Nitrogen Shares Come Down to Earth

09/09/2008 12:00 am EST


Vahan Janjigian

Editor, Bottom Line's Money Masters Stock Report

Vahan Janjigian, editor of Forbes Growth Investor, says a fertilizer company offers good growth at a lower price.

Terra Industries (NYSE: TRA) supplies nitrogen-based products to the agricultural and industrial markets. Through various facilities and a majority stake in Terra Nitrogen (NYSE: TNH), TRA produced 2.98 million tons of ammonia in 2007.

Approximately 75% of the output was used to make fertilizer sold to national agricultural retail chains, farm cooperatives, and other agricultural customers. Principal products include ammonium (AN), urea, and urea ammonium nitrate solutions (UAN).

TRA also derives a small amount of revenue from the sale of methanol, a natural gas derivative used to make formaldehyde, acetic acid, and other chemical intermediates. Last September it merged its UK subsidiary with assets from Kemira GrowHow, the largest producer of compound fertilizer in the UK, to form GrowHow UK Ltd. These operations generated $47 million, or 16% of total income from continuing operations, in the first half of 2008.

TRA has seen explosive growth over the past several years due to increased global demand for grains and other agricultural products. Strong economic growth in China, India, and other developing nations has led to greater disposable income levels and improving diets.

Furthermore, rising gasoline prices, environmental concerns, and government subsidies have piqued interest in alternative energy sources derived from agricultural feedstocks such as ethanol. In fact, the amount of corn used for ethanol production in the US more than doubled over the past five years to 2.1 billion bushels.

These factors have led to an exceptionally strong pricing environment for nitrogen-based fertilizers. The company’s revenues grew 28.5% in 2007 to $2.36 billion based largely on higher selling prices. The operating profit margin surged to 17.8% from just 3.6% in 2006. Pro forma net income available to common shareholders was $246.6 million or $2.37 per share versus a loss of $887,000 or a penny per share in 2006.

Net income for the first half of 2008 quintupled to $302.3 million or $2.91 per share. These stellar results came despite delays in shipments stemming from the Midwest floods in the second quarter.

Stocks exhibiting this kind of growth typically sell for rich valuations. However, some investors are growing concerned that historically high prices for agricultural commodities cannot be sustained.

Indeed, rising grain prices are behind TRA’s recent growth. In fact, a rapid decline in grain prices must be considered a significant investment risk. Natural gas prices could also spike. Natural gas is the company’s largest input, accounting for 44% of total costs in 2007.

Such worries explain why TRA sells for favorable multiples. Yet industry fundamentals are promising and demand should remain strong. In fact, the Agriculture Department. predicts that total plantings for all grains in the US will increase 3.3% in 2008 to 303.4 million acres.  As a result, we expect strong growth and high prices to be sustained for nitrogen-based fertilizers. (The stock closed under $44 Monday—Editor.)

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