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

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.


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.

$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.

$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.

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.


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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