Description

Rentech, Inc (RTK) presents an opportunity to purchase a collection of undervalued assets with a path toward unlocking intrinsic value off 100% upside.  RTK’s 60% stake in publicly traded master limited partnership Rentech Nitrogen Partners, LP (RNF) more than covers RTK’s entire enterprise value and RNF itself is significantly undervalued.  Further, management’s transition from black belt capital destroyers to semi-shareholder friendly over the past two years brings a needed and unappreciated catalyst. I recommend an outright long position in RTK, though hedging out RNF creates an alternatively attractive negative stub. 

Sum of the Parts Valuation:

That RTK trades at a discount to its stake in RNF is not a new phenomenon; in fact, it has been the case since RTK separated RNF into a public MLP in November of 2011.  What makes the company attractive today is management’s evolution from capital destroyers to something closer to garden variety overpaid mgmt.  For 25 years, RTK had been clean-tech hype company with the (unattainable) goal to “develop and commercialize certain alternative energy technologies.”  In 2006, management dumb-lucked its way into the fertilizer business by purchasing an ammonia fertilizer plant for $70mm with the intention of spending another $1bn to create a clean diesel coal gasification plant. The subsequent structural change in US natural gas prices combined with rocketing UAN/Ammonia prices made the plant worth $1.5bn operating in its original purpose as a fertilizer plant.  RTK unintentionally found its way to a 20 bagger. 

The subsequent IPO of 40% of the fertilizer business into an MLP owned by to the public was the first shareholder friendly event.  However, shareholders were still left with management intent on using the MLP distributions from RNF to subsidize its alternative energy R&D.  Perhaps they simply realized more personal wealth could be created by focusing on MLP businesses; In February, 2013, the company changed course and announced it would shutter/mothball/sell its entire alternative energy business. Instead of focusing on money losing R&D, management would instead focus its efforts on purchasing profitable energy businesses.  RTK announced 2 deals simultaneously three months later in May. RTK acquired a wood chipping business with $20mm of expected EBITDA in 2013 and separately announced it would entering the wood pellet production business with $15mm of EBITDA upon ramp up by 2016.

Milestones on the path to new Rentech:

• RTK was a multi-decade money pit of alternative energy
• November 2011: RTK accidentally creates value with a fertilizer plant.  RTK IPOs 40% of the fertilizer plant into an MLP named Rentech Nitrogen Partners, LP and retains 60% ownership
• February 2012: RTK announces share repurchase plan and subsequently purchased 9.1mm shares in 2012 @ $1.81/share
• November 2012: RNF acquires Agrifos, an ammonium sulfate fertilizer producer for $158; 2013 EBITDA projected to be $24.3mm
• December 2012: RTK pays special dividend of $0.19  per share.
• February 2013: RTK announces it will exit the alternative energy space, mothball its PDU in Colorado and attempt to sell it along with 450 acres land in Natchez, MS. Sold land for $9mm in April, 2013
• May 2013: RTK acquires Fulghum Fibers, a wood chip business and a wood pellet business with a projected combined $35mm in EBITDA. 

Rentech Nitrogen, LP

Rentech Nitrogen, LP is a dominant supplier of fertilizer in the corn belt producing UAN, Ammonia, Urea and synthetic ammonium sulfate.  RNF owns two plants, though its East Dubuque, IL produces the bulk of the EBITDA.  Owing to its location in the middle of the corn belt, RNF receives a premium of approximately $120/ton on Ammonia and $60/ton for UAN over product sourced from the Gulf Coast.  Rather than pay for shipping, much of the East Dubuque production is picked up by farmers directly at the plant.  Ammonia prices have ranged in the $550-$600 range for the past few years and current prices remain strong in the low $700 range.  Natural gas represents about 50% of cost of goods and has been relatively stable at $4.  Full year distribution guidance from RNF is $2.60 share for 2013, implying an 8.7% yield.  However, 2013 contains a significant amount of noise due both planned and unplanned outages and new supply that will come online toward the end of the year.  According to management, the $2.60 guidance includes the impact of $0.65 of planned and unplanned outages.  Two expansion projects nearing completion (70K tons of ammonia in IL and 115K tons of ammonium sulfate in Pasadena) are expected to add an additional $0.90 of distribution in 2014 based on March 2013 fertilizer pricing.  The expansion projects represent a 23% increase in the East Dubuque plant and a 20% increase in its Pasadena ammonium sulfate plant.  Simple math means over $4 per share of distributions in 2014, or a 13.5% yield. The two other pure play MLP ammonia/UAN competitors, Terra Nitrogen Company, LP and CVR Partners, LP trade at 7.3% and 9.2% respectively on 2013 estimates.  RNF should trade at a premium due to its close proximity to its customers and its clean financial structure. RNF’s general partner has no incentive distribution rights scheme detracting from potential upside.  Further RNF maintains reasonable leverage of 2x 2013 EBITDA  pro forma for a $320mm debt issuance in April that fully funds its expansion projects, pays downs its existing $206mm debt, and  pushes out the nearest maturity to 2021.  Should RNF be priced at 8% yield on a $4 distribution next year, it would be priced at $50 instead of today’s price of $30. 

Fulghum Fibres:

Following the long overdue decision to exit alternative energy in February of 2013, RTK shifted its focus to acquiring energy assets providing mid-teens after-tax returns and stable revenue.  In May, 2013 RTK announced it would acquire Georgia-based Fulghum Fibres for $112mm. Fulghum’s 32 wood chipping mills represent 70% of the US contract chipping business and operate under long-term fee per ton contracts large paper companies (Weyerhaeuser, Rock-Tenn, Internationl Paper).  EBITDA in 2013 is guided to $20mm, in line with 2012. Over the past 25 years, business retention has been 95% and 60% of 2013 EBITDA already contracted through 2017.  Management’s long term plan is to acquire or grow the business large enough to create another MLP.  The deal is still unseasoned, though the 5.6x EBITDA appears to be a reasonable price, particularly if management can ultimately drop the business into another MLP and create value through tax arbitrage.  Sufficed to say this is a dramatic improvement over the proverbial “wood chipping” of shareholder capital in pursuing alternative energy.

Wood Pellets

Simultaneous with announcing the Fulghum Fibres deal, RTK also announced a deal with Graanul Invest to convert two decommissioned fibre board facilities to wood pellet production.  The company expects to become the largest supplier of wood pellets in Eastern Canada to the Canadian and European utility market. EBITDA is expected to be $15mm when ramped up, though the timing is a distant 2016. In conjunction with the deal, RTK has secured 10 year take or pay contracts with two utilities and locked up the requisite wood supply. Total equity investment by RTK for 50% (Graanual owns other 50%) is $17.5.  An additional $35mm is expected to be financed, though RTK has volunteered to be the bank if a third party doesn’t step up.

Valuation

Admittedly, Rentech, Inc is a messy hodgepodge, which unsurprisingly creates the opportunity.  The market has not yet appreciated the transition of the parent from an alternative energy spec burning $70mm per year to an industrial/paper/energy business generating $20mm in EBITDA ($0 EBITDA after corporate).  Rentech Nitrogen should be valued near between $45-50 at an 8% yield on 2014 distributions of $3.50-4.00.  This equates to $4.50-5.00 per share of value to RTK.  Fulghum Fibres should be worth the $0.50 per share they paid.  The Wood Pellet business is early to value, though the equity investment is relatively small and will be made over time as the project unfolds.  I assume it is worth at least the $0.15 per share investment. Parent net debt (inclusive of Fulghum and Wood Pellet investments) is $0.15 per share. Corporate overhead is running near $20mm, which I back out at 5x for $0.40 per share.  The overhead figure should decline as mgmt further reduces the alternative energy headcount which stood at 109 employees 12/31/12. Total value pencils out to of $4.50-$5.00 or 100%+ upside.

Risks

• Management has become somewhat shareholder friendly, but this is still the same mgmt that spent like drunken sailors on alternative energy.  They don’t own much stock and are hence more motivated by their cash compensation. 
• The new timber businesses the company has entered may underperform an overhead may not decline as quickly or dramatically as it should.
• While it would be a net positive to the stock, should management decide to spin off or sell its 60% stake in RNF, there would likely be tax consequences. Management has not been specific on the issue, though they bristle at the idea of relinquishing the cash flow they need to grow the business via acquisition.  I expect long term capital gains would apply, though I am not certain
• RNF hedges much of its current year natural gas exposure and fertilizer sales.  However, investors are implicitly short natural gas in the long term since it comprises 50% of fertilizer cost of goods.
• Given the attractive pricing in the fertilizer market, there is some growth in ammonia capacity expected over the next few years.  The risk to pricing should be offset by our large dependence on foreign nitrogen. We currently produce 50% of our country’s nitrogen fertilizer needs with 50% coming from imports.  The marginal cost should be determined by foreign production, which depends on significant higher natural gas inputs.

Catalyst

• Appreciation of RNF toward intrinsic value
• Dramatic turn around at RTK parent due to the May purchase of a $20mm EBITDA business (Fulghum Fibre) while simultaneously exiting the cash burning alternative energy space
• Collapsing of the implied negative stub of RNF/RTK