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3 Big, Fat Yellow Flags That Should Keep You Away From This Fertilizer Stock

If CVR Partners (NYSE: UAN  ) delivered an outstanding fourth quarter and rewarded its shareholders with record dividends in 2013, Rentech Nitrogen (NYSE: RNF  ) sent shockwaves among investors with horrendous numbers and a massive cut in dividends.

What went so drastically wrong at Rentech, when even a company like PotashCorp (NYSE: POT  ) didn't suffer as big a drop in sales or profits and even maintained its dividends, despite facing severe headwinds from unprecedented industry developments in recent months? It's time investors pause and dig deeper.

The big drop no one expected
Rentech swung to losses worth $17.4 million in Q4 versus a profit of $17.6 million in the comparable period last year. Its top line shed a massive 41% year over year. Management blamed softer nutrient prices and lower production because of plant outages for the revenue drop.

Are Rentech Nitrogen's golden days over? Image source: Company website.

Nutrient prices are largely uncontrollable, and affected nearly every player in the industry. But Rentech took the hardest hit of all. If last-quarter sales from PotashCorp's nitrogen division slipped 10% year over year, CF Industries reported a small 4% drop in its nitrogen sales during the fourth quarter. Interestingly, CVR Partners, which is very similarly structured to Rentech, saw its last-quarter revenue surge 25% year over year.

So how do you explain this huge variance?
Rentech's primary nitrogen-producing facility at East Dubuque, Ill., was down for nearly two months during the fourth quarter. Yes, you read that right. Aside from 31 days of planned downtime for maintenance, a fire forced the plant to shut down for another 29 days. Since the company operates out of one plant only, it paid a heavy price for the loss in production.

But a bigger concern was the lower production at Rentech's Pasadena facility, which produces ammonium sulfate, or AS fertilizer. After acquiring Agrifos in late 2012, Rentech edged out Agrium (NYSE: AGU  ) to become the largest AS producer in North America. Naturally, Rentech was betting big on the acquisition to fuel future growth, but the results have been disastrous so far.

A deal gone wrong?
During its third quarter, Rentech took a charge of $30 million as impairment after it lowered its profitability outlook from the Pasadena facility. In other words, the acquisition hasn't proved as fruitful yet as the company expected. What's alarming is that the problems continued into the fourth quarter, with the facility facing several "unplanned disruptions" that hurt production.

Rentech's Pasadena facility. Image source: Company website.

Worse yet, Rentech is still selling AS at lower prices as compared with Agrium. So while Agrium realized $303 per tonne of AS in its last quarter, Rentech sold AS for only $190 per tonne in Q4. Meanwhile, Rentech's input costs continue to be high. As a result, it ended Q4 with gross loss margin of 32% at the Pasadena Facility, compared with gross loss margin of 5% in Q4 last year.

With additional capacity going online at its Pasadena facility, Rentech projects positive earnings before interest, taxes, depreciation, and amortization for the facility this year. Sounds good, but how Rentech plans to achieve it remains to be seen.

How does all this affect you?
Most investors who own Rentech shares in their portfolio have high dividends in mind since the master limited partnership can pass on its income to its shareholders instead of paying tax. Unfortunately, Rentech's dividends are losing appeal.

Rentech distributed only $1.67 a share in financial year 2013, compared with $3.30 per share in 2012. Rentech's dividends could slide further if its profits don't pick up soon. But there's a bigger problem.

Can you rely on such management?
It looks like Rentech's management has started taking the business lightly in its bid to impress shareholders. For example, the $0.05 dividend per share that the company paid during the fourth quarter came from the insurance proceeds that it had claimed against the fire at the East Dubuque facility. I simply don't understand the move, and I'd call it bad business sense.

Worse yet, Rentech may not be keeping enough cash aside even to run its day-to-day business in its bid to pay dividends. What else do you understand when the company says that it may be unable to distribute all the cash available in 2014 if management has to use some of it to "replenish working capital reserves" that depleted last quarter? If that was the case, why did Rentech pay dividend out of the insurance proceeds? It all looks very dicey to me.

The Foolish bottom line
Rentech has too many problems to deal with, and the fertilizer market isn't particularly strong right now. And the company's dividend distribution strategies raise serious questions. I'd steer clear of Rentech and instead look at other MLPs that are consistently growing their top and bottom lines and doling out greater dividends.

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Read/Post Comments (5) | Recommend This Article (2)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 17, 2014, at 5:46 AM, Interventizio wrote:

    Good analysis Neha.

  • Report this Comment On March 17, 2014, at 6:24 AM, Nehams wrote:

    Thanks much, interventizio.

    -Neha

  • Report this Comment On March 17, 2014, at 10:21 AM, loonman wrote:

    Granted it has been a tough road for the small nitrogen producers over the winter, but the coming couple of quarters should help them recover. Soil moisture is good over much of the country thanks to the heavy snows this winter. Fortunately the thaw is coming in small spurts of warmth followed by brief cold snaps. This type of weather will keep the moisture in the soil instead of it all running off in one big flood. Planted acres will be high and grain prices are reasonable. The spring application season will be a little late due to the harsh winter; but fertilizer demand will be strong. The uncertain gas situation in the Ukraine will result in lower imports of UAN into the States. Nat gas will ease from winter highs, helping to reduce production costs. North American nitrogen producers will have a good season. The big guys like CF and Agrium will fare better than Rentech and CVR; but they all should do fine if they can keep the plants running.

  • Report this Comment On March 17, 2014, at 10:24 AM, SoBeIt wrote:

    Because in this business, there is cash-on-hand due to pre-season orders, by the time management was voting on 5 cents distribution versus, it probably slanted their vote to not show $0.

    However, a plant can always break down. So future $ in the kitty is a SAFE approach.

    This is a margin business. With US natgas plentiful, the risk of running one plant for both CVR and RNF was the same.

    The addition of the Pasadena plant to the Dubeque facilty lowers the risk of one plant for RNF. You did say that Pasedena was expected to be cash positive. With an opportunity to sell their products at a higher price ($190 versus $320 market), it seems that there is a lot of headroom for earnings to get better?

    Invest when prices are low and sell when stocks are high?

  • Report this Comment On March 19, 2014, at 5:02 PM, KevinT747 wrote:

    A couple of comments:

    The price comparison between Agrium and Rentech Nitrogen is not on an apples-to-apples basis. Agrium, like CF Industries, reports gross pricing, which is not net of transportation or logistics costs. Rentech Nitrogen and CVR Partners report netback pricing. Additionally, Rentech Nitrogen's average Q4 pricing is $190 per short ton, not tonne. If Agrium is reporting on a per tonne basis, then you would have to reduce their pricing by ~10% before beginning your comparison.

    With regards to Q4 production at RNF's Pasadena plant, there was also considerable planned downtime for expansion and reliability tie-ins along with the unplanned disruptions.

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