While the MLP space is dominated by the oil and gas sector, in last week’s article we began to explore some of the more exotic master limited partnership offerings. This week we continue our exploration of nontraditional MLPs by looking at the partnerships supplying fertilizer.

Rentech (Nasdaq: RTK) has been around for more than a decade, and it has shifted strategies several times. Full disclosure: Rentech’s Chief Technology Officer Harold Wright is a former manager of mine when we were both at ConocoPhillips, and I have visited Rentech’s facility in Commerce City, Colorado.

For most of Rentech’s existence, the company has sought to commercialize alternative fuels. At one time it had ambitions to build a large coal-to-liquids (CTL) plant, but federal legislation ultimately nudged it instead into the biomass-to-liquids (BTL) space. The company did build a BTL demonstration plant, but ultimately shut it down and has now refocused its efforts on becoming “one of the largest wood processing companies in the world.”

During its interesting journey as a company, Rentech acquired two ammonia nitrogen fertilizer facilities, which turned out to be a profit center that funded the alternative energy research. In November 2011, Rentech spun off this fertilizer business into an MLP called Rentech Nitrogen Partners LP (NYSE: RNF).

In the months leading to the spin-off, RTK’s market capitalization was about $200 million. Rentech maintained 60 percent ownership of RNF, and three months after the spin-off RTK’s market cap had risen to $400 million, while investors had bid RNF up to $1 billion. Interestingly, RTK’s share of RNF was worth more than RTK’s entire market cap, a situation that persists. The market currently values Rentech at $482 million, while the valuation of Rentech Nitrogen Partners makes RTK’s 60 percent stake in RNF worth slightly more than $600 million — another illustration of the premium investors have been willing to pay for MLPs.

RNF owns two fertilizer production facilities, one in East Dubuque, Illinois and the other in Pasadena, Texas. The partnership is a pure play on nitrogen fertilizer, which is produced from natural gas and which is therefore subject to natural gas price volatility. The Illinois plant is in the heart of the Corn Belt, and as a result will also be subject to corn price volatility (i.e., high corn prices will mean higher fertilizer demand, and vice versa). Modifications to the Renewable Fuel Standard, which supports corn prices by encouraging the production of ethanol, could significantly affect demand for nitrogen fertilizer.

RNF had a solid 2012 when natural gas prices were lower, but the recovery of natural gas prices this year has eaten into margins. This, as well as some unscheduled outages led RNF to recently reduce its 2013 distribution guidance to $2.05-2.20 per unit from $2.60 previously. The partnership already paid out $0.50 in Q1 2013 and $0.85 in Q2, which leaves $0.70 to $0.85 to be paid for the rest of 2013. At the current price, this implies an annualized yield for the final two quarters between 5.3 percent and 6.4 percent. But fertilizer is a seasonal business, and including the two distributions already paid for 2013 bumps the 2013 yield to roughly 8 percent.

Rentech has two competitors in this space. Terra Nitrogen Company LP (NYSE: TNH) owns and operates a nitrogen fertilizer plant in Oklahoma. The general partner is a wholly owned subsidiary of CF Industries Holdings (NYSE: CF), the second largest nitrogen fertilizer producer in the world.

Terra Nitrogen’s claim to fame is the extraordinary performance of units. Over the last 10 years, the price rose from approximately $5 to the current level above $200. Like RNF, Terra Nitrogen profits from historically low natural gas prices. Thus its most recent distribution, equivalent to 7.9 percent on an annualized basis, might be reduced if the cost of its main input rose dramatically.

One other risk factor for US-based fertilizer manufacturers is the threat of cheap Chinese exports. China produces fertilizer predominantly from coal instead of natural gas, and with natural gas prices increasing in the US and global coal prices declining, Chinese fertilizer has become much more competitive.

Enter CVR Partners LP (NYSE: UAN), the only company in the US to produce fertilizer from petroleum coke (petcoke). Petcoke is a byproduct of petroleum refining, and prices are usually set off coal prices, since these two products compete in the same niche. Thus the same dynamics that currently threaten the distributions of Rentech Nitrogen Partners and Terra Nitrogen Company play in CVR Partners’ favor.

CVR Partners’ fertilizer plant is located in Coffeyville, Kansas, adjacent to the refinery owned by CVR Refining (NYSE: CVRR). CVR Energy (NYSE: CVI), majority-owned by Carl Icahn via Icahn Enterprises (NYSE: IEP), is the general partner and owns most of the units for both CVR Partners and CVR Refining.

CVR Partners’ results are up across the board in 2013. Sales rose 6.6 percent in the first half compared with the first half of 2012, while EBITDA was up 10 percent, and distributable cash flow was up 6.3 percent. But unit prices have been weak, registering a decline of 25 percent year-to-date. This has pushed the yield of CVR Partners up to the range of 9.8 percent to 10.9 percent based on the most recent guidance.

Investing in fertilizer MLPs is not for everyone. There are special risks that must be recognized, and that won’t be acceptable to the more conservative income investors. But a growing global population means growing fertilizer demand, and patient investors who are selective with their entry points may find this sector to be richly rewarding.

(Follow Robert Rapier on Twitter, LinkedIn, or Facebook.)

 

Portfolio Update

Genesis Tells a Bullish Tale

Secondary offerings are a fact of life for MLPs, and for many are an essential  source of cheap capital given the lofty valuations and costly growth plans. Such deals almost always price at a decent discount to the market to account for the equity dilution and, in addition to securing the needed funds for the MLP, they can sometimes provide a market “tell” based on the subsequent trading action.

We may have gotten one of those on Wednesday when Conservative Portfolio holding Genesis Energy LP (NYSE: GEL) sold 5 million units in an upsized follow-on offering and gave its underwriters a promptly exercised option to buy an additional 750,000 units. All told, this represented a dilution of nearly 7 percent for unitholders. The offering priced at a 4 percent discount to the prior day’s close.

Trading opened next morning just above the discounted price, and then a funny thing happened: units rallied 6.3 percent from the offering price on massive trading volume, closing at the high. It was the second biggest rally after a follow-on offering in at least five years, according to the indispensable Hinds Howard of MLP HINDsight. Shares have since drifted slightly lower.

The trading action implies confidence in the ability of Genesis to continue growing its distributions at something close to the double-digit rate it’s managed to sustain for nearly a decade. For a relatively leveraged partnership with a debt more than five times trailing EBITDA, selling equity yielding just above 4 percent makes more sense than issuing bonds yielding 5.75 percent, as Genesis did in February.

Last week, investors jumped on the opportunity to build positions in this growth play profiting from the development of new tight oil basins. We think they will be rewarded in the long run. Continue buying GEL below $55. 

— Igor Greenwald