Welcome to "Stock Smackdown," where two of your favorite fertilizer stocks will go head to head in a battle for superiority. They'll each be judged on a series of objective merits, including valuation, earnings quality, and dividend quality.

The winner will be the stock that racks up the most points at the end of the competition. Let's go to ringside and meet our two combatants, Terra Nitrogen (NYSE: TNH) and CVR Partners (NYSE: UAN).

In this corner...
Fair warning: I'm a pretty big Terra bull. I've written positively on the company before. I dubbed it one of the stocks you should buy to buck the "sell in May" trend, and I earlier wondered if it might be the best fertilizer stock around. Fool analyst Dan Dzombak's Value Investor 500 list validated my optimism by ranking Terra first among all U.S.-based companies. There are a lot of positives in Terra's corner. But that doesn't mean I'm going to rig the match in its favor, and CVR Partners is no slouch, either.

Like Terra, which can generate superior margins thanks to the support of majority owner and leading fertilizer-purveyor CF Industries (NYSE: CF), CVR has the backing of CVR Energy (NYSE: CVI), which allows it to make use of cheap raw materials flowing directly from CVR Energy's nearby refinery. As my fellow Fool (and fertilizer guru) Neha Chamaria notes, CVR Partners also enjoys the benefits of location in other ways: It's smack dab in the American corn belt, near a major railway line. Every little advantage counts in this battle.

Valuation battle
We use many different numbers when talking about the value of a stock. The price-to-earnings ratio is the standard, so we'll check each company's current P/E and five-year historical average P/E. We'll also use price to free cash flow. Earnings can be gamed with a number of different accounting tricks, but free cash flow is harder to manipulate, making it a favored metric here at the Fool.

In each case, the difference between a stock's current ratio and its five-year average ratio will be more important than the numbers themselves. Stocks trading significantly lower than their average ratios may have more room to return to that middle ground.

For the tiebreaker, we'll check one less-used financial metric: the debt-to-equity ratio. A company with little or no debt is usually in better shape than one leveraged to its eyeballs.


Terra Nitrogen

CVR Partners

P/E 12.3 13
5-Year Average P/E 12 12.8
P/FCF 13.2 14.8
Debt/Equity 0 0.3

Sources: Wolfram Alpha; Morningstar; Yahoo! Finance. Winners in bold.

It looks like Terra takes this round, in part due to its longer history on the markets. CVR has a chance to come back. How will it fare in the next round? Let's find out.

Earnings quality battle
A company can be cheaply valued without being a good value. To balance out our valuation fight, let's look at a few key earnings statistics for each company. We'll look at gross and net margins, a five-year annualized rate of earnings growth, and consecutive years of both positive earnings and earnings growth since 1992, two decades ago. A company with no momentum today is less likely to become a superstar later -- it has happened before, but not often.


Terra Nitrogen

CVR Partners

Operating Margin 63.9% 45.6%
Net Margin 36.5% 44%
3-Year Annualized Earnings Growth 26.5% 27.1%
Consecutive Profitable Years 8 7
Consecutive Years of Earnings Growth 2 1

Sources: Morningstar; Wolfram Alpha. Winners in bold.

Terra takes the earnings quality crown, despite a strong showing from CVR Partners on bottom-line results. Can Terra come out ahead for good in the dividend battle ahead?

Dividend battle
A growing company is great, but one that pays you back is even better. Since both companies are paying dividends today, let's see how strong and stable they really are. We'll examine yield, the earnings and free cash flow payout ratios, the five-year annualized dividend growth rate, and each company's current streak of uninterrupted payments.

Those payout ratios are important, particularly the free cash flow payout ratio. Companies that pay out more than they take in can rarely sustain such practices for long.


Terra Nitrogen

CVR Partners

Dividend Yield 7% 9.8%
Payout Ratio 110% 267.8%
Free Cash Flow Payout Ratio 112.5% 320.5%
5-Year Annualized Dividend Growth 3.4% N/A
Years of Uninterrupted Dividends 8* 1

Sources: Morningstar; Yahoo! Finance; Dividata. Winners in bold. *Terra did not pay dividends consistently from 1998 to 2004.

CVR's unsustainably high payout ratios are major red flags. Although both companies are master limited partnerships and thus obliged to pay out nearly all of their earnings to shareholders, CVR's big payout is coming from the cash pile created by a debt issuance and an IPO. Rentech Nitrogen Partners (NYSE: RNF) is in a similar position, having recently gone public while issuing debt, and is now tapping both sources of new cash to pay out much larger dividend yields than may be sustainable.

Terra takes this round handily and thus sweeps the competition.

What the numbers tell us
It can be tempting to jump on a huge yield, like CVR's 9.3% or Rentech's eye-popping 15.4%. But it's also important to know where the payout is coming from, and if it can't be held up by a company's earnings, you could be in for a painful cut and a market correction. If CVR's ratios were in better shape, it might be heading into a pitched battle in the finale, but it just can't compete with Terra's history and stability.

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This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.