Description

Description

Terra Industries (TRA) 7% 2017 bonds trading at $73 offer an safe corporate credit with approximately 10% current carry and 12% YTM. Please see my earlier write up on TRA equity 12/12/2005 (long equity recommendation) and 1/14/2008 (short equity recommendation) for back ground on TRA and nitrogen fertilizer industry.

Long TRA 7% 2017 Bond Thesis

The sell off in corporate bonds has resulted in a few babies being thrown out with the bath water. TRA 7% 2017 bond is one the babies being thrown out that offers relatively juicy current carry, 12% YTM and minimal risk of capital loss. 

TRA’s capital structure is

7% 2017 Bonds           $330 mil.

4.25% Preferreds         $2 mil. outstanding

102.13 mil. shares at $17.74 with a market cap of $1.8 bil.

$680 mil. of cash

Basically TRA has 2X the cash on its balance sheet for the $330 mil. outstanding debt issue. I can run thru LTM credit metrics but EBITDA going forward is going to drop of a cliff. EBITDA for 2008 will be approx $1 bil. and I expect 2009 ebitda somewhere between $200-$400 mil. The nitrogen fertilizer industry is notoriously cyclical – the equity markets when TRA traded at $55 forgot the cyclicality. Even with $200 mil. ebitda (consensus from the equity analysts crowd is $500) TRA bonds should trade at under 2X Debt/EBITDA. 

So TRA offers a cash collateralized 2x Debt/EBITDA bond with 12% YTM.   Even for a highly cyclical industry like nitrogen fertilizer that is cheap. 

Catalyst

Eventually credit markets rationalize and TRA trades at 8-10% YTM. I don’t expect credits markets to rationalize anytime soon. Till then one collects 10% current carry.

Company realizes that it can buy back bonds with the cash on balance sheet. Eventually someone in Sioux City figures out that buying back bonds at a discount is better than trying to time the buy back of stock.

Opportunities to invest in new projects dry up and cash continues to build on balance sheet. TRA has been unable to do any new Greenfield expansions in Trinidad or Peru.

Risks

Leveraging on balance sheet. I know TRA management they are scared and petrified of what happen to them the last time they had a liquidity crisis. This management team will not lever up the company or use its cash balance to buy back stock. All buy backs of stock will be confined to free cash generation. The bonds trading at a discount and with cash on balance sheet will eventually lead to a buy back or tender for the bonds. 

Private equity buyout. Unlikely in this market and very unlikely that anyone levers up a nitrogen fertilizer company.

Nitrogen cycle gets real ugly and TRA is cash flow negative. Unlikely given where US natural gas is pricing relative to natural gas in Europe. Even in 2005 when TRA was mis-hedged and burning cash the bonds traded above par and there was more debt and no cash cushion. 

Catalyst