Description

After reading Helopilot’s writeup and his commentary on leaving UAN out of his writeup, I thought it would make sense to write up UAN! I think the fact that it is ignored by much of the investment community is very much key to the thesis (it is not a shot at you helopilot so don’t take that the wrong way!)

The main draw for me:  I like levered commodity bets where the underlying commodity is very volatile and the capital stack is locked in place for years to come. I am not a commodity expert and don’t pretend to be but I do think I am somewhat intelligent on capital structure and I like buying cheap options. If at some point in the next several years UAN/Ammonia prices improve then the stock doubles. I have played this game in the ethanol space, the power space, oil and gas, fertilizers, refiners (NTI and CVRR) and others and sometimes it works sometimes it doesn’t but I think there is a very good shot this one does line up quite well but you should certainly size it appropriately in your own book.

Very briefly the company owns two facilities: one is attached to the Coffeyville refinery and has a1,300 ton-per-day capacity ammonia unit, a 3,000 ton-per-day capacity UAN unit, and a gasifier complex having a capacity of 89 million standard cubic feet per day of hydrogen. The other facility was purchased from an old VIC favorite (?) Rentech and was eventually seized by Blackstone which led to a large overhang in the shares (which has created part of the opportunity). The old Rentech facility is  located in East Dubuque Facility and has a 1,075 ton-per-day capacity ammonia unit and a 1,100 ton-per-day capacity UAN unit. The East Dubuque Facility uses natural gas as its primary feedstock.

The capital stack is reasonably debt heavy and the company is a variable pay MLP. It typically targets paying out close to 100% of its earnings in a dividend.

The company has no maintenance covenants on its debt and the bonds, which are first lien secured, are trading @ 107 (!) implying a yield closer to 5% and are due in 5 years. The debt is implying a near bulletproof yield which is well out of whack relative to what the equity is implying. The company currently has an approximately $1bb EV and debt comprises $620mm of it; That debt is trading at a 5% yield and we believe the equity is on the cusp of re-rating significantly higher with a mid-cycle FCF that could be closer to nearly 30% of the current share price, and could lead to an implied share price between $7.50-$8.50.

From the period 2011 through 2015 the company paid out distributions equal to $7.50 a share the stock currently sits @ $3.75 (let that sink in for a minute. That is a really big number).  While those high flying numbers from 2011 to 2015 brought on significant capacity, I do believe prices will (and are) rebounding some and this will lead to a re-rating of the stock. We believe the more liquid larger cap players are starting to recognize this with CF up nearly 20% YTD (and CF having recently bought in its own MLP TNH in april of this year of their view on valuation)

I would suggest reading research reports from GS/Cowen and other players on their assumptions of UAN pricing. I think there is a significant realization that demand is starting to catch up with the supply that was created during what were clearly strong earnings years in 2011-2013 and that as demand catches up prices will increase..the question is when and by how much.

Icahn effectively controls this vehicle through his ownership of CVI. It is our belief that he is hoping to either spin this out or eventually sell it. He has been selling controlling stakes recently including TPCA and FDML. We believe this is a smaller position for him and that now that Blackstone has sold their holdings (which were collateral on a loan to Rentech) that he will most likely look for a way to monetize this in order to further clean up the CVI/CVRR story as some of the selling pressure of a large non-natural owner will subside.

As per the last conference call management was optimistic on pricing as demand is catching up to supply “Observing this fill season compared to last year, we believe the global and domestic trade flows have largely adjusted to the increased production capacity in the U.S. Trade flows in the U.S. have readjusted to customers' buying product at each location based on the lowest distribution costs delivered from domestic production facilities rather than imported product delivered from river terminals.”

We believe on mid-cycle pricing, which I would argue is $225 UAN and $400-$425 ammonia the company could do close to $0.65 a share annually in distributions. Put whatever dividend yield you want on it, but assuming a 10% yield implies about a $6.50 a share stock price which equates to close to a 9.00x multiple (I would argue high for a mid-cycle commodity but I think others think I am using below mid-cycle earnings). The company believes mid-cycle for the assets is closer to $200mm of EBITDA which at a 7.5x multiple would put the shares closer to $8.00. There is a lot of leverage in the structure and the business itself but I look at the long dated nature of this option and what the theoretical distributable cash is for a business that effectively provides a key component to a staple business and I like my chances that at some point the dividend spigot turns back on and the stock trades meaningfully higher in the next 2-3 years.

Further with the debt well above par, there is a chance the company can call the debt next year and extend the runway even further. I will point out that since the company has shut down the dividend in 2015 that the business has been close to FCF break even on a cumulative basis which to me implies they can weather the storm.

There are lots of other considerations to the story; natural gas pricing; does anyone really want a pet coke plant relative to traditional facilities; a decline in heavier oil usage in the US; Chinese coal based production etc but in reality what this is about is believing in their ability to keep running the plants efficiently (which they have done outside of some recent glitches) and if you believe the unknowable future of this commodity has a chance to rebound from current prices. If it does, the company will drive up the dividend and the stock will ratchet higher.

I will include my very basic and tiny summarized model which I am sure will be nitpicked to death but it is very much a measure with a micrometer and chop with an axe type story. Enjoy the back of my napkin.

Catalyst

Besides for the obvious on pricing plant maintenance is an issue

Disaster in HY Market as if the credit markets lose faith in the business I think it makes the equity less attractive on a relative basis

Lower for longer on agriculture prices in the USA leading to real demand destruction as UAN is less of an exporting business and more focused on domestic producers)