CVR Partners (UAN): Forget Oil, Fertilizer Is The True ‘Inflation Trade’ Today

Stock Market


Large-capacity workshop for the production of ammonia of a petrochemical plant.  Exterior of tube furnace, Shaft converter, CO2 adsorber with copy space.

Aliaksandr Yarmashchuk / iStock via Getty Images

Over the past few weeks, the spike in market volatility has led to dramatic increases in commodity prices. Crude oil is now firmly over $ 100 per barrel, both wheat and gold are near all-time highs, and the surge in nickel prices temporarily broke the London Metals Exchange. To be fair, commodity-driven inflation has been dramatically impacting the market for over a year; as I’ve discussed for some time, Russia’s invasion of Ukraine has merely exacerbated those pre-existing issues.

We’ve discussed the potential fallout in natural gas, oil, coal, and shipping, but one of the most important trends this season may be in fertilizer and food. Russia is the top global exporter of fertilizer. Due to its immense size compared to its population, Russia has extreme export power and is the largest global exporter of many raw commodities. Russia is also the top exporter of natural gas, the most expensive ingredient in fertilizer production, and numerous other key fertilizer inputs. Fertilizer prices were skyrocketing well before the “Russia issue” due to high natural gas prices (particularly in Europe). Just as fertilizer prices started declining, the global fertilizer supply chain was thrown back into disruption.

Fertilizer producer stocks such as CVR Partners, LP (UAN) have seen stellar gains over the past six months as the shortage has become quite dramatic. While UAN has benefited from the nearly three-fold increase in fertilizer prices, the company’s bottom line is also negatively impacted by higher input costs. Despite this, the company’s cash flow per share has risen from roughly zero in late 2020 to $ 17.6 today, giving the firm an attractive TTM “P / CFO” of 6.1X. See below:

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Data by YCharts

Similar to shipping companies, today’s unique situation poses a mix of positive and negative factors for CVR. The company will likely face an increase in uncertainty throughout the rest of 2022. On the one hand, it appears that the fertilizer shortage will continue to grow due to even higher natural gas prices. Of course, the spike in input costs may mean companies like CVR see no increase in earnings and may even see their income slip. Much of this will depend on trade dynamics between countries which indirectly impact fossil fuel and fertilizer prices. Let’s take a closer look.

Shortages are Good and Bad For Fertilizer

Manufacturers face shortages on many fronts today. This includes energy & electricity as well as other material input costs. Additional areas of production stress include labor shortages, shipping slowdowns, and specific regulatory measures. On the one hand, this has led to dramatic increases in producer selling prices, but it has also led to substantial cost increases. For example, higher natural gas prices have caused many fertilizer plants to be temporarily shut down, particularly in the UK, where the energy crunch is worse, meaning those fertilizer plants were losing money on the cost front despite high selling prices. As fertilizer supplies wane, farmers must pay more to produce, which is incredibly inelastic for farming chemicals. This causes food prices to rise but may still mean no profit gain for farmers. See below:

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Data by YCharts

Food prices, fertilizer prices, and energy prices are closely tied together. Over the past two years, we have seen fertilizer prices increase faster than energy. For example, fertilizer prices have doubled since last year while natural gas has risen by ~ 60%, causing CVR’s margins to climb. Currently, natural gas accounts for ~ 47% of CVR’s feedstock costs, with most of the remaining portion going to Petroleum Coke (43%). Importantly, CVR’s Coffeyville plant is the only plant in North America that uses a Pet Coke-based fertilizer production process. This gives the company a competitive advantage in today’s expensive natural gas market since, according to the firm’s last investor call, available Pet Coke supplies have risen.

CVR also has an advantage from being situated in the US Natural gas prices in Europe are currently € 113 / MWH, which translates to ~ $ 37 / MMBTU, over 8X higher than today’s US natural gas prices. Importantly, fertilizer and its derivatives are traded overseas worldwide via dry bulk shipping. Natural gas is comparatively challenging to transport overseas as it must be compressed into liquid natural gas. Since LNG creation is an expensive and timely process, it is still not causing a significant overall increase in North American gas exports to Eurasia. As such, natural gas prices are comparatively high in Europe while fertilizer prices are only slightly higher.

This situation is beneficial for US fertilizer producers even if they do not export since they indirectly benefit from the highly competitive pricing power of exporters. Russia has even better competitive pricing power than does the US since it has more free natural gas and other energy products. Thus, as Russia halts fertilizer exports to maintain its food supply, those few countries like the US with sufficient domestic energy supplies gain significant pricing advantages.

Overall, I believe this situation is net-bullish for CVR’s bottom line growth. While the company will continue to pay significant sums in energy costs, it has a superior cost profile than domestic and foreign competitors. As such, its selling prices are likely to remain well above its input costs, and that spread may continue to grow due to Russia’s fertilizer export freeze. Of course, even higher fertilizer costs may constrict North and South American farmers. While their short-term demand is inelastic, I can only imagine some farmers will eventually leave open acreage if fertilizer prices rise by so much that they cannot make a profit. Thus, I only expect this situation will benefit CVR in 2022 and 2023, but the firm’s margins will still likely return to “normal” levels in the long run.

What is UAN Worth Today?

As is the case with many commodity-centric firms today, CVR Partners was in a challenging situation before 2020. Prior to then, fertilizer prices were comparatively low as overseas production rose, particularly in China. With prices down, CVR could not turn a positive gross profit, and the firm’s balance sheet leverage climbed as its working capital trended toward zero.

Since then, fossil fuel production cuts, labor, and shipping issues have upended the market, causing many countries, including China, to restrict fertilizer exports. For now, this shift has been a saving grace for CVR Partners and other fertilizer producers, finally allowing the company to turn a large enough profit to slightly reduce liability burdens and build a small working capital supply. See below:

Chart
Data by YCharts

CVR is a Limited Partnership as opposed to a C-Corporation, so it usually pays out a very high portion of its EBITDA as dividends which, for investors, are taxed as long-term capital gains. Given the company’s previous financial situation, it should come as no surprise that it is not looking to pay all of its income out as dividends and is instead reducing its hefty debt load. Of its total $ 93M last quarter EBITDA, it is reserving around $ 37M (~ 40%) for interest and debt repayments as well as planned capital expenditures. Today, this equates to a high 9.4% TTM yield which could rise further as debt is reduced.

Of course, at this point, I do not expect CVR’s incredibly high income to last much past 2022-2023. Fundamentally, the company’s increased profits stem from US fertilizer producers having lower input costs than most overseas competitors. As long as Russian natural gas imports to Europe are falling and developing countries restrict fertilizer exports, this pricing advantage will remain. However, in the long run, I expect US natural gas prices will eventually rise similar to Europe’s due to increased US LNG exports and limited energy production in the US Fundamentally speaking. At the same time, many factors are giving CVR an immense short-term advantage, but there are few structural changes today that give it a permanent competitive advantage. Thus, while the firm may see a stellar $ 20- $ 30 EPS in 2022 and likely a similarly elevated income in 2023, it could fall back into low or even negative territory after that.

The Bottom Line

Short-term investors looking to ride the “Inflation” or partly-related “Russia War” trends may see substantial gains in UAN. It is among the small but fascinating basket of stocks that have a net gain from today’s high uncertainty. Even more, its dividend yield may easily be 20% + in 2022-2023, given its high expected earnings. Fundamentally, the company has a clear competitive advantage today despite higher input costs since its foreign and domestic peers generally face even higher input costs.

However, from a longer-term perspective, I see many reasons to be careful with UAN. The company does have an extremely high debt burden which gives it little wiggle-room in case prices decline again or, more feasibly, if US energy prices rise high enough that CVR Partners becomes unprofitable. In my view, there is a bit more risk of continued upside in natural gas prices than in fertilizer prices, so the company’s cash flow is volatile. If we assume its income will inevitably return to near-zero levels, its stock would be expensive today even with temporarily high distributable cash flow.

Overall, I am neutral on UAN and would generally avoid the stock as a long-term investment at its current price. That said, I would not be surprised to see the stock climb much higher in the short run as investors scramble for those few “inflationary hedge” stocks. Finally, if its profits remain high enough to substantially reduce its leverage or if Eurasia’s energy crisis worsens dramatically, CVR Partners may become a more robust long-term investment.



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