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

CF
$US
Millions
2009 2010 2011 Q1 2012 Q2 2012 Q3 2012
Revenue 2,608 3,965 6098 1,528 1,736 1,359
Gross profit 1,028 1,618 3420 913 1,130 791
Margin 39.40% 40.80% 55.90% 59.70% 65.10% 58.20%
Net Profit 449 441 1761 432 678 458
Margin 17.20% 11.10% 28.73% 28.30% 39.10% 33.70%

CF Industries is a potash- and nitrogen-based producer, which gives the company the best of both worlds and perhaps the most flexibility and security. In addition, Terra Nitrogen is an indirect, wholly owned subsidiary of CF Industries, so CF gains some of Terra’s strong cash flow.

As the table shows, CF produces gross margins of around 60%, up from 40% in 2009 thanks to natural gas prices. Unlike Agrium Inc. (USA) (NYSE:AGU), CF manages to translate the majority of its gross profit into net profit, making the company look highly cash generative.

Return on Shareholder Equity

Return on shareholder equity is a good measure of how profitable a company is, and how good the management is at improving the balance sheet. Return on shareholder equity also highlights how efficient the company is, and what kind of return on investment shareholders can expect.

Terra Nitrogen is by far the best here. The company’s cash-producing operations have allowed the management to build its net cash balance, while still spending on capital expenditures.

However, over the past five years, both Agrium and CF have managed to produce a ROE of about 4% per year. Indeed, Mosaic and PotashCorp — the potash producers who have underperformed with other valuation metrics — produced an average ROE of 5.5% for the same period. Although these nitrogen producers have grown more quickly, they have not been able to utilize their free cash as well as the potash producers.

Cash Flows

Cash flow statements for fiscal 2012

$US Millions Terra Nitrogen CF Industries Agrium
Operating Cash Flow 425 1953 1112
Investing Cash Flow -22 -220 -925
Dividends -422 -77 -42
Issuance/(Reduction) of Debt, Net 0 -13 387
Change in Capital Stock 0 -489.3 8
Net Change in Cash -20 1014 514
Net Cash/Debt 160 -610 -1000

Terra Nitrogen once again has the winning cash flow. As I have already mentioned, the company is a limited partnership, therefore it returns the majority (90%) of its profit to shareholders through dividends or cash distributions. Terra Nitrogen is the only business in this analysis that has a net cash balance.

That said, CF industries has a solid cash flow and is returning cash to shareholders through both dividends and stock buybacks. Even so, CF still has cash to spare, and a net change in cash of $1 billion over 2012 has allowed the company to work on reducing net debt.

Agrium is at the back of the group once again. The company is using the majority of its operating cash flow on investing, and as a result, it’s having to issue debt to remain cash flow-positive. In addition, the company pays the smallest dividend (by dollar volume) in the group.

Conclusion

Overall, the best fertilizer company appears to be Terra Nitrogen, despite being the smallest. Terra has the best margins, has produced the best return on equity and has plenty of free cash, which is has to return to shareholders or re-invested due to its partnership structure.

However, I am hesitant about Terra’s size, and the fact that the company only has one manufacturing facility.

CF industries came out as the next best company in this group, and it’s a major shareholder of Terra Nitrogen. So, on that basis, I believe CF industries could be the best company of this group, both for economies of scale and its holding in Terra Nitrogen.

The article Long Term Investing in Fertilizer originally appeared on Fool.com and is written by Rupert Hargreaves

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