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The recent pullback in fertilizer stocks may have left investors panicked, but it has also created an opportunity for long-term investors. While I particularly like CF Industries (NYSE: CF ) and Agrium (NYSE: AGU ) , I am not writing off PotashCorp and Mosaic completely either. I am just waiting for the dust to settle on the potash market.
However, there's one fertilizer stock that has nothing to do with potash and has crashed 24% over the past three months, but still doesn't make it to my watchlist.
The market loves CVR Partners (NYSE: UAN ) for its double-digit dividend yields, but are those dividends sustainable? Inherent weaknesses render CVR's profits uncertain, and management hasn't been acting too responsibly either. If you are long CVR, here are things you must know about the company.
CVR is a one-plant company. That comes with a price, as the company proved in its last quarter. A sudden break down at the facility which lasted nine days cost CVR 50 tons of ammonia per day, hurting the company in two ways: Sales declined as ammonia production fell 16%year over year, and margins took a hit when CVR later purchased 4,000 tons of ammonia at higher market prices to convert it into its primary product, urea ammonium nitrate or UAN.
How that affects you
While it will be unfair to blame CVR for the unexpected outages, the incident highlights CVR's vulnerability and the uncertainty of its dividends. Aside from lower nutrient prices, loss due to shut down had a key role in CVR's revised full-year dividend guidance. CVR expects to pay something between $1.80 and $2.00 as dividend per share for 2013. Until the first quarter, CVR was looking at a dividend per share of $2.15 to $2.45. Ouch.
Rentech Nitrogen (UNKNOWN: RNF.DL ) , a master limited partnership like CVR, has had a similar fate recently when it cut its 2013 dividend outlook. Though Rentech's plant was also shut down briefly last quarter, it was a planned one (for maintenance), and hence already factored in the company's earlier guidance. So Rentech's smaller dividend can primarily be attributed to lower fertilizer prices. Moreover, unlike CVR, Rentech now operates out of two plants and has broadened its product portfolio, thanks to a recent acquisition.
No diversification = Greater risk
Aside from the single-plant risk, CVR is an undiversified company, which is certainly a disadvantage. In fact, CVR has narrowed its product focus significantly over time.
As a pure-fertilizer play, CVR lacks Agrium's growth potential. Although considered a fertilizer company, Agrium gets more than 65%of its revenue from seeds and crop protection products, which naturally places the company in better stead.
But one may consider Agrium an exception and argue that most companies, like CVR, depend on fertilizers for revenue. That's true, but CVR deals only in nitrogen, while most peers are diversified into potash and/or phosphates. Slice it down further, and CVR starts looking riskier with just one nitrogen-based product - UAN - to rely on.
Why, and why not UAN?
UAN is a low-cost and high-margin product, which explains why it makes up nearly half
of CF's nitrogen product mix. So CVR is perhaps on the right track. But at the same time, CF also produces a good mix of urea, ammonia, and other nitrogen compounds aside from UAN. This diversity paid off in CF's second quarter when, despite a 26% drop in urea prices, its topline remained flattish year over year on the back of firmness in other products.
In contrast, CVR has essentially become an all-UAN company now – It converted 98% of the ammonia produced to UAN in its last quarter. So CVR's profits now hinge on UAN, and if its prices weaken, CVR's bottom line and dividends could take a big blow.
Treading a dangerous path
In fact, even at current rates, CVR is paying out more in the form of dividends than it can afford. CVR's free cash flow payout ratio for the trailing twelve months was uncomfortably high at 183%, meaning the company is burning cash at an alarming rate.
While CVR is better positioned than Rentech Nitrogen -- which sports an alarming FCF payout ratio of 326% -- it is not the best choice in the industry. Terra Nitrogen (NYSE: TNH ) beats this game with well-supported dividends – it matches payout with the cash flow it generates. Moreover, Terra is among the few companies that have consistently generated higher free cash flow than net income. Terra's dividend yield at 7.6% may be the lowest among the three companies, but it is also the safest.
Can you believe this management?
Uncertainty and risk are an inevitable part of every business, but what perturbs me is CVR management's lack of foresight. Earlier in the year, while announcing its expansion programs, CVR projected a "significant double-digit increase" in dividend for 2013. Forget double-digits -- Investors are unlikely to see any growth in CVR's dividends this year.
More importantly, I strongly believe that management should have informed investors about the unexpected plant outage when it occurred, especially since the incident had a direct impact on dividends. Instead, CVR chose to remain silent until the day of its earnings release, catching the market unaware. The stock has plunged 18% since then.
I would have given CVR a score each for using petroleum coke instead of the volatile natural gas as input, and maintaining a comfortable debt-to-equity ratio of 27%. But I seem to be losing faith in CVR's management. What if the company borrows funds tomorrow only to support its dividends? I'll certainly sit out the discount in CVR's stock until I'm sure the company is being managed well.
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