Terra Nitrogen Company, L.P. (TNH): Is This Stock Destined for Greatness?

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Investors love stocks that consistently beat the Street without getting ahead of their fundamentals and risking a meltdown. The best stocks offer sustainable market-beating gains, with robust and improving financial metrics that support strong price growth. Does Terra Nitrogen Company, L.P.
(NYSE:TNH) fit the bill? Let’s look at what its recent results tell us about its potential for future gains.

What we’re looking for
The graphs you’re about to see tell Terra Nitrogen Company, L.P. (NYSE:TNH)’s story, and we’ll be grading the quality of that story in several ways:

Growth: Are profits, margins, and free cash flow all increasing?

Valuation: Is share price growing in line with earnings per share?

Opportunities: Is return on equity increasing while debt to equity declines?

Dividends: Are dividends consistently growing in a sustainable way?

What the numbers tell you
Now, let’s take a look at Terra’s key statistics:

TNH Total Return Price Chart

TNH Total Return Price data by YCharts.

Passing Criteria 3-Year* Change Grade
Revenue growth > 30% 53.7% Pass
Improving profit margin 79.3% Pass
Free cash flow growth > Net income growth 279.4% vs. 215.6% Pass
Improving EPS 215.9% Pass
Stock growth (+ 15%) < EPS growth 145.3% vs. 215.9% Pass

Source: YCharts.
* Period begins at end of Q4 2009.

TNH Return on Equity Chart

TNH Return on Equity data by YCharts.

Passing Criteria 3-Year* Change Grade
Improving return on equity 125.2% Pass
Declining debt to equity No debt Pass
Dividend growth > 25% 190.4% Pass
Free cash flow payout ratio < 100%** 106.3% Fail

Source: YCharts and Morningstar.
* Period begins at end of Q4 2009.
** 100% used due to MLP structure requiring 90% earnings payout.

How we got here and where we’re going
Terra very narrowly misses out on a perfect nine out of nine passing grades. Had we analyzed the company a year ago, it might well have passed — Terra’s dividend payouts were lower than its free cash flow in 2011. And those dividend payouts have been huge and hugely attractive, as the company hasn’t financed its payout with debt at all despite maintaining a yield in excess of 7% for years. Terra Nitrogen Company, L.P. (NYSE:TNH)’s already achieved greatness for early shareholders, but is it destined for more? Let’s take a look.

As a publicly traded subsidiary of fertilizer maker CF Industries Holdings, Inc. (NYSE:CF), Terra Nitrogen Company, L.P. (NYSE:TNH) gets beneficial access to the natural gas feedstock available to its parent. Since both companies operate on similar manufacturing models, we can also use CF Industries Holdings, Inc. (NYSE:CF) as a gauge of Terra Nitrogen Company, L.P. (NYSE:TNH)’s potential. This year, CF is improving — especially on the bottom line. Its earnings per share grew 30% year-over-year as of its most recent report, thanks almost entirely to the plummeting costs of natural gas. The problem Terra faces is that it’s less able to adapt to changing market trends than its larger parent. Natural gas prices are pretty much the end-all for Terra, although higher capital expenditures and production agreements with CF Industries Holdings, Inc. (NYSE:CF) can impact the MLP’s ultimate profitability. Where are natural gas prices going? It sure looks like the wrong direction, as far as Terra’s profitability is concerned:

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