OCINF - CVR Partners Became A 'Buy' Again

2023-10-31 08:00:32 ET

Summary

• CVR Partners' stock has declined by 33.3% since September 2022, but high dividend payouts have made it an above-average performer.
• The fertilizer market has experienced a sharp correction this year, causing a decline in shares of fertilizer manufacturers.
• The recent conflict between Hamas and Israel has sparked fears in the fertilizer market, impacting the Israeli port of Ashdod and potash fertilizer exports.
• On October 30, 2023, the company released its operating results for Q3 FY2023. Let's dive in.
• It seems to me that CVR Partners is back on the path to stability, and taking into account a possible turnaround in fertilizer prices, the company has a chance to maintain its high yield.

The last time I wrote about CVR Partners (UAN) was in September 2022, when 1 unit was trading at nearly $117. Currently, UAN trades at $78, a decline of 33.3% in nominal terms, partially offset by high dividend payouts that ultimately made UAN an above-average performer in its industry :

Of course, my previous bullish thesis cannot be called successful. However, you must understand how quickly the situation changes in cyclical markets in our time: What seems obvious today may not be so tomorrow due to geopolitical events, sudden disasters, etc. In general, fertilizer prices this year continued their sharp correction after a phenomenal rise in 2021-2022 - this was the main cause of the decline in the shares of fertilizer manufacturers:

Recently, however, the situation started to improve gradually. Since June of this year, when European natural gas prices bottomed out, they have more than doubled:

In case you didn't know, Ammonia, urea, and ammonium nitrate are some of the most common nitrogen-based fertilizers produced using natural gas as a feedstock in a process called the Haber-Bosch process . In this process, natural gas is converted into ammonia, a key component of these fertilizers. So when natural gas prices rise, the cost of producing nitrogen fertilizers increases, which, in turn, should lead to higher fertilizer prices.

Hamas' attack on Israel sparked a new round of fears in the fertilizer market, as the Israeli port of Ashdod, located north of the Gaza Strip and a key hub for the country's potash fertilizer exports, is in emergency mode amid the deadly conflict, Bloomberg reported Oct. 10, 2023 .

But even if we discount the potential spread of unrest in the Middle East as a bullish catalyst for global fertilizer prices and focus on just market fundamentals, I think there's hope for a brighter future for producers than this year.

As I was going through the quarterly reports of various fund managers, I came across Palm Harbor Capital's Q1 FY2023 letter [proprietary source] in which the fund managers justify their position in OCI N.V. ( OCINF ) with words about the strong fundamentals of the industry.

But the above commentary is about the European market, and the article you are reading is about CVR Partners, an American company. So I decided to check the setup described above for the U.S. market and got a roughly similar picture: If we look at the long-term situation for grains, we see that grain stocks are actually very low and grain prices remain consistently high.

Farmers should be motivated to maximize their yields to take advantage of high market prices - this increased demand for crops leads to higher fertilizer usage, as farmers seek to enhance their crop yields by providing adequate nutrients to their crops. So with stronger demand and a relatively fixed supply, fertilizer companies may be able to charge higher prices for their products, which is what I expect to happen.

Now that we have the general background of the industry in front of us, let's talk directly about CVR Partners.

On October 30, 2023 , the company released its operating results for Q3 FY2023, and we see that sales decreased by 16.54% this year due to the decrease in ammonia prices.

CVR Partners' average realized gate prices for UAN showed a reduction over the prior year, down 48 percent to $223 per ton, and ammonia was down 56 percent over the prior year to $365 per ton.

Source: Seeking Alpha News

At the same time, EBITDA more than tripled and net profit amounted to 7 cents per unit:

In Q3 FY2023, CVR Partners' fertilizer facilities produced a total of 217,000 tons of ammonia, according to the report. Of this production, 68,000 net tons were available for sale, while the remainder was converted into other fertilizer products, including 358,000 tons of UAN. This marked a significant increase compared to Q3 FY2022 when the facilities produced 114,000 tons of ammonia, with 36,000 net tons available for sale and the rest used for other fertilizer products, including 184,000 tons of UAN. The increase in production this year was attributed to improved operational reliability after scheduled maintenance turnarounds in FY2022. By the way, the total CAPEX fell from $25.6 million to just $8.3 million (YoY) precisely for this reason.

On September 26, 2023, CVR Partners and its subsidiaries amended their credit agreement (the "ABL Amendment"), increasing the total available credit from $35 million to $50 million and extending the maturity date by 4 years to (September 26, 2028). The credit shall be used for working capital, capital expenses, and general corporate purposes, the press release clarifies.

UAN also declared a cash distribution of $1.55 per common unit for Q3. This distribution will be paid to common unitholders on November 20, 2023, if they were recorded as such by November 13, 2023.

For Q4 FY2023, CVR Partners forecasts slightly lower utilization but about the same direct expenses as Q3, with CAPEX between $10 million and $15 million.

I don't think UAN will achieve a payout close to $10.5 per unit for Q4 FY2023 as it did last year, but most likely the company's dividend yield will remain quite protected provided industry selling prices gradually rebound.

Even ignoring the seasonal factor (Q3 distributions were the lowest in recent years) and extrapolating $1.55 over the next 12 months, UAN's dividend is ~8% at the current share price. Again, in my opinion, this is the most pessimistic option, severely underestimating UAN's true potential after the maintenance that the company's facilities have undergone in 2022.

I don't see any problems with liquidity: thanks to the extension of the ABL agreement, credit risks for UAN look even lower. At the same time, UAN shares are trading at only 3.8 times EV/EBITDA [TTM], which is historically low:

Unfortunately, we do not have access to UAN's FWD EV/EBITDA ratio to examine the cyclical impact and analysts' forecasts, but in general, UAN seems to be massively undervalued relative to the industry as a whole (based on the TTM metrics):

Concluding Thoughts

Of course, investing in CVR Partners carries inherent risks that should be carefully considered, including exposure to the volatile prices of nitrogen-based fertilizers, regulatory and environmental challenges that can impact production costs, and the cyclical nature of the agricultural industry, which heavily influences UAN demand. Economic downturns, competitive pressures, weather-related uncertainties, and geopolitical factors can also affect the company's performance.

But despite these risks, it seems to me that CVR Partners is back on the path to stability, and taking into account a possible turnaround in fertilizer prices, the company has a chance to maintain its high yield (maybe not fully, but much higher than the industry), and the existing undervaluation provides a good margin of safety for investors.

However, non-U.S. investors should keep in mind that they will have to pay a 10% tax on the sale of their UAN position (i.e., 10% of the amount of funds that would settle resulting from any transaction or distribution, not just 10% on the calculated gain). But if you file a U.S. tax return form , you will get most of what was withheld back.

Taking into account all the pros and cons, I have nevertheless decided to reaffirm my previous "Buy" rating this time.

Thanks for reading!

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