The case of TNH
Terra Nitrogen Company is structured slightly differently than other nitrogenous fertilizer producers such as Potash Corp. (POT), Agrium Inc. (AGU), and its majority owner, CF Industries Holdings Inc. (CF). It’s an MLP (master limited partnership). Master limited partnerships are limited partnerships that trade publicly.
The MLP (master limited partnership)
A limited partnership is a person or group that provides capital to an MLP while receiving periodic income distributions from an MLP. The general partner, in this case CF Industries Holdings Inc., is responsible for managing the MLP’s (Terra Nitrogen Company’s) affairs and receives compensation linked to the performance of the venture. To be classified as a master limited partnership, the company must derive 90% of its cash flow from real estate, natural resources, and commodities. Since fertilizer chemicals are essentially commodities, Terra Nitrogen Company can be established as a MLP.
Terra Nitrogen Company falls
MLPs are highly sought-after by income or dividend investors because as long as these companies distribute most of their cash flow to investors, they don’t get taxed at a corporate level. Because of this, MLPs tend to have stable income—but not all of them do. As we saw over the past few days, Terra Nitrogen Company LP (TNH) sank 23% since the start of November and 30% from the average price since mid-2012. While the company boasted a high dividend yield of 8.0% before the recent fall, dividends have been at risk primarily because of lower fertilizer prices caused by increased supply out of China. We’ve highlighted this trend in our series Must-know: Why Terra Nitrogen Company could cut dividends by 25%.
Will other companies be affected?
Yet CF Industries Holdings Inc. (CF), Agrium Inc. (AGU), the Market Vectors Agribusiness ETF (MOO), and Potash Corp. (POT) haven’t fallen. So will other fertilizer stocks and ETFs follow suit? Unlikely, overall. Some of these companies are influenced by different factors because they run a retail operation (Agrium) or they focus more on potash production like Potash Corp. (POT). While CF Industries will be a pure-play nitrogenous fertilizer producer after it sells its phosphate asset to Mosaic Co. (MOS), it looks like share prices are being supported by a large cash base that can be used to increase dividends, an ongoing share buybacks program that raises the value of earnings, and production expansion that will drive positive risk-adjusted returns (although this production increase is quite far ahead, in 2015 or 2016).
But since Terra Nitrogen Company LP (TNH) is an MLP that doesn’t store cash, it can’t initiate buybacks to support share prices. This means when earnings fall, so do dividends. And because MLPs are often purchased for their dividends, lower dividends mean lower share prices.