Still time to climb aboard Terra haywagon

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The search for a solid investment that should outperform the market can take a variety of forms, but if you’re looking for a debt-free company with a generous dividend yield — whose share price has survived this summer’s correction — almost any route you take leads to Verdigris, Oklahoma.

The town, population 4,000, is northeast of Tulsa and is home to the Terra Nitrogen Co. Limited Partnership (TNH/NYSE), whose sprawling plant next to the Verdigris River turns out anhydrous ammonia and ammonium nitrate solutions, used in nitrogen fertilizer products.

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Still time to climb aboard Terra haywagon Back to video

That one of the best stocks in the agricultural space can be found south of the border might be quite a shock for Canadian investors who tend to only have eyes for Potash Corp. or Agrium Inc.
Terra was acquired in April, 2010 by Deerfield, Illinois-based CF Industries Holdings Inc. in a US$4.7-billion merger that produced the dominant player in the U.S. nitrogen fertilizer business — and caused Agrium Inc. to abandon its US$5.4-billion offer for CF.

Although 75% owned by CF, Terra Nitrogen still trades as a limited partnership, which means it must distribute all its available cash to unit holders. North American farmers have been furiously planting crops and spreading fertilizer, forcing up the price for ammonia and increasing the cash Terra Nitrogen pays to the point where it now yields about 6%.

The partnership has paid out nearly US$9.95 a unit in distributions already this year, well up from US$5.01 last year, and ahead of the US$8.92 paid out in 2009. Distributions peaked at US$15.08 per unit in 2008 but unit holders got almost nothing between 1999 and 2003.

Terra was the only name that appeared when we set some simple but hard-to-meet standards and applied them to the Google Finance stock screener’s list of 8,253 companies and exchange-traded funds. (Google insists on lumping in ETFs with companies, showing, for example, that the Vanguard Growth ETF has a net profit margin of 1,197% and a return on equity of 16,600%, but that is a separate topic).

Our candidate company had to have a total debt to equity ratio of no more than 1% in its most recent year, which narrowed the list to just 1,487 names. Further, our debt-free candidates had to pay a dividend that yielded at least 4%, and had to have some momentum: the share price had to be up by at least 5% over the past 13 weeks and 10% over both the past six months and over the past year.

Terra Nitrogen shares have had a lot of momentum. Long-term shareholders have traded in their bus tokens for luxury cars, since the units are up 729% over the past five years and 2,900% over the past decade.

This year alone, the shares have climbed 75% and 43% over the past three months. They now trade at a lofty US$186, to the point where the partnership trades at 16.3 times trailing earnings of US$11.39, 13.3 times book value and 5.1 times sales per units. The price shows investors are willing to pay up for an industry-leading 81% return on equity and a net profit margin of 35.7%, also the best in the industry.

For the second quarter ended June 30, the company reported earnings of US$128.9-million on net sales of US$198.6-million, up dramatically from US$66.7-million on net sales of US$166.9-million in the same quarter a year ago. The results reflected the 48% price increase for ammonia and the 47% higher price fetched for urea ammonium nitrate, the company said.

Writing at The Motley Fool website (fool.com), columnist Seth Jayson lauds Terra Nitrogen’s free cash flow. In a Sept. 12 article, Mr. Jayson notes Terra Nitrogen generated US$381.9-million in cash flow from its US$674-million in revenue, a 56% ratio that is far better than its parent CF Industries 35.3%, Potash’s 13.4% and Agrium’s -1.0%, he says. Mr. Jayson goes a step further to flag questionable sources of cash flow, and finds that “With questionable cash flows amounting to only 0.8% of operating cash flow, Terra Nitrogen’s cash flows look clean.”

Despite the strong fundamentals, the soaring price of Terra Nitrogen makes it a speculative investment like gold or silver, and like precious metals, ammonia prices could plunge without warning. The best strategy appears to be to take a small position and regularly take profits to lower your average cost and cut the risk.