CTVA - CVR Partners: Don't Miss The Forest (Industry) For The Trees (Dividend)

2023-05-10 12:44:53 ET

Summary

• Essentially, "Fertilizers and Agricultural Chemicals" is a solid, reliable, and sustainable industry. Everybody needs to eat, food must be grown, and fertilizers are to be used.
• Nevertheless, supply-chain disruptions that were caused (first) by the pandemic and (then) the Russia-Ukraine war have completely distorted this industry's normal trends.
• CVR Partners, LP has been the industry's "poster child" when it comes to excess returns and paying money back to unit-holders. However, this long-lasting honeymoon has come to an end.
• We believe that UAN is holding up high solely thanks to the upcoming fat distribution. Once we pass the ex-date, we fear that the unit price may catch up with the recent performance of UAN's peer group.

UAN 1Q/2023 Earnings

CVR Partners, LP ( UAN ) is a manufacturer of ammonia and urea ammonium nitrate (“UAN”) solution fertilizer products.

Highlights from the 1Q/2023 earnings press release :

• Net income of $101.87M, or $9.64 per common unit, compared to $93.66M, or $8.78 per common unit last year >>> +8.8% Y/Y
• Revenue of $226.26M compared to $222.87M last year >>> +1.5% Y/Y
• EBITDA of $124.30M, compared to $123.42M last year >>> +0.7% Y/Y
• UAN average realized gate prices were down 8% Y/Y to $457 per ton ($496 last year).
• Ammonia average realized gate prices were down 16% Y/Y to $888 per ton ($1,055 last year).

“CVR Partners achieved solid results for the 2023 first quarter led by record production , including a combined ammonia utilization rate of 105 percent, offset somewhat by lower fertilizer pricing during the quarter,” said Mark Pytosh , Chief Executive Officer of CVR Partners’ general partner. “The maintenance work that was completed during last year’s turnarounds has improved reliability at both nitrogen fertilizer facilities and we plan to continue to invest in additional reliability projects during the next two to three years.

“The spring pre-planting season is off to a robust start and the U.S. Department of Agriculture estimates that planted corn acres will increase approximately 4 percent this spring compared to a year ago, driving strong demand for nitrogen fertilizer,” Pytosh said. “Our focus for the remainder of the year is on safe, reliable operations while maximizing our free cash generation.” (Source: earnings press release.)

Conclusion : In-spite of record production, lower prices are setting the tone, turning UAN into a no-growth company.

Fertilizer prices are now back to - or even below - levels that we've last seen in early 2021.

Now, if we're back to early 2021 prices, and since there are no more (severe) disruptions to the supply-chain, the question is how high UAN deserves to trade and what is a sustainable multiple?

Time Travel

We believe that if prices are back to 2021 levels - the unit price should trade within the 2021 levels too. We wouldn't go as far as saying that UAN deserves to trade at the 2021's low ($14.70), but it certainly deserves to trade below the 2021 high ($87.34).

Furthermore, based on the down-trending channel over the past few months, it looks as if ~$109, where the 200-DMA is, represents a resistance and low 80s-high 70s is where the support might be.

With UAN stock trading today close to $105, it's safe to say that it has very limited upside potential (of only about 4% to $109) compared to a significant downside risk of about 24% (using $80 as a target).

6:1 ratio in favor of risk isn't a compelling ratio for us to keep holding UAN, especially when we see what's going on within the (Fertilizer) industry.

Peer Group

At first glance, when comparing how far off-high UAN is trading at compared to its peer group*, it doesn't seem as if UAN is particularly expensive or special.

[*Fertilizers and Agricultural Chemicals Stocks: The Mosaic Co. ( MOS ), Nutrien Ltd. ( NTR ), Corteva Inc. ( CTVA ), Sociedad Quimica y Minera de Chile S.A. ( SQM ), CF Industries Holdings Inc. ( CF ), FMC Corp. ( FMC ), ICL Group Ltd. ( ICL ), The Scotts Miracle-Gro Co. ( SMG ), American Vanguard Corp. ( AVD ), Bioceres Crop Solutions Corp. ( BIOX ), Intrepid Potash Inc. ( IPI ).

Looking back three years, UAN is trading ~41.5% off-high, right at the middle of the fertilizer pack.

However, when looking at the total return of UAN and its peer group over these past three years - it certainly feels like UAN is on a league of its own.

We're not writing this article in order to explain or judge UAN's return over recent years. Que Sera (over the past three years) - Sera .

Completely Detached

Nonetheless, what happened over the past few weeks or months is relevant - and quite stunning. While its peer group pulled back meaningfully over the past month, as well as YTD, UAN seems as if it's living in a bubble that isn't affected by what is happening around it.

Judge for yourself:

• Past month: Not only is UAN the only name which is up, but it's outperforming the per group average return by ~26%.

• YTD: UAN is one of only two names that are up this year, a period that has seen most names in the industry losing 10%+ of their value.

• Since 1/1/2022: UAN is the top performer, and although it's not the only name that gained - the average return of the industry is negative, in complete contrast to UAN's >60% total return.

This begs the question: What's so unique about UAN that it's going up when most everybody else is going down? Is UAN so special/ undervalued that it deserves to trade completely detached from its peer group?

Past Performance is no Guarantee of Future Results

Of course, one may claim - and rightly so - that UAN is a hidden jewel, a small-cap with very little coverage (none on Wall Street!), that deserves a lot more attention than it gets.

Moreover, based on its ridiculously-low trailing multiple, UAN does seem to be one of, if not the most attractively-priced fertilizer stocks out there.

Fair enough, but what about the near future?

Based on its forward multiple, UAN is about to see its title changing from "the most attractive" (over the past 12 months) to "the least attractive" (over the next 12 months).

Same goes when measuring UAN based on a forward EV/EBITDA ratio. Based on this measurement, UAN is the most expensive name among its peer group.

In last week's conference call , Dane Neumann - UAN's CFO - said that "Looking ahead to the second quarter of 2023, we estimate our ammonia utilization rate to be between 95% and 100%." Recall that in 1Q/2023 consolidated ammonia plant utilization was 105%, i.e., UAN expects lower utilization rates compared to (the unusually high utilization rate of) Q1.

Another factor that was addressed by UAN's CEO, Mark Pytosh, is the impact of warm/er weather on nitrogen costs/prices (emphases ours), consequently on (bringing back more) supply:

"Warmer-than-expected weather in Europe and the U.S. starting in December has led to increased natural gas inventories and lower prices in the U.S. and Europe. As a result, spot prices for all nitrogen fertilizer products have fallen from the high levels in the fall . With sustained lower natural gas prices in Europe in the first quarter, we have seen some of the off-line European nitrogen production capacity come back online. Recent estimates indicate European nitrogen production operating at around 80% of capacity, up from 60% in the fall of 2022.

Natural gas market dynamics have driven nitrogen fertilizer prices to largely be set by the marginal price of European natural gas for production input costs plus logistical costs. While prices of nitrogen fertilizer in the U.S. have fallen since the winter, natural gas prices have also fallen into the area of $2.20 per MMBtu, setting U.S. nitrogen fertilizer production costs at the low end of the global cost curve ."

Economics 101: Higher supply = Lower prices.

What is holding up the unit price so well over recent weeks and months then?

Past Distributions are no Guarantee of Future Distributions

UAN has done a phenomenal job in making its unitholders happy in recent weeks, months, and years.

Very happy indeed.

No other fertilizer stock has been offering a dividend yield anywhere near the one offered by UAN - and that trailing 21.9% you see below is before the last (already) announced distribution is being taken into consideration.

From the company's most recent press release :

"CVR Partners also announced that on May 1, 2023, the Board of Directors of the Partnership’s general partner (the “Board”) declared a first quarter 2023 cash distribution of $10.43 per common unit, which will be paid on May 22, 2023, to common unitholders of record as of May 15, 2023."

Once this $10.43 will be paid, the company's cumulative cash distributions over the past trailing twelve months will be $32.75 per common unit = about 1/3 of the current unit price!

Further per the company's press release,

"CVR Partners is a variable distribution master limited partnership. As a result, its distributions, if any, will vary from quarter to quarter due to several factors , including, but not limited to, its operating performance, fluctuations in the prices received for its finished products, maintenance capital expenditures, use of cash and cash reserves deemed necessary or appropriate by the Board."

Don't get us wrong: We view UAN as a decent long-term holding and we remain under the belief that UAN is certainly capable of delivering excess returns over the long run, just as it did in recent years.

Nonetheless, we believe that in light of the current state of the economy (slower growth, risk of recession), monetary policy (still tightening without a rate cut being part of the official Fed's game plan for 2023), industry (lower food and fertilizer prices), and UAN specifically (lower utilization, likely lower distributions) - we would be better off sitting on the sidelines for a while.

For that reason, we suggest selling today (May 8) at $104.51, ahead of the upcoming distribution (ex-date May 12) that we believe to be holding the unit price artificially high with many people looking to cash in the fat $10.43 distribution.

We believe that albeit something out of the ordinary (in favor of the company and/or industry) happening between now and ex-date, CVR Partners, LP might be subject to a far-greater fall than the automatic adjustment of the unit price (to the distribution) on ex-date.

We're letting CVR Partners, LP go as a tactical move and we're likely to revisit this name once the current euphoria out of the upcoming distribution, and the fond memories of past distributions, fade away.

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