Tuesday, April 10, 2018

CVR Partners - Nitrogen Fertilizers

OVERVIEW

CVR Partners is a variable distribution master limited partnership that makes and sells nitrogen fertilizers in the United States.





In an oversupplied and rational market, as currently, the marginal cash delivered cost of nitrogen fertilizers should determine their market price. 



In an import dependent market like the United States, the marginal cash delivered cost of nitrogen fertilizers is determined by two elements:

  • the marginal importer's feedstock cost; and
  • the marginal importer's cash cost to insure, transport, and store the fertilizer product.


and therefore, given CVR Partners' 2017 product mix and $3 Henry Hub gas price:



note: "CAFD" = cash available for distributions, i.e. dividends.

Or, assuming for the sake of argument that (a) the natural gas price faced by the marginal importer is $9/mmbtu; and (b) CVR Partners' product mix reverts back to its historical pattern:

 and therefore:



Investors motivated to look two or four years ahead may find that the feedstock cost faced by marginal importers is likely greater than $9/mmbtu equivalent. 

For example, translating Chinese lump anthracite producers' feedstock equivalent pricing yields the following translation:


Alternatively, as demand growth absorbs the capacity added in the last few years and as capacity utilization rates rise, the list of marginal producers will increasingly include older European plants that are less efficient at converting natural gas into nitrogen:



So at $70/barrel Brent oil one might expect $7.50/mmbtu natural gas prices in Europe. But the older plants consume 35% more gas per ton of nitrogen so the $/mmbtu on an equivalent basis is $7.50 x 1.35 = $10. And so on.

THESIS

That was the overview and what follows is the investment case for CVR Partners at the price that it is trading at today.

This is what the relationship between importers' marginal cash delivered cost and CVR Partners' average selling price ("ASP") looks like for anhydrous ammonia ("ammonia") and for urea ammonium nitrate ("UAN"):





The contention of this write up is that the gap between fair values and actual ASPs, representing as it does cash variable costs borne by financially motivated agents is not sustainable and will close. 

This series of charts is a useful additional clue as to the peculiarity of the situation in 2017.  



 
CVR Partners' 2017 performance would have looked like this in the absence of  the logistics gap:



I have set aside the associated improvements in urea and nitric acid pricing for the sake of simplicity.

95 million in distributions should be good for >$10 unit prices.

RISKS

The risks to this thesis are NAFTA-dissolution and China trade war related. Mexico is the principal consumer of US corn and China is the principal consumer of US soybeans. A trade war with either country will likely disrupt nitrogen fertilizer trade flows and may prolong the time required for the logistics gap to close.

China's response to a tariff war may be to allow the yuan to devalue. That would flatten the cost curve so that the longer term upside potential outlined in the "overview" section above would be reduced.

On the other hand, a potential opportunity outside the scope of this write up is the development of a Chinese ethanol industry which would cause a substantial increase in corn, and therefore, nitrogen demand.



USEFUL RESOURCES

Weekly ammonia and urea prices at the US Gulf Coast http://www.mosaicco.com/resources/3185.htm

Quarterly AN and Urea prices at Black Sea ==> quarterly implied UAN price at Black Sea (using the formula 45% AN plus 35% urea): 
http://www.eurochemgroup.com/en/downloadcentre/

Monthly urea and UAN prices in the US interior
https://marketintel.intlfcstone.com/MIPublic/Home.aspx?secid=158

Anything put out by CF Industries is worth paying careful attention to.

54 comments:

  1. https://www.dropbox.com/s/6ccx9r6npue221y/Simple%20Model%20for%20upload.xlsx?dl=0
    Should be downloadable. Let me know if it's not.
    Entering values in the yellow cells should spit out sensitivities. Beware GIGO.

    ReplyDelete
  2. Additional data source for those interested in what's going on in China -- i.e. everyone
    http://www.stats.gov.cn/english/pressrelease/index.html

    Fortnightly release titled "Market Price of Important Means of Production in Circulation" presents domestic urea prices (metric tonne) and coal prices.
    So. for example, thelatest bulletin reports anthracite at RMB 1324/t and urea at RMB 1972/MT
    Urea at RMB 1972/MT translates to ~$280 per short ton. Etc

    ReplyDelete
  3. Glad to see a new post! Really appreciate your ideas and analysis.

    ReplyDelete
  4. I am so happy you are back. I missed your posts!You are one of the most independent minds in the value investing arena.

    ReplyDelete
  5. Yara Q1 2018
    https://www.yara.com/investor-relations/reports-presentations-2018/

    ReplyDelete
    Replies
    1. Thanks for sharing, red. From my ignorant point of view, most interesting was slide 16 on the slowing capacity additions in the medium term (and possibly the first question/answer). Do you think China will be able to fill demand in 2020/21, say? And if so, at what cost?

      Delete
    2. Well I think one can retrace China utilization rates to come to a first approximation of the incentive price for increased Chinese production. And then fine tune it by adjusting for increased electricity rates, decreased rail transport subsidies, increased environmental compliance costs, higher ocean freight rates, increased labor costs, and so on. And, of course, the sheer cash cost of restarting idled plants. CF's presentations over the last, say 8 quarters, are good sources for this.

      I think it would be very hard to come up with an incentive price that is lower than RMB 1800/st or RMB 1985/MT for urea, all things considered.

      Of course that's separate from the main thrust of the investment case for the North American fertilizer producers. NA urea prices, for example, are currently (April 2018) $57/st below what would be parity with Chinese prices.

      Delete
    3. https://www.profercy.com/2018/04/china-exits-international-urea-markets-with-q1-2018-exports-down-75-on-year/

      Delete
  6. Hey red,
    I thought I'd share Bruce Berger's video on CVR:
    https://youtu.be/EJRKItfFC7M

    ReplyDelete
    Replies
    1. I watched it. Thx for posting. I'd caution that he has more things wrong than right -- the causes of oversupply, CVRP's cost structure, ete etc. I'd recommend to anyone interested in this stock that they simply read the S-1s for the cost structure and read through CF's materials for an understanding of the industry dynamics.

      Delete
    2. Gets to conclusions I agree with but not a rigorous path there. Talked about fertilizer pricing in technical analysis terms, not supplier cost curves

      Delete
  7. http://www.snl.com/IRW/file/4533245/Index?KeyFile=1001236417
    cf pp 9-18

    Differences between Yara and CF presentations of future capacity accounted for by difference between plants' commissioning CF's materials) and those plants' production"ramp up" (Yara's materials)

    NB CF doesn't like to change the cost curve assumptions once they've been set in the fall of the prior year. The assumed drivers (coal price, USDCNY etc) are higher and much higher than they were then.

    Etc and so on. Worth listening to the call tomorrow of course

    ReplyDelete
  8. What do you think the market is missing? If I'm reading what you posted correctly UAN prices have no where to go but up yet the stock is trading at 52 week lows.

    ReplyDelete
    Replies
    1. Levered cyclical in the later stages of the economic cycle + its natural unitholder base is dividend-seeking? That's some of it no doubt. Why own it now rather than later?

      Methanex a couple of years ago, for example, was in a similar sort of situation: also a beneficiary of the North American gas feedstock advantage although operating in a shakier end market. The market liked Methanex and then didn't and then did again.

      Also there was a credit fund that owned several million units of CVRP -- a depressing story that I won't trouble you with -- and it has sold all (or virtually all) of those units over the last few months.

      Delete
    2. Which fund?

      Delete
    3. Funds managd by GSO Capital Partners, a Blackstone entity. Rentech Inc owned ~7 million units of CVR Partners. These units were pledged as security for loans extented to Rentech by GSO Capital Partners. When Rentech was close to being bust GSO took ownership of the units and sold them off more or less immediately at prices ranging from $4.25 to $2.90. They show up as a long series of 13-fs in CVRP's recent filings history.

      Delete
    4. An opportunty to guage how "the market" feels about annual $1.40/unit distributions at an assumed $250/MT ammonia selling price
      https://www.prnewswire.com/news-releases/oci-partners-lp-reports-2018-first-quarter-results-and-announces-0-38-quarterly-cash-distribution-300643392.html

      Delete
  9. Also just wanted to say +1 to you posting again hope it continues as I do find your posts though provoking.

    ReplyDelete
  10. Anyone find this interesting from the CC?
    "We had carryover tons that we hadn't delivered yet from the fall season and that blends down that average price in the first quarter for UAN. Ammonia was higher than last year, but UAN I recalled a blended number of fill [ph] tons at much lower prices and then everything we sold this year has been at much higher prices than the fill [ph]. So, it's kind of blended number. So those are the two dynamics in that. And as we get into the second quarter, we will benefit from 100% at the higher pricing"
    ....
    "And so, you will see a very different price profile in the second quarter versus the first."

    ReplyDelete
  11. Assuming normal operating rates at East Dubuque 2Q pricing should be close to pricing realized in Q2 2016

    ReplyDelete
  12. https://www.icis.com/resources/news/2018/05/09/10220210/iran-s-4m-year-urea-exports-to-be-hit-by-potential-us-sanctions/?cmpid=SOC|Twitter|ICISFertilizers|sf189251472|sf189251472&sfid=701w0000000uPCR&sf189251472=1

    maybe

    ReplyDelete
    Replies
    1. https://www.profercy.com/2018/05/iran-sanctions-to-cause-headaches-but-unlikely-to-change-fertilizer-status-quo/

      And maybe not. I agree with this piece.

      Delete
  13. Thanks for sharing Red.

    USA playing with international market. Not too fair for Iranian people.

    ReplyDelete
  14. What are your views on the debt. If fertilizer prices don't recover can they make interest coverage and refi maturities?

    ReplyDelete
  15. It was me with the account of my wife.
    : )

    ReplyDelete
  16. "What are your views on the debt. If fertilizer prices don't recover can they make interest coverage and refi maturities?"

    If fertilizer prices stay at 2017 levels for five years and there is no prospect that they will recover at the end of those five years the most useful hypothesis to go with is that they won't be able to refi maturities in 2023.

    ReplyDelete
  17. http://innovo.etnet.com.hk/common/corpan_cache/HKEX-EPS_20180515_003146566_0.PDF

    Starting to see the light in the food and catering business, and good news for the development project of Henqind Island in spite of the delays.

    However there´s a long way to run till reach the numbers of 2014 first quarter. The Gross operating profit was nearly double.

    ReplyDelete
  18. Nafta talks set to drag in to next year after missed deadline
    https://www.ft.com/content/a57682cc-59e7-11e8-bdb7-f6677d2e1ce8

    ReplyDelete
  19. Ah. Obrador v Donald, then.

    ReplyDelete
  20. thanks for blogging

    some counterpoints to your thesis and wondered how you counter this.

    1) i read somewhere that the currently global nitrogen capacity utilisation stands at 78%. and that it would have to reach 85% before the pricing regine changes.

    2) for about 8 months US imports very little or no chinese nitorgen. for those months the pricing signal would be to dissuade the anthracite coal producers from sending supplies to US, i.e. that cost is the ceiling as opposed to the floor.

    3) and for those 4 good months - from nitrogen pricing perspective its bad that china is being push out of the cost curve i.e. it would matter less and the more cost efficient chinese bituminous coal or europeans becomes more relevant pricing wise. and as capacity is added in non-chinese locations in the next couple of years this point will become more relevant.

    in the short term - steeping of the curve will be great. i.e. higher coal prices/tariff. but, it is expected that the chinese coal prices are likely to come down.

    from the long term adjustment of supply might be a longer process. i.e. if say the pricing improves in the next year i suspect the chinese supply will probably come back online. things need to get dismantled, put to different use, etc.

    all this is moot if you think you are buying a dollar for 10c.

    ReplyDelete
    Replies
    1. Thanks for the questions:

      re: 1) Which pricing regime?

      My "thesis" at this price is not concerned with the global cost curve but about the deficit between North American prices and international parity.

      You will not, I think, find any analysis from any source arguing that global fertilizer prices will be at or below 2017 levels. My write up above explicitly assumes global prices at 2017 levels and then posits that North American prices will rise to parity with that global price level. Consequently I'm going to set aside 2) and 3) because the questions aren't relevant to the thesis.

      I recognize your questions from conf call transcripts and discussion boards and such. My recommendation -- since this is a volatile stock -- is to just put some numbers together.

      (1) Either the marginal cost is $X or it isn't.
      (2) Either NA traded below parity or it didn't.
      (3)Either marginal producers do their best to price according to marginal cost or they don't.

      These are the three propositions to be tested. I've provided some data sources above. Test them and decide -- that's the best way for a long-only investor to approach this, in my opinion.


      Delete
    2. the point i was trying to make was
      1) the marginal delivered cost is different at different points/months in the year.
      2) going forward as more middle eastern/african supplies comes in the marginal cost only goes lower for more months.

      i guess the main difference is you are looking at marginal delivered cost as one number based on annual numbers. but given the level of oversupply dicing it further may be worthwhile.

      re. "pricing regime" - from a oversupply based/marginal cost pricing to a more demand led.

      Delete
    3. just to be clear the reason the marginal cost will be different at different points of the year is because WHO the marginal supplier is jamaica/canada vs me/africa vs eu vs china

      Delete
    4. Fertilizer demand and pricing is seasonal, yes.

      It is seasonal because storage costs cash money.

      And because storage costs cash money importers and traders try to approximate just in time delivery and thereby cause peak/congestion pricing at each of tanker, barge, and and truck levels.

      There is a trade off: storage cost v incremental freight & handling cost. So, assuming profit-seeking importers/traders/producers etc it is not easy to see how a regime of global oversupply can cause planned or repeated distortions from normal patterns of seasonality.

      One time shocks can happen as in late 2016 to early 2017 when importers underestimated the amount/timing of domestic supply that came on stream.

      There's a market share mindset that CF reports some Middle Eastern producers have and we'll see how long that persists when they see their product re-exported month in month out, to Brazil and Europe and, why not?, China, at a $40/t spread.




      Delete
  21. I guess Future Bright's finally re-rating?

    ReplyDelete
  22. http://www.farmfutures.com/story-weekly-fertilizer-review-0-30765

    ReplyDelete
  23. https://www.icis.com/resources/news/2018/06/01/10227278/urea-prices-up-as-producers-commit-june-cargoes-start-selling-for-july/

    ReplyDelete
  24. Seems like the NAFTA situation is deteriorating, even though Mexiko excludes corn and soybean for now...

    ReplyDelete
  25. I think the way that the Renenwable Fuel Standard fight ended up is a leading indicator for how things will play out with Mexico
    https://www.desmoinesregister.com/story/money/agriculture/2018/06/05/grassley-epa-pruitt-ethanol-rfs/672458002/

    ReplyDelete
  26. You have recently bought Best Pacific International.

    It looks cheap after the recent collapse in share price. Do you know why it's falling? Can't find a reason. Trade war?

    Also they have some prominent customers. Do you consider the business to be high quality and the costumers to be sticky?

    Any reply would be appreciated. Have looked though the 2017 presentation.

    Still holding Texhong since 2014 :)

    ReplyDelete
    Replies
    1. It first fell after revealing gross margin contraction. Gross margin conracted principally because of the cost of unused capacity as it "ramps up" production in its new Vietnam factory. The line item is spelled out in the financials. The gross margin at normal capacity utilization ought to be in the 31% to 33% range, (Sportswear material sales are growing at >70% per year and now make up almost half of its elastic fabrics sales).

      It then fell because of trade war fears. About 40% of its sales are directly or indirectly targeted to the United States. Offsetting that is that it could shift some US targeted production to its Vietnam factory. Its Vietnam factory accounts for 30% of the company's designed production capacity. The cost of any tariff would also be presumably shared up and down the supply chain - i.e. US consumers, US retailers, garment manufacturers, fabrics manufacturers, fabric manufacturers, yarn producers, and so on up the line. How it would be distributed among these parties is going to depend on relative market power. Best Pacific is a one-stop-shop, high quality, reliable producer with just in time capabilities and there's little reason to believe that it would bear the lion's share of the tariff burden.

      So either growth overcomes margin compression or margins expand or both. Once uncertainty dies down the earnings multiple should expand to 12x or 13x.

      That's the way that I see it.


      The customers have proven to be sticky in the past. There is increasing cross selling of fabrics and webbing to its major customers. It has established a joint venture with a regional powerhouse customer ini Sri Lanka etc.

      There are governance concerns. It bought into a life insurance venture, for example. The amount of capital allocated was small but it something not to be ignored in my opinion.

      Delete
  27. https://finance.yahoo.com/news/azul-reports-june-traffic-121500371.html

    ReplyDelete
    Replies
    1. If I had to guess 'd say that sentiment and fx will improve after the presidential elections in Oct. Until then it's uncertainty + summer trading volumes ==> volatility

      Delete
  28. Replies
    1. Watch Fibria and Suzano's share prices (they will be one entity soon enough). Weak BRL is very very good for them just as a weak BRL is a drag on Azul's profitability. There may be an opportunity in the summer / in this volatility to hedge by going long both.

      Delete
  29. http://www.farmfutures.com/trade/trumps-tariffs-could-reshape-global-ag-trading-years

    ReplyDelete
  30. https://twitter.com/Profercy/status/1016718889588314113
    1.CF's swing capacity is at the US Guld
    2. CF is netback focused
    3. Inland & International freight costs are equal
    ==> CF sets the floor for domestic pricing of UAN

    ReplyDelete
  31. Liked very much this one:

    https://www.oakmark.com/Commentary/Commentary-Archives/Bill-Nygren-Market-Commentary-2Q18.htm

    Bill Nygren

    ReplyDelete
    Replies
    1. Thanks for sharing, David!

      Delete
  32. Yara Q2 https://www.yara.com/siteassets/investors/057-reports-and-presentations/quarterly-reports/2018/2q-2018/2018-2q18-web-presentation.pdf
    Points of interest:
    - Spreads between European, Asian, & NA nat gas (& LNG) prices
    - Continued intimate relationship between Chinese anthracite & urea prices
    - the negative Ammonia upgrading margin
    - the North America discount to international parity, which appears to be running at $20/st of urea
    - etc

    ReplyDelete