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At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." Today, we'll show you whether those bigwigs actually know what they're talking about. To help, we've enlisted Motley Fool CAPS to track the long-term performance of Wall Street's best and worst.
And speaking of the best ...
This week, we get a chance to take a glance at perhaps the most promising ag-industry stock I've seen in quite some time. For years, investors in the red-hot agro-sphere have focused most of their efforts on the most obvious beneficiaries of the agriculture boom: Monsanto for seeds; Archer Daniels Midland for crops; and PotashCorp (NYSE: POT ) , Mosaic (NYSE: MOS ) , and CF Industries (NYSE: CF ) for the fertilizer farmers use to turn Monsanto's seeds into ADM's crops.
This week, however, the smart folks at Brean Murray did investors a favor and introduced us to a novel way to play the ag boom. Initiating coverage of Rentech (NYSE: RTK ) with a buy rating, the analyst praised the company's "solid foundation ... in a proven and growing efforts of Rentech Nitrogen Partners (NYSE: RNF ) ," a subsidiary that helps Rentech to manufacture natural-gas-based nitrogen fertilizer. Brean waxes particularly enthusiastic over Rentech's "unique strategy for the development of their clean fuels technology ... along with strategic partners, minimizing their capital requirements."
Wait. Hold up a sec. "Clean fuels?" What happened to the fertilizer?
I know. That spooked me, too. If I had a dollar for every time some analyst pitched me a biofuels investment idea that was "unique" or "revolutionary" or "about to change the world," well, I could buy a whole bunch of shares of Verasun, Aventine Renewable, and Pacific Ethanol -- that's what I could do. But bear with me for just a moment, and I promise this will all make sense in the end.
Yes, Rentech is a crazy, pie-in-the-sky biofuels stock. Like a million other hairbrained schemes, it promises to achieve energy independence for America with a revolutionary technology to synthesize gas from biomass and waste materials (which, if nothing else, sounds more scientific than pulling an energy-efficient rabbit out of a hat). But underlying this crazy thesis is a business that's actually doing a whole lot better than it looks. Maybe even good enough to give the renewable energy thesis enough time to play out.
Rentech... and the other Rentech
You see, while as unprofitable as any other crazy renewable energy stock on the surface, Rentech is actually doing a whole lot better where it counts: on its cash flow statement. In fact, this year, Rentech is on track to report its best results in ages. While "net profit" is still negative, Rentech's free cash flow is closer to profitability than it's been in 12 years -- just $2.9 million short of breakeven. Meanwhile, operating cash flow is the best it's been, ever. Over the past 12 months, Rentech generated operating cash flow of $36.5 million.
But that's not the point.
The real point about Rentech is not Rentech the alternative-energy pipe dream, but its subsidiary, Rentech Nitrogen Partners, a pure-play fertilizer company whose $66 million in annual free cash flow is keeping its parent company afloat. Brean mentioned this one almost in passing (it's clearly much more enthusiastic about Rentech Inc.'s alt-energy program). But at the same time as it initiated coverage of the parent company with a buy rating, Brean also gave investors permission to buy the subsidiary that it majority-owns: Rentech Nitrogen.
And if you ask me, for good reason. Wall Street expects Rentech Nitrogen, a fertilizer company that's already GAAP-profitable, to double its profits this year, then maintain this level of profitability (more or less) at least through 2014. (Which is as far out as analyst estimates go.) Let's take a look at how RNP stacks up against the competition:
Free Cash Flow as a % of Net Income
Sources: Yahoo! Finance; S&P Capital IQ.
As you can see, Rentech Nitrogen costs more than any of the better-known fertilizer plays. But it's growing faster, too. It also rivals CF Industries (a stock I've praised in the past) in its ability to generate great gobs of free cash, and it far outpaces the free cash flow that PotashCorp and Mosaic produce. As a result, Rentech Nitrogen actually sells for less than 13 times free cash flow -- quite a bargain if it manages to hit the 22% growth rate the Street has it pegged for. Last but not least, as a "nitrogen" play, Rentech Nitrogen slots right into the pro-nitrogen buy-thesis Citi laid when it recommended CF earlier this month.
Meaning no offense to Brean Murray, I personally see a lot more to like in little Rentech Nitrogen Partners than in the analyst's favored Rentech Inc. But considering that I wouldn't ever have heard about the former if Brean hadn't recommended the latter, I'll thank the analyst just the same.
I think this stock's got potential, and to show my level of conviction, I'm rating Rentech Nitrogen Partners an "outperform" in my CAPS portfolio. Want to see how it turns out? Follow along, and feel free to jeer if I'm wrong.