.60% 29.00% 31.20%
Net Profit 416 735 1348 155 869 128
Margin 4.00% 6.80% 8.20% 4.30% 12.60% 4.40%

Agrium Inc. (USA) (NYSE:AGU), unlike Terra produces a wide variety of fertilizer products. Unfortunately, this has translated into lower gross and net margins for the business. In addition, due to Agrium Inc. (USA) (NYSE:AGU)’s size, the company has higher management costs, which reduce net margins even more.

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