Terra Nitrogen Company falls more than 23% (Part 2 of 2)
Earnings down for nitrogenous fertilizers
Earnings for nitrogenous fertilizer producers have fallen by more than 30% for this last quarter compared to the same quarter a year ago. CF Industries Holdings Inc. (CF) recently reported an earnings decline of ~33% due to lower prices as well as fertilizer sales.
When it comes to the nitrogenous fertilizer business, prices often matter more than sales volume. Unless a company is one of the more expensive producers, it’s pretty much guaranteed to sell fertilizers, because farmers need to apply them every year. This makes demand less sensitive to price. TNH’s earnings for the third quarter fell 30% from the same period a year ago.
Note that we’re excluding special one-time items to calculate earnings changes in order to get a clearer picture of how the core operating business is performing. We use a year-over-year comparison because fertilizer sales can be seasonal.
The question that investors might be asking right now is will fertilizer prices stay low? Unlikely—for reasons CF Industries Holdings Inc. (CF) mentioned in its report, and we’ve already seen prices rebounding (those who check our website regularly will know this). However, will fertilizer prices rise back up to what they were at the start of this year? The prospect is minimal. In CF Industries’ latest call, there wasn’t really optimism that prices would fly back up to where they were at the beginning of the year. Managers at Potash Corp. (POT) were even more cautious about a possible change in China’s fertilizer export policy that would make world urea prices cheaper next year (see Why Potash Corp. remains cautious about nitrogenous fertilizers).
Terra Nitrogen Company valuation
To do a quick valuation, Terra Nitrogen Company (TNH) has historically traded at an 8.0% dividend yield. Before the 22% drop, dividend yield stood around 8.0%. This means that if dividends over the next few quarters fall X% from last year, share prices should also fall by roughly X% as well. Since dividends closely follow the company’s earnings over the medium to long term, share prices will have to fall by ~X% too if dividend yield is to remain at 8.0%.
As fertilizer prices are rebounding, the earnings drop for the next few quarters (compared to the previous year) will likely be less severe than what we saw during the recent third quarter. If we say earnings will decline about 30% from last year’s average, then TNH could be valued at $154, which would make TNH suitable for a value play if share prices fell below $150 a share. Beware, however, as this could be a value trap (there’s a reason why prices are now this low) since fertilizer prices aren’t likely to recover much, based on the current prospects.
We encourage investors to read CF Industries’ earnings call, as management mentioned a couple of factors that will have a great influence on the performance of nitrogenous fertilizer producers next year. See Key drivers that CF Industries managers deem important in 2014. These factors will also affect Agrium Inc. (AGU), POT’s nitrogenous fertilizer business, and the Market Vectors Agribusiness ETF (MOO).
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