Rentech Nitrogen's (UNKNOWN:RNF.DL) wild ride has left investors panicked. After doubling in value in just eight months' time by February this year, the stock has lost a staggering 46% since. Investors had pinned hopes on Rentech's second-quarter earnings release for a breather, but Rentech not only missed Street estimates by a gaping margin, but also lowered its dividend distribution guidance. Juicy dividends are otherwise the most attracting factor about the stock.
Moving forward, Rentech's earnings report raised too many yellow flags that are hard to ignore. The company's future dividends may be at stake, which raises the critical question: Are Rentech's golden days over?
Higher revenue, but...
While Rentech's second-quarter revenue increased 47% year over year, the incremental sales failed to convert into higher profits. In fact, Rentech's Q2 net income dropped 30% year over year. Worse yet, the company's gross margin dropped significantly to 38%, from 65% a year ago.
Interestingly, Rentech attributed both, the higher revenue and the lower margin, to its Pasadena facility, which it acquired from Agrifos late last year. If I were to make an apples-to-apples comparison and exclude the Pasadena facility which Rentech didn't own in Q2 2012, the numbers should still leave any investor worried.
...nothing great about it
Revenue from Rentech's primary nitrogen-producing facility at East Dubuque slipped 13% year over year in the last quarter, largely due to lower volumes. That's in sharp contrast to the 1% improvement in sales that CF Industries (NYSE:CF) reported for its nitrogen division during the last quarter.
Higher natural gas prices added to Rentech's woes. Natural gas is the key input for nitrogen fertilizer, and makes up roughly 50% of Rentech's cost of sales. Rentech paid $4.12 per million metric British thermal units of gas in Q2, compared to $3.64 per MMbtu it paid last year.
Comparatively, the average gas cost for other nitrogen producers, CF and Agrium (NYSE:AGU), was considerably lower than Rentech's in their respective last quarters -- CF paid $3.79 per MMbtu while Agrium paid $3.67 per MMBtu of gas. The gap will continue, since Rentech has booked 83% of its projected full-year natural gas for $4.17 MMbtu, while CF has locked in 90% of its gas requirement through November at $3.67 per MMBtu.
Clearly, Rentech doesn't enjoy the economies of scale that CF or Agrium does, which is reflected in its lower sales volumes and higher input costs. What is worrisome is that prices of urea and ammonia are softening while those of natural gas prices strengthening. That's a double whammy which could put Rentech in a margin vise moving forward.
Why you need to worry
Dismal numbers from Rentech's Pasadena facility is a bigger worry. After acquiring Agrifos, Rentech has overtaken Agrium as the largest ammonium sulfate, or AS, producer in North America. AS fertilizer -- a mixture of nitrogen and sulfur -- is widely applied to soybeans and wheat, and now ranks as Rentech's primary product.
A closer look at Agrium's financial data for 2012 proves that ammonium sulfate is a high-margin product -- Agrium's 2012 gross margin per tonne of AS was 29% higher, year over year.
More importantly, AS contributed positively to Agrium's wholesale division's gross profit last year even as its primary fertilizer products like potash and phosphate failed to deliver. So Rentech should be in a better position than a company like PotashCorp (NYSE:POT), which derives more than 65% of its sales from the two nutrients. In the last quarter, gross profits from PotashCorp's potash and phosphates divisions slipped 24% and 6%, respectively, year over year. PotashCorp's margins could head lower in the future following the recent shake-up in the fertilizer industry.
Something's not right here
Unfortunately, Rentech is yet to reap the AS benefit. I was particularly surprised by the huge gap between the selling prices for Agrium and Rentech in the last quarter -- Rentech sold AS at an average of $289 per tonne, while Agrium's AS price averaged $451 per tonne.
Rentech's management pointed out that wet weather conditions in the U.S. and cheaper urea products from China delayed its sales, and prices had already dipped by the time it sold AS. Frankly, I don't find much reason in that explanation, because weather conditions and cheaper substitutes affected every company, including Agrium. Yet, Agrium squeezed out much better margins on AS. Moreover, prices of key input, sulfur, have also eased in recent months.
My major concern is that unless Rentech generates profits out of AS, its Agrifos acquisition will remain questionable, especially since an additional 20% capacity will come online by the end of this year. The acquisition could change Rentech's fortunes, because AS is a profitable product, and the acquisition gives Rentech access to the high-potential Brazilian market. Whether Rentech can capitalize on the opportunity has yet to be seen.
What you can lose
The real problem is that Rentech's dividends could slide if its profits don't grow. As a master limited partnership, Rentech can pass on income to its shareholders as dividends instead of paying tax, which explains the stock's double-digit dividend yield of 13.2%.
Rentech expects to distribute anything between $2.05 and $2.20 per share this year, which is substantially lower than last year's dividend of $3.30 per share. While plant turnarounds and lower nutrient prices are to blame, lower dividends may soon become normal with Rentech.
A year back, I had sounded the warning bell on Rentech's lopsided cash flows and dividend payout ratio. The situation has only worsened since. Rentech's free cash flow for the past twelve months is less than half the net income it earned, and its cash flow payout ratio (dividends paid out of FCF) for the period is a shocking 326%. Those dividends certainly don't look sustainable to me.