Shares of CF Industries (NYSE:CF) were up more than 10% after the company revealed that it's considering an MLP. That's actually not a real stretch for the company as it already controls the general partner of MLP Terra Nitrogen (NYSE:TNH). Let's take a closer look at why investors love this idea.
MLPs shield partnerships from corporate taxes because they pay out nearly all of their income to investors. This structure tends to be valued higher in the marketplace. But not all companies can become MLPs. According to U.S. tax code, the structure is primarily limited to those companies in a natural resource focused business. CF Industries, like Terra Nitrogen, will likely qualify because it uses natural gas to make nitrogen fertilizer.
Why it works for CF Industries
America's natural gas boom has enabled CF Industries to go on the offensive and invest to expand its capacity. That growth will begin to hit the bottom line over the next few years as its cash outflow to fund construction costs diminishes. That leaves the company with a lot of cash flow at its disposal, which could be used to fund a greater dividend as the following chart shows.
Further, that leftover cash could be enhanced if the company didn't have to send a chunk of its profits back to Uncle Sam in taxes. Not only that, but an MLP does open up CF Industries to some interesting possibilities. For example, by putting some of its assets into an MLP, the company can then use that vehicle to grow. It can issue new units or debt to fund growth initiatives or acquisitions.
Fertilizing big yields
The fertilizer industry has been a great area for investors looking for income growth. CF Industries recently boosted its payout by 150%, though that pales in comparison to the likes of PotashCorp (NYSE:POT): Its dividend has surged 950% over the past three years. Meanwhile, Agrium (NYSE:AGU) boosted its dividend by 50%. Clearly, the fertilizer space is a pretty good place for investors searching for a growing dividend.
Low natural gas prices have enabled nitrogen producers to make a lot of money over the past few years. Because of America's abundance of natural gas, this trend is likely to continue and is a big reason why CF Industries is spending now to increase its nitrogen capacity. But once that spend is done, shareholders will harvest the rewards.
Investors should expect higher dividends in the future even if CF Industries decides not to move some of its assets into an MLP. The company's cash flow is expected to increase while its outflow will grow smaller. That's the exact recipe investors need to see higher dividends.
Fool contributor Matt DiLallo has no position in any stocks mentioned. The Motley Fool owns shares of CF Industries Holdings and PotashCorp. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.