Description

CVR Partners (UAN) equity is under-appreciated (no sell side coverage), mis-perceived (variable distribution MLP likely also falls by wayside) and offers an asymmetric set-up as I pencil out >150 - 250% upside over the next 12-months (dividend yield of >35% p.a. is highly probable providing significant downside support). For many years, the fertilizer industry suffered from a S/D imbalance and the fertilizer equities traded like death. Having two assets / less scale, UAN was perceived to be “at risk” during the down-cycle given a looming 2023 debt maturity, heightened perceived leverage based on period of under-earning, murky fertilizer outlook (until recent), and UAN paid no dividend (death-knell for an MLP) = ultimately impairment risk was top-of-mind for unitholders. Kudos to offtherun who wrote up UAN equity in Jan 2021 as simply needed to believe in “survival” for the equity to be massively asymmetric. Fast forward to today, lot has changed over the past year and yet the market is largely ignoring. Over the past 12-months, UAN successfully refinanced the debt overhang (currently trades < 6%) effectively removing impairment risk + variable distribution has been turned back on (MLP purgatory is ending). More notably, the fertilizer market outlook has significantly improved and UAN’s two US assets are particularly well positioned for the “sweet-spot” environment we are in. I ultimately think UAN will be valued at >$250 - $350 / unit (inclusive of dividends) versus a ~$103 current price as the market does not yet fully appreciate how significant of a beneficiary UAN will be in the ensuing multi-year up-cycle with strengthening demand and US being >$300 / ton cost advantaged versus ROW given the global energy crises + significant “free option” on the Ukraine/Russia crises as this provides meaningful supply uncertainty and could have an even greater impact on n-term earnings power). The recent Ukraine crises only enhances and accelerates the path to further upside on UAN (getting this option for free as the stock has largely traded sideways versus its fertilizer peers that have moved vertical over the past few weeks).

Fertilizer market is in the “sweet spot” zone and is starting to be appreciated by other “big cap” fertilizer companies, yet UAN has renamed largely off-the-radar (stock has moved sideways for the past few months). The “sweet spot” set-up is on both Supply and Demand: 1) Supply: reminds me of the US Revolution in 2009-2010 when the market started to appreciate the cost curve shift benefiting US commodity chemicals industry … US fertilizer industry was lowest cost before world energy crises and is now the ultra-low-cost player and this might be sustainable at least for the next 24-months if not longer … in addition, add Ukraine/Russia supply uncertainty to the mix provides a “free” upside option as meaningful % of global supply overhang, etc and 2) Demand: ROW is asking for US fertilizer, farmers are extremely healthy, renewable demand for crop is only expanding. Similar to US commod chemicals from 2009-2010, ultimately think investors will circle around a replacement value concept on many of these assets as the cost curve positioning, earnings power and ultimately strategic interest will enforce this view upon investors. 

In the current environment particularly with 3-5 year lead-times and cost inflation / supply chain bottlenecks, UAN’s replacement value is likely well north of >$4Bln. I assume a much more conservative FV of >$2.5 - $3.5Bln value to get to ~150% - 250% upside to the equity (factoring in ~$70 / unit of dividends over the next 24-months). Additionally, NOT factored into the fair value waterfall, there is meaningful upside particularly if the Ukraine / Russia crises sustains. As a lateral way to frame FV, another way to triangulate value and indicative of how far off-the-radar UAN is (CVI >30% ownership, MLP wrapper could be some of the reasons), one of UAN’s closest comps (given size of footprint) is LSB Industries (LXU - doesn’t suffer from an MLP wrapper). LXU currently has an enterprise value within spitting distance of $2.5Bln. I view the UAN assets as superior to LXU (cost curve positioning, logistical advantages, etc), yet UAN trades at a steep discount ($1.6-$1.7Bln TEV currently).  

Divergence: In the current fertilizer backdrop, couple areas of divergence that I think the market is missing which provides an exciting set-up: 1) supply curve has significantly shifted driven by the energy crises and whereas US fertilizer cos were lowest on curve by >$125/ton in the past, this is now likely closer to >$300 / ton (or higher given >80% of COGS are linked to energy be it natural gas or coal in China), 2) demand is extremely healthy (multi-year downturn has shifted to an up-turn driven by lot of variables, farmers are healthy and end-market pricing is extremely good), 3) trade-flows are meaningfully changing: this dynamic was occurring even before the Ukraine / Russia crises, as the NA market is lowest-cost in the planet and rest of world is asking for more and more of our fertilizer product, 4) UAN’s 2 assets historically had a replacement value of >$2.5 - $3.5Bln (I’ve historically viewed $2-$3Bln per 1MM tons to be the rule-of-thumb w/ a 3-5 year lead-time), but given cost inflation / supply chain bottlenecks, my bet is this figure is now closer to $4Bln+ for UAN assets, 5) even assuming modest EBITDA / ton (i.e. assume Ukraine / Russia overhang is resolved tomorrow), I pencil out a high probability of receiving >35% dividend yield per annum for at least the next 2-years which implies the “creation value” through the equity will be inside of $1Bln in 2-yrs time (variable distribution MLP, receive the cash in the interim), 6) even assuming more modest “normalized” assumptions, I back into a YE 23E “equity creation: value that is extremely inexpensive (inside of ~4x EBITDA using very punitive assumptions).

Market backdrop: Not much to add on this front, other than the fertilizer market is extremely tight right now. Supply uncertainty globally (UAN stock is flat since Ukraine / Russia crises, unlike pretty much every other fertilizer company that has gone vertical), and US cost curve positioning given global energy crises … Demand extremely good given the output price backdrop. While difficult to know the longevity of the current fertilizer upcycle, I’d bet there is much risk to this being >2-years than not … I’m currently modeling in 1-year of outsized returns, 2^nd year of moderating returns and then reversion back to more normalized levels

Why now: US is lowest cost player globally. What was once a >$125 / ton cost edge is now likely well north of >$300 / ton (and in the current backdrop, will probably surprise to the upside at >$400 / ton). When ~80% of the cost of ammonia / UAN is energy, US is well positioned with natural gas prices at current levels.

Replacement value: As discussed above, given the US cost positioning and the extremely tight S/D backdrop, the market will likely shift its focus to a replacement value concept. Same dynamic occurred around Westlake and Lyondell years ago … mkt at first was stunned by the “over-earning” potential, but then ultimately did the math of replacement value (not to mention a 3-5 year lead-time assuming permitting possibility). For UAN’s 2 assets, safe to say >$4Bln is likely the going rate right now. I’ve haircut this figure to $2.5Bln in my assumed FV of ~150% upside, but if it ever got closer to $4Bln, would imply closer to >230% upside on the equity.

FCF / Dividend potential: See math below, I ultimately think unitholders will receive close to $70 / unit of dividends over the next 24-months (versus ~$103 current). By YE 23E, the “equity create” factoring in dividends will be closer to $925MM. And I think the replacement value will be front-&-center with a >$2.5Bln price tag.

Where the puck ultimately moves: UAN has a parent (CVI) that is either a buyer or seller of this asset. My personal view is that CVI is dealing w/ Icahn (>70% holder) and likely monetizes UAN to another fertilizer company who is willing to pay up for the asset. Time will tell, but I’d expect some M&A in the fertilizer space given all the points above. LXU with a strengthening currency might try and make a run at UAN,  but I could envision this playing out to other stronger / scaled players.

Risks: In most other commodities, focus is on “demand destruction” and rightly so. Maybe the same applies to fertilizers and I’m missing it, but I think fertilizer are the “solution” to demand destruction as farmers will require more and more of this to help alleviate the supply pressures.

Other analysts have pointed out 1 of their facilities uses pet coke versus natural gas … I’m comfortable w/ this risk and don’t see this materially impacting UAN on the cost curve. Witness Q4 (pre-Ukraine) EBITDA / ton from UAN at ~$325 / ton (versus ~$176 average in 2021 at large).

Earnings power could be less than I suspect … counter-point is even if I’m wrong on the dividend stream over the next 24-months (let’s say its $50 versus ~$70), thrust of the thesis is that supply is structurally tight and getting tighter and replacement value will be the proxy for value … if UAN “create” is $925MM in 24-months time (~$70 of dividends) or $1-$1.1Bln, not going to be the dictator of FV … ultimately, as long as replacement value is >$2.5Bln, UAN will likely be gobbled up by a larger player.

Catalyst

1) Earnings power, 2) dividend distribution, 3) strengthening possibility of a landgrab particularly around smaller assets like UAN