Description

CVR Partners, LP (Ticker: UAN)

Recommendation

Buy CVR Partners, LP (CVR) units.  CVR is a variable distribution MLP formed by general partner CVR Energy (CVI) to own and operate its nitrogen fertilizer business.  CVI, itself controlled by Carl Icahn, owns 34% of CVR’s units and 100% of the GP interest but there are no IDRs to the GP.  Given the stretched balance sheet and the weak fertilizer market, the Company has been unable to pay a distribution since Q3 of FY19.  As a result, the units have become orphaned and were recently trading as if the Company was at imminent risk of filing for bankruptcy, even as the bonds traded close to par.  The MLP structure and the continued CVI overhang likely haven’t helped either.  With liquidity of $74mm and no debt maturities till FY23, insolvency issues should be off the table for at least two years.  This provides the Company with some runway to refinance its capital structure and to participate in any improvement in the fertilizer market.  

While I wish I were smart enough to predict nitrogen fertilizer prices (or that of any other commodity), there are indications that the recent improvement in the market may continue well into 2021 and perhaps beyond.  While there are other much higher quality businesses, such as CF Industries, to play the ag/fertilizer/commodity/inflation theme, I think the risk/reward here is very compelling.  With a market cap of only $174mm, I think CVR units are a solid way to express a leveraged bet on stronger fertilizer prices.  Pre-covid, this time last year, CVR’s market cap was around $350mm and has even been over $1.0bn within the last five years.  Many of its peers have recovered to near pre-covid levels but CVR units continue to languish.  If the Company resumes paying a distribution later this year and can also refinance the 9.25s at a materially lower rate, the units will likely rerate higher, perhaps significantly.  But we’ve heard about improving ag/fertilizer conditions before in recent years and it’s entirely possible that this is yet another head-fake in which case this will prove to be a value trap once again or worse, a money losing investment. 

Clearly, there are lots of longstanding issues/questions/concerns here with the corporate structure that impacts valuation.  Why keep the MLP structure?  What does CVI continue to own this asset?  What happens to CVR when Icahn finally exits CVI?  I don’t have any good answers except that CVI management continues to like the asset and believes that it’s significantly undervalued.  Additionally, at a recent conference, CVR CFO said that it’s more likely that they sell themselves than engage in any acquisitions.  Eventually, all these corporate structure issues have to be sorted out but I have no idea when that will be.  

Company / Business Overview

The Company produces nitrogen fertilizer products at two plants located in Coffeyville, Kansas and East Dubuque, Illinois (acquired in 2016).  Both facilities manufacture ammonia and further upgrade to other nitrogen fertilizer products, principally urea ammonium nitrate (UAN).  Below is a quick summary of plant capacity and recent utilization levels:

Coffeyville is the only nitrogen fertilizer plant in N.A. that utilizes a pet coke gasification process to produce nitrogen fertilizer.  Pet coke, the plant’s largest raw material used in production, is purchased from CVI and third parties. East Dubuque’s largest raw material used in the production of ammonia is natural gas, which is purchased from third parties.

The Company overall upgrades ~90% of its ammonia production into UAN because the economics are more favorable. Coffeyville is almost entirely a UAN producer at the moment whereas East Dubuque upgrades a portion of its ammonia production into varying amounts of UAN, nitric acid, and liquid and granulated urea, depending on market demand, pricing, and storage availability.  Below is a summary of the Company’s historical production by product:

The facilities continue to demonstrate consistent and efficient operations. Despite having only two production sites, CVR benefits from its back integration into ammonia production and its diversity in feedstocks because Coffeyville uses pet coke and the East Dubuque uses natural gas. The Company also benefits from its geographic footprint with access to the Corn Belt, through East Dubuque, as well as the Southern Plains, via the Union Pacific and BNSF rail lines from Coffeyville.

Thoughts on the Nitrogen Fertilizer Market 

After a weak 2020, the global nitrogen fertilizer market fundamentals have improved considerably in recent weeks: 

Global urea values have rallied since the beginning of the year:

Specific to the Company, UAN NOLA prices have also improved but are still near the lows of recent years: 

While I don’t place a lot of value on low volume commodity futures trading activity, the March 2021 UAN NOLA swap is suggesting much stronger pricing for spring season this year than what we would typically see:  

Again, I’m not smart enough to explain how and why nitrogen fertilizer prices move the way they do but we can take a look at some key factors that are currently moving the markets and how they might continue to drive near-term strength.

First, the fertilizer industry in the U.S. will see demand strength this spring that will likely be the highest in many years, driven by the significant price increases of corn and soybeans. The prices of corn and soybeans have increased to a level not seen since 2013/2014.  Farmers are expected to increase acreage of both soybeans and corn this year in response to higher prices.  Estimates call for ~90 million corn acres to be planted in 2021.  China is contributing to this demand as it continues to import record high amounts of U.S. corn and soybeans.  China is ramping up its corn purchases to feed a pig herd recovering from a deadly virus.  Expected poor yield in Brazil due to drought conditions will also contribute to demand for U.S. product.  Increased ethanol production coming out of the pandemic related demand crash will also drive demand for corn. Net net, record crops are good news for nitrogen fertilizers.  

Second, the industry supply/demand dynamics appear to be increasingly favorable for fertilizer prices and therefore to U.S. producers.  We’ve heard this part of the thesis before so take it with a grain of salt.  N.A. nitrogen production facilities should remain at the low-end of the global cost curve for the foreseeable future.  Analysts expect energy spreads between N.A. and Europe and Asia to continue to widen after the unsustainable convergence of natural gas prices in 1H 2020.  As a result, in the absence of higher global nitrogen prices, margins of higher-cost producers in Europe and Asia will be pressured.  

As the chart below shows, the marginal producers are Chinese companies with anthracite coal-based nitrogen complexes.  Due partly to China’s long-running efforts to reduce reliance on imported coal, Chinese coal prices have increased to levels not seen in many years thus steepening the urea cost curve even further. The country is facing a coal shortage and this has led to several cities going dark as authorities limit power usage.  China claims the shortage is due to a demand spike but it’s not clear to me how much the Australian coal import ban is impacting the situation.  The logical takeaway is that all this eventually leads to less Chinese urea production and higher global nitrogen fertilizer prices.  It’s interesting that the Chinese did not participate in the recent India tender that closed with 1.25mm tons supplied. The higher cost Chinese plants did not have product in position to compete with producers from lower cost MENA and Russia.  How long this favorable dynamic remains in place is anyone’s guess.

Capitalization

CVR has a market cap of $174mm and a total enterprise value of $773mm.  There’s a $25.5mm ABL revolver that is currently undrawn.  The Company also has a $645mm 9.25% secured bond that matures in June 2023.  Management has completely mismanaged the efforts to refinance this bond over the years even when business was healthy.  They first started looking to call the bond in 2018 but the board decided to wait and then business weakened.  The bond can be called at par in June but rate indications are all over the place at the moment.  The CFO is hoping that with a strong 1H financial performance, a refinance can be achieved at an attractive interest rate.  Net debt totals $599mm, or 5.7x my estimate for FY21 EBITDA.  Total liquidity, inclusive of $48mm in cash, stands at a comfortable $74mm.

Summary Financials

The Company is not diversified and therefore the P&L tends to be volatile.  Production rates are generally stable and so revenues and EBITDA volatility are driven by nitrogen fertilizer prices.  Maintenance capex is roughly $15mm per year and total capex usually runs in the $18 – 20mm range per year. With cash interest of $60mm per year, the Company needs to generate at least $80mm in EBITDA annually to be cash flow breakeven. 

When fertilizer prices are strong, the Company is able to pay distributions to unitholders but there are quarters where nothing is paid.  A successful refinance of the 9.25s is critical for unitholders as every 100bp reduction in the interest rate represents $6.5mm in extra cash flow that could potentially be available for distribution.  At the current market cap, this represents 3.7% per 100bp rate reduction.       

For FY21, I’m modeling an improvement from the previous year’s results based on higher expected UAN prices.  But to be conservative, I’m not projecting a blowout year but something that resembles FY19 profitability.  We will see if this time really is different and we get an extended period of higher industry prices but it seems prudent to keep expectations low given recent history.  Additionally, it’s unclear how much of the Company’s spring production has been pre-sold at prices prior to the recent rally.  That would be unfortunate as the Company’s Q1 would not benefit from the high market prices for fertilizer.  We will learn more about this shortly when the Company reports its year-end numbers.  While it’s unlikely, I’ve also assumed that the 9.25s are not refinanced this year at a lower rate.  Even then, I have the Company generating $26mm in free cash flow for the year, for a yield of 15% to the units.  Based on this forecast, I expect some distributions to be made to unit holders.   

Valuation Thoughts

I believe that the business is worth $678mm – $1.2bn based on an EBITDA range of $90 – 130mm.  I think my assumed EBITDA multiple range of 7.0 – 9.0x is conservative given where the comps are trading and where the Company itself has traded historically.  This gets me to a market cap of $31 – 571mm, or $3.00 – 50.00/unit.  The range is wide but not unusual for a levered equity of a pure commodity business potentially coming out of trough industry conditions.   

For reference, the Company’s mean market cap and mean EBITDA multiple over the last five years has been $415mm and 11.7x, respectively.  I believe this compares favorably to the current market cap of $174mm.    

Catalyst

* Continued strength in the ag and fertilizer fundamentals

* Mid-year refinance of the 9.25s

* Resumption of distributions to unitholders