A Unique Way to Play Natural Gas

We’ve done something a little different this week, featuring a new trading idea each day that my research team and I find intriguing as a potential deep value for 2015. I hope you’ve been enjoying this series so far.

Today we’re going to look at a stock that’s been on my short list to go long. It could potentially double from its current level. But if the company keeps up the momentum, it could even become a 200% gainer.

See how this fertilizer company is potentially sowing some very profitable seeds …

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STOCK OF THE DAY: Terra Nitrogen (TNH)

Terra Nitrogen (TNH) produces and sells nitrogen fertilizer products for agricultural use. I’ve written recently about deflation taking hold in Europe and elsewhere, but food prices are one of the exceptions to that rule.

Even if the world can produce enough food for everyone, it isn’t always available in the right place at the right time. That means the food business can keep growing — and TNH is a key player.

Lower energy prices could give Terra Nitrogen another boost. Natural gas is a big part of the fertilizer production process. Lower gas prices combined with higher fertilizer demand could give companies like Terra a double boost.

The Alpha Scorecard cash flow valuation model assigns TNH a $236.87 12-month target price. That’s more than double its current price around $116, so you can see the potential.

Better yet, Terra Nitrogen has a 6.8% yield, so when the time is right to buy, you can get paid a little cash while you wait.

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What could go wrong? Well, fertilizer isn’t the most exciting business, so you won’t see Terra Nitrogen in the headlines very often.

Agriculture policy is also politically sensitive in most countries. You never know when some bureaucrat will change the rules.

TNH popped higher in the last month as energy prices fell, and I think the stock price may be a little ahead of itself. I’m watching for a chance to buy at lower prices — and then hold for the long run.

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If you want to catch up on the first four trading ideas we covered together this week, you can click on the stock name to read what our Alpha Scorecard valuation tool is telling us about them:

We’ll return with your next Afternoon Edition and the sixth stock in our seven-part series on Tuesday, Jan. 20. In the meantime, I wish you a safe and enjoyable long holiday weekend, and I thank you for your continued readership.

Your time and thoughts are valuable to me, and my inbox is open all weekend. I’d love to hear your thoughts about these stock ideas, the markets or any other investing-related topics you’d like to know more about.

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U.S. stocks rose on above-average volume today, bringing the S&P 500 back above the 2000-point level. The major benchmarks are still in negative territory for 2015.

Today’s top-of-mind issues were fallout from the Swiss currency move, economic data and of course the energy sector. Here are some quick highlights.

  • As we predicted yesterday, the sharp change in Swiss franc/euro exchange rates caught some players unprepared. FXCM, a large currency broker, lost its entire capital base as customers failed to meet margin calls. The firm is in talk with Leucadia National Corp. (LUK) for a cash infusion.
  • Energy stocks zoomed higher as crude oil climbed. SPDR Energy ETF (XLE) rose 3.25% and WTI crude oil fell 5.3% to $48.69.
  • The economic data wasn’t necessarily good, but at least it wasn’t terrible. That’s how traders saw it, anyway. U.S. consumer confidence rose to an 11-year high as unemployment receded and lower gasoline prices brightened driver moods.
  • The Consumer Price Index recorded its biggest monthly drop in six years, falling 0.4% in December. No mystery what caused it — the energy component of CPI by itself plunged 4.7% last month.
  • CPI rose 0.8% for the full year 2014. That historically low figure makes the Federal Reserve’s monetary policy decisions a tough call. Traders today seemed to read it as likely pushing back any interest rate hikes into late 2015.
  • Lower inflation expectations are also putting downward pressure on long-term bond yields. The benchmark ten-year U.S. Treasury rate dropped to almost 1.7% this week before rising to a still-low 1.84% today. Mortgage rates are sliding too, so now might be a good chance to review yours. Refinancing could pay off.

Good Luck and Happy Investing,

Brad Hoppmann

Publisher

Uncommon Wisdom Daily

Your thoughts on “A Unique Way to Play Natural Gas”

  1. Brad Hoppmann’s articles are particularly enjoyable. His info on health and similar issues shows great depth and I feel that I have learned very much. My compliments also for the quality and detail of his financial articles.

  2. Your suggestion to refinance my mortgage,sounds like good advice,but, maybe you have advice on whose offering refinance opportunities(even w impeccable credit) on fixed rate mortgages??

  3. Comments on TNH: I recently voiced disagreement with Brad on this recommendation of Infoblox (BLOX), a company in the cyber security business. But I like what I see in the recommendation he’s providing today. Since I don’t mean to be negative as a rule in my commentary I thought I would share what I see in the quick analysis of this company – Terra Nitrogen Company (TNH). However you should recognize that it’s a lot quicker to discard a business after a first look at its financials than it is to accept it. In fact the “first look” is really nothing more than clearing some early hurdles when separating the bad from the good in stock companies you would like to invest in. That said – here’s what I see on first look for TNH.

    1) The company is in the fertilizer production business, which is an established field that’s critical for agricultural production worldwide. They have a large and steady market for their output – one that’s not going anywhere since people must eat food and fertilizers are an important way ag producers achieve the production needed from their fields. And the business has some very solid and desirable other companies in it – such as Potash Corp. of Saskatchewan (POT) that are quality firms. Furthermore fertilizer is not a terribly competitive business. You have to have the mineral assets to be a player so you don’t see lots of new companies popping up to steal your firms market share all the time. This is a plus of the industry.

    That said Terra Nitrogen (TNH) does not operate in the most profitable segment of the fertilizer industry – which is potash. But nitrogen is an important product that is well worth producing nonetheless. It may also help that the potash production corner of the market has experienced some major disruptions involving the world’s largest producer in Belarus. And the political implications of being aligned with Russia may further complicate things from that source, which could help American producers such as THN. There are other profitable nitrogen producers – and fertilizer in general is a worthwhile industry to be in. The industry is best followed by watching industry leaders POT and Mosaic (MOS). It is also possible that TNH could become a takeover target for one of these larger firms. There have been takeovers of nitrogen producers within the last few years, although of much larger companies than TNH.

    2) TNH has good financial ratios which suggest that it has good profitably. They are:

    – P/E – 9.6 [excellent]
    – profit margin – 37% [excellent]
    – operating margin – 60% [excellent]
    – current ratio – 3.6 [phenomenal – and you’ll see why later]
    – debt to equity ratio – 0 (they have no long term debt) [the best possible number]

    These are quality numbers across the board. They company also pays a hefty regular dividend that’s averaged 6.9% (on today’s market price) in the last 5 years (although closer to 8.3% based on last years stock prices).

    3) Financial statements:
    Their income statement is great – with few numbers to confuse readers and lots of profit. Their gross profit margin (not usually stated in reports) calculates at 29% and their sales/general/administrative (GSA) expenses are a modest 2.3% suggesting outstanding control of overhead expenses that maximize profits. (compare to BLOX where GSA was 60% of revenue) There is nothing to dislike here. TNH is making money and lots of it.

    Their balance sheet is what I would call “rock solid” – (and I don’t use that term lightly). Their accounts payable and receivable about equal each other (good – can pay bills with expected invoice recipes) and they have a great deal of cash – some of which has been getting used to expand their plant and equipment in the last year. This is also good because if they can expand their capacity they can make even more money and this bodes well for stock price appreciation. So while you often see companies with high dividends being paid out that can be a sign that the business is growing by plowing money back into the business. But that’s clearly not the case here. THN is both paying hefty dividends and adding capacity – the best of both worlds.

    Their cash flow statement is also squeaky clean, and confirms what I expected about capital expenditures. They are building more production capacity by ramping up capital expenditures. in 2013 (most recent info) the spend 99 million on new plant and equipment, which is twice what they spend the year before and 6 time what they spend 2 years ago. This makes it clear they see opportunities to grow their revenue by adding to capacity. No doubt they are also pleased by the long term outlook in energy which will help them by lowering the costs of production. Nitrogen production is a fairly energy intensive business (more so than other fertilizers) and lower costs of energy projected in the future will be a great help to their bottom line.

    And the financials also reveal two things I really like. First – they are not raising capital by selling stock (and diluting the shares holed by current investors) and second they are not buying back stock in the open market. While this is often viewed as a positive use of cash by analysts it is easily my least favorite of the options company managing has when it comes to using shareholders money. I prefer both dividends and growth by a large margin over stock buybacks which are often futile and burn shareholders capital needlessly. These are signs of sharp company management that also give confidence in how the company is being run.

    The only think I don’t like about this company is that their price book ratio (P/B) is not very attractive at almost 8. I would prefer a P/B ratio of less than 2.5, and preferably less than 1.5 when you can get it. But the P/B ratio means they don’t have a lot of book value left in their plant and equipment – even though they may have a lot of actual life left in production facilities that have been written off for tax (aka – book) purposes. And with the money being spent on new equipment that is likely to change as the value of their assets grow. Furthermore while P/B is an important measure it is not as critical as profitability which TNH seem so have plenty of.

    Stock price: TNH’s stock price has fallen badly in the last few years (but that’s good if you’re a buyer). I always like to see if stock price changes are justified by changes in earnings since in its ignorance, the market is so focused on short run profits. So while THN’s stock price has fallen to around half or less than what it was a few years ago profits have only fallen about 30%. This means the stock price SHOULD have fallen to about 2/3 of its previous level – but it did not – it fell more, making the company cheaper to buy and more attractive to new investors. And when profit decline is compared to market leader Potash Corp. of Saskatchewan (POT), I see that their revenue has fallen a lot more that TNH’s has – suggesting that the revenue rollback is more of an industry issue than something TNH is doing wrong themselves. But I don’t worry about that because I think it’ll work out find in the long run as fertilizer is a traditionally profitable industry that should come back nicely over time. I further expect some decline in unit prices of fertilizer (especially in nitrogen) because of the falling costs of energy. That’s been dramatic enough that I’d expect to see prices and revenues go down because of lower costs but that does not necessarily mean profits will fall. Rather I see that as costs are being squeezed out those savings will be in part handed over to customers in the form of lower prices. That’s to be expected and should not worry stockholders.

    And one last issue with THN – they are not a very large company – and there is always risk associated with that. Larger firms like POT are more stable and able to whether problems and have more capital which can be a plus for various reasons. But we are seeing an improving global economy and this particular industry is less likely to see falling sales due to hard times because everyone has to eat and fertilizer usages is how the ag. industry helps make that happen. However larger companies like Potash Corp. of Saskatchewan (POT) and Mosaic (MOS) are also quality firms and could also be worth looking into for your investment dollars. But overall industry health is good and that suggests that even smaller firms like TNH could well also turn out to be profitable investments as well.

    SUMMARY: Terra Nitrogen Company (TNH) looks like a good little American firm that’s attractively priced at this time. They are very profitable and they operate in a “good” industry that’s known for low competition and stable market for their products. TNH seems to be well run and has no debt at all – which is the best way for a small company to be, and which significantly lowers the risk investors might face buying into a smaller firm. They also seem to be growth focused in spite of that hefty dividend – and overall they look like a really attractive little company.

    All of that said it’s a good idea to read up more about a business before investing – especially a small one – and become more familiar with their circumstances. I recommend additional research including reading their annual and quarterly reports – as well as reading up on their larger competitors POT and MOS. Keep in mind that industry issues are likely to be better reported on through POT and MOS and that a healthy industry bodes well for all the companies in it, including TNH.

    So Brad- thanks for bringing this one to our attention. It looks well worth considering for us all.

    John

  4. I am enjoying the new information very much. Outstanding analysis and I continue to follow up with your recommendations. By doing my outside research and learning more, is very intriguing and interesting to look at fresh ideas. Thanks keep up the good work.!

    January 2015

  5. You thoughtfully recommended that we consider refinancing our mortgage. Are there any refinance entities that will refinance a mortgage for a retired individual who is receiving social security and RMD from qualified accounts?

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