Description

Yara is a global fertilizer and distribution company recently spun out from Norsk Hydro (a Norwegian energy and aluminum company). It trades on the Norwegian (Oslo) stock exchange under ticker YAR (YAR.NO on Bloomberg) and an OTC ADR in the U.S. under symbol YARIY. Yara is trading at 7.1x 2003 eps. The business is cyclical, but average earnings over the cycle will be around 6.00 NOK per share (I estimate a range of 4.00 to 9.00 eps over the cycle). A 12x multiple on mid-cycle eps yields a price target of around 72 NOK, or 50% above the current price. [all numbers in this write-up are in NOK which is currently 6.89 NOK/USD]

Yara breaks its business into three segments: upstream, downstream, and industrial. Upstream consists of Yara’s wholesale fertilizer business which includes worldwide ammonia and urea production (a large portion of which is sold to Yara’s downstream segment). The downstream division markets the upstream (as well as some of its own) finished fertilizer products in what is essentially a margin business. The industrial division is the largest producer of CO2 in Europe and also sells industrial nitrogen such as nitrate for civil explosives.

There are no pure comps for Yara. Agrium (AGU) is probably the closest and trades at 15x 2003 eps (vs. 7.1x for Yara). AGU trades at 12.2x 2004 eps (vs 6.5x for Yara). Yara has a better business (low cost producer, higher returns on capital) than Agrium’s. On ebitda, Yara trades at 4.5x adjusted (see below) 2003 ebitda vs. over 6x for AGU. Other companies in the industry, although not great comps given different composition of business, are Potash, IMC Global, K+S, and Kemira. Yara trades at a significant discount to these companies as well.

Mgmt has committed to paying out 30% of net income in dividends over the cycle. Based on 2003 eps of 6.81, dividend would be 2.04 or a 4.3% current dividend yield. Probably won’t start paying dividend until later this year though. Management also expressed a willingness to buy back stock with Yara’s ample free cash flow.

I will not go into tremendous detail on Yara’s operations. For further reading, check out their (very helpful) website at www.yara.com. Download the “Yara Fertilizer Industry Handbook, March 2004” and the “Capital Markets Day Oslo London New York, December 3-5, 2003” (both can be found at (http://www.yara.com/en/investor_relations/presentations/index.html) as well as the March 12 analyst presentation. These materials give great detail and insight into the fertilizer industry in general as well as Yara’s operations.

A few comments on Yara’s business: A large portion of its ebitda (over 50% in 2003) comes from its downstream segment. Downstream consists of storage warehouses, mixing facilities, and distribution centers all over the world. This segment is essentially a fixed margin business. They simply buy ammonia from their own upstream production and potash, DAP etc. from other fertilizer companies, create specialized nitrates and NPK and sell to local farmers, cooperatives etc. at a mark-up. This business has been very stable over time.

A critical advantage for Yara is its two joint ventures in Qatar and Trinidad. These are highly profitable as Yara has access to super cheap natural gas (less than $1 in Qatar, and slightly over $1 in Trinidad).

Extra capacity at Qatar: Yara has recently expanded its production capacity at Qatar so that its share of production will increase by 100,000 tons ammonia and 300,000 tons of urea. This increased production capacity will add approximately 100 – 150m NOK ebitda to their 2003 number.

You can make your own assessment of “macro” trends for fertilizer, buy my view is that reduced grain inventories, recent higher prices realized by farmers for corn, soybean, other crops, increased demand from China, India and Brazil will create very positive demand (and fertilizer spreads) over next several years.

Just a few more things to consider when looking at Yara’s numbers.
1) They “understate” ebitda because they include only their net income from the joint ventures, not the joint ventures’ ebitda. My ebitda numbers are adjusted for this (adds approximately 200m ebitda to company’s reported numbers).
2) Going forward I give them credit for the additional capacity at Qafco (adds 150m to ebitda).
3) Historical numbers have been dramatically affected by currency movements (most recently the strengthening of NOK vs. USD, although NOK vs. Euro also has impact). Recent numbers look a lot better if you “adjust” for currency. You have to decide how to think about that. I have not made any currency adjustments in the numbers used for valuation above.
4) Looking back over the last cycle at reported numbers is misleading. Yara has taken out over 3bn NOK of operating costs in the last 3 years in a dramatic restructuring of the business. In their March 12 investor presentation they “recast” historical financials using the new cost structure. This shows an ebitda of over 7bn NOK at the last peak in 1996 (translates to over 11 NOK eps).
5) Free cash flow is very strong over the cycle (should be higher than net income given depreciation in excess of capex) but is somewhat lumpy. As cycle turns up and prices increase, company has large working capital increase (as in 2003). The cash flows back as prices head down and working capital declines.

Some risks to consider:

Norwegian gov’t owns about 35% of Yara. They’ve committed to hold their stake until at least September 2004. Company thinks gov't may hold much longer. Gov’t has very hands-off ownership approach so I’m not too worried about their trying to tamper with the business, but they may want to dispose of their stake at some point.

Yara is currently renegotiating its gas contract in Trinidad. Company expects a “modest” increase in price. I believe they’re paying around $1.25/mmbtu now and price will likely go up around $0.25 to $1.50. This would represent 30m NOK decrease in EBITDA. EBITDA for 2005 should be over 5bn NOK, so shouldn’t be a major issue.

Currently Yara is benefiting from the spread between European and U.S. natural gas prices. Much of Yara’s production is in Europe where natural gas prices have been $1 - $2 lower per mmbtu than in the U.S. Yara loses some of its relative cost advantage to the extent that U.S. and European natural gas prices converge.

Some additional ammonia capacity is scheduled to come onto the market (primarily in the Middle East) in 2005/2006. Offsetting this are recent plant closures announced in the U.S. (see Terra and Mississippi Chemical for examples) and the positive demand dynamics (see above) which should more than offset increased capacity.

Catalyst

-1Q earnings (to be announced on Friday, May 7) should be very strong based on sales prices (and spreads) realized so far in 2004 (despite sig drop in ammonia during 1Q)
-Announces high (4% + yield) dividend later this year
-Increased analyst coverage and awareness (especially with U.S. investors)
-Strong FCF generation goes to pay down debt and buy back stock long term