6 Stocks to Buy in May: Terra Nitrogen

You might have heard that this month is just no good at all for your portfolio. That old saw, "Sell in May and go away," has a bit of truth to it. According to Ned Davis Research, those who sold the S&P 500 (INDEX: ^GSPC  ) in May and bought it back in October would have turned $1,000 into over $75,000 by repeating the strategy since 1950. That absolutely trounces the performance of May buyers who sold in October; they barely even came out ahead over more than 60 years.

But I'm not here to tell you to run into the arms of cash or Treasuries. May buyers -- the smart sort who would rather hold great stocks for a long time -- still have opportunities, and I'm going to share a great one with you today. It operates in an industry that thrives in the summertime, when farmers are working to make sure their crops come up big and healthy. It's Terra Nitrogen (NYSE: TNH  ) , a high-yielding fertilizer master limited partnership, majority-owned by CF Industries (NYSE: CF  ) , one of the world's largest fertilizer producers. Its combination of growth, profitability, big-money protection, and dividend power make it one of the market's best-kept secrets.

Terra has already had a great year, more than doubling in the past 52 weeks. Despite that major move, its 16.8 P/E still more closely resembles a steady conglomerate than a hot growth stock. But valuation and gains alone aren't enough to justify this stock's place in your portfolio. It's important to look at how well it performs against its peers, and also at how broader macroeconomic trends for fertilizer and crops can help keep it growing.

Feeding the world
Much of our modern industrial-agricultural complex, from farm to table (but also including many other practical non-food applications), is built on corn. It shows up in everything, from the contents of a Happy Meal to the fuel for your car. As Michael Pollan wrote:

In corn, I think I've found the key to the American food chain. If you look at a fast-food meal ... virtually all the carbon in it -- and what we eat is mostly carbon -- comes from corn.

Corn is processed into many food products, and is a feedstock of choice for farm animals. But corn is also a demanding crop, requiring a half gallon of fossil fuel to produce a single bushel. Much of that comes from the production and use of fertilizer, particularly the nitrogen-based types made by Terra and derived from natural gas. I'll get to that in a moment, but let's get back to corn. The USDA predicts that 94 million acres of corn will be grown this year, breaking a record that's held since 1944. Wheat and soybeans, also important American cash crops, will combine with corn to consume record-high acreages, 3% more than what was planted last year. And there's been a great deal of crop innovation since 1944, pushing yields per acre higher and higher.

All those acres, tuned for maximum production, demand lots of fertilizer to reach their potential. Farmers have swung heavily toward the nitrogen-based fertilizer Terra specializes in, particularly urea ammonium nitrate, or UAN. There is a risk of crop price declines after such a bumper crop, but for the near term, these worries may be overblown. Corn exporters recently booked their biggest one-day sale since 1994, and China may well drive greater demand after Argentine farmers suffered through a damaging drought that hampered harvests. Corn prices have moved sharply higher so far this year after a year-end drop in 2011, easing farmers' fears that they might not get the same high returns they saw last year.

Growth factors
Farmers need fertilizer to make the most of their acreage, and there are three major types used in large-scale farming: nitrogen, phosphate, and potash. Phosphate and potash use has been largely flat over the past few decades, but nitrogen use has soared, now making up 97% of all fertilizer applied to corn. That goes a long way toward explaining why Terra and CF have vastly outperformed PotashCorp (NYSE: POT  ) and Mosaic (NYSE: MOS  ) -- two phosphate and potash specialists -- over the last few years. Just take a look at the way prices per ton of key nitrogen-based fertilizers have gone, and how Terra's sales volumes have held up against swings:

Year

Ammonia Cost/Ton

Ammonia Tons Sold

UAN Cost/Ton

UAN Tons Sold

2007 $380 349,000 $224 2,013,000
2008 $616 303,000 $330 1,980,000
2009 $369 307,000 $191 1,761,000
2010 $335 335,000 $193 1,958,000
2011 $473 385,000 $299 2,047,000

Sources: Terra Nitrogen annual reports.

That doesn't tell the whole story, though. Terra uses natural gas to make its fertilizers, and the price of that vital input has been a boon to Terra's bottom line over the same time frame when paired with the boom in the price of the fertilizers it produces:

Year

Cost of Natural Gas (per MMbtu)

Terra Nitrogen Profit Margin

Dividends Paid per Share

Effective Annual Yield*

2007 $6.84 32.3% $11.12 28.2%
2008 $8.59 46.8% $13.60 9.9%
2009 $4.83 28.4% $5.95 4.9%
2010 $4.63 35.7% $6.37 6.3%
2011 $4.31 63.5% $17.08 15.7%

Sources: Terra Nitrogen annual reports and Yahoo! Finance. *Assumes cost basis for shares purchased on first trading day of the calculated year.

When you consider that its least-profitable year resulted in a 4.9% yield for those buying into the stock at the beginning of January -- and a cumulative 14.2% increase in value -- Terra's appeal becomes a little more evident.

A key bullish argument for this company hinges on both the continued corn boom (in demand and prices) and the continued low cost of natural gas. Well, consider these two tidbits: Chinese corn consumption grew from about 150 million metric tons in the 2006 planting year to about 183 million metric tons last year, eliminating the country's corn exports and all but wiping out its surplus stocks, and the U.S. Energy Information Administration expects natural gas prices to stay flat through 2013. Even if Terra's absurd profit margins decline somewhat due to any number of factors (as happened during the recession), shareholders can probably still expect to hold one of the highest-yielding stocks around as global corn demand continues to grow.

Price, performance, potential, and a possible predicament
Let's get down to the nitty-gritty of Terra's prospects for your portfolio, and what you need to do to make the most of its unusual corporate setup. Since we're discussing companies you should seek out in the summertime, let's first take a quick look at Terra's summer performance against its performance in the winter:

Year

Summer* Dividends

Summer* Total Share Growth

Winter* Dividends

Winter* Total Share Growth

2007 $4.57 96.9% $6.55 21.4%
2008 $7.83 (38.7%) $5.77 60.1%
2009 $4.32 (18.4%) $1.63 (18.1%)
2010 $3.61 47.2% $2.76 2.1%
2011 $8.59 61.8% $8.49 70.5%

Sources: Yahoo! Finance and YCharts. *Summer is May 1 through Oct. 31; winter is Nov. 1 through April 30.

This is not to show that you should buy the stock in May and then sell it in October -- that would be a decidedly un-Foolish thing to recommend. It's merely to show that (barring recessionary slumps) Terra has done extremely well for shareholders despite the market's tendency to decline when it gets warm, and its dividend payments are typically higher in the summer thanks to higher in-season demand for its fertilizers.

One downside to owning this stock is its structure as a master limited partnership, or MLP. That means they pass income directly to shareholders, which results in high yields but a more complex bit of calculation come tax day. It does require some education, and the link above offers a great starting point, but if you can handle a little legwork or have a good accountant at hand, the benefits will far outweigh the extra effort needed to tend to your investment.

With many positives and few negatives, Terra Nitrogen could be a great addition to your portfolio that can help your gains resist the summertime blues.

Fool contributor Alex Planes holds no financial position in any company mentioned here. Add him on Google+ or follow him on Twitter @TMFBiggles for more news and insights. The Motley Fool owns shares of CF Industries Holdings. Motley Fool newsletter services have recommended buying shares of PotashCorp. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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  • Report this Comment On May 05, 2012, at 10:59 AM, JimmyZangwow wrote:

    Pollan was correct, corn is important, but what is important to corn? - NITROGEN. Can't help but think that natural gas is going to rise in price, and soon. Then what happens to this stock?

    By the way, well-written piece, Thx

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