Aliaksandr Yarmashchuk
Aliaksandr Yarmashchuk
A couple of hours ago (as I write this) CVR Energy announced that it was exploring strategic options for the fertilizer business that it owns 37% of, CVR Partners, LP Common Units (NYSE:UAN). This confirms what I have long thought would happen, as I have mentioned in my previous article about CVR Partners. In this article, I would like to explore a fair value on the sale of CVRP.
CVR Partners is a Master Limited Partnership engaged in the production of nitrogen fertilizers in the heartland of the Mid-West. Most of its sales are of urea ammonium nitrate ("UAN"), with the balance being ammonia. They sell a very small amount of urea, DEF, nitric acid and carbon dioxide, but not really enough to move the needle. Because the stock symbol and the product they sell are both "UAN," I will use CVRP to describe the Partnership and UAN to describe the fertilizer. To complicate matters even more, CVRP is 37% owned by CVR Energy whose ticker symbol is CVI.
CVR owns two production facilities. Its original plant is located in Coffeyville, Kansas and in 2016 it bought its East Dubuque, Illinois plant from Rentech Nitrogen. Also, since this is a partnership, the equity is units, not shares of stock and cash payments made are distributions, not dividends.
To get a better understanding of the business, the markets that they operate in and the Partnership itself, I highly recommend reading some of my previous articles on CVRP. And yes, I know that there are over 50,000 comments on them, many of which update the articles, but it is impossible to go through them all on a timely basis. But I will try to explain everything that one needs to know here.
Over the last four years, the price of CVRP has fluctuated wildly. In 2020, during the pandemic when prices for everything collapsed, it reached a low of $5.70. In 2022, after multiple supply-curtailing events in the nitrogen fertilizer world, capped by the war in Ukraine, it reached a high of $179. But even that was well below its (split adjusted) high of $320 back in 2012. Over the last two years, it has trended down and closed today at just under $64.
Much of the price fluctuations of the equity units can be attributed to tracking the prices of nitrogen fertilizers. But analysts (and strategic buyers) value nitrogen fertilizer plants based on "normalized" prices for the fertilizers. What these "normal" prices are is, of course, subject to debate, but also subject to change as other factors change. In the case of nitrogen fertilizers, a brand new plant that cost $3 billion to build just four years ago, now costs $4 billion because of the inflation that we have experienced. Also, with the removal of Russian natural gas piped into Europe, the price of natural gas in much of the world is much higher than it used to be, and most likely will stay that way. So what was the "normal" or "average" price for nitrogen fertilizer is certainly higher than it was only four years ago.
So what are the ways of valuing CVRP's assets? They are:
1) Comparable sales of other nitrogen fertilizer plants.
2) Capitalized income flow.
3) Replacement cost.
4) Stock market prices of other nitrogen fertilizer companies.
I will take these one at a time.
There has been only one comparable sale in the last seven years, and that is the sale of the OCI plant in Wever, Iowa to Koch Industries that was announced in December of last year. That sale was for $3.6 billion dollars.
Now to compare Wever to CVRP's two plants we start with nameplate capacity. Wever has a nameplate capacity of 885,000 tons of ammonia per year and has the capacity to upgrade virtually all of it to higher margin urea and UAN. CVRP's plants have a nameplate capacity of 865,000 tons of ammonia, but only have the capacity to upgrade about 80% of that. However, last year CVRP did extensive capital improvement work on its plants and has produced at a rate of as high as 908,000 tons of ammonia. So on a capacity basis, the assets really are almost identical.
The next comparison is plant locations, which affect product pricing. The closer to the farmer your plant is, the less the transportation costs, and therefore the more valuable the plant. The Wever, Iowa plant is right in the middle of the corn belt. So is one of CVRP's plants, in East Dubuque, Illinois. CVRP's other plant is in Coffeyville, Kansas, which is also close to a lot of farmers, but is also closer to the port of New Orleans, where cheaper imports can come to the U.S. So prices in Kansas can be 3-7% lower. Prices in Illinois are usually 2-3% higher than in Iowa, so Wever does have a slight price advantage due to location, but it is pretty small.
Next up is the age of the plants. Wever was built (finished) in 2017 (at a cost of $3 billion; more on that later) and so is quite new. CVR's plants were built in the 1960s, so they are quite a bit older. But for these plants, major turnarounds occur every 2-4 years where big chunks of the plants are replaced, as well as cleaned and repaired. So many of CVRP's plants really are quite new too. But clearly, a new plant is valued more than an older plant.
Finally, there is the value of carbon abatement at the plants. There is none at Wever or E. Dubuque, but CVRP's plant at Coffeyville has been removing and sequestering CO2 and nitric acid with equipment installed a few years ago. They have said that their products can be certified as "Blue" (meaning made with fossil fuels, but with the carbon sequestered), which is valuable both because in the near future, Blue fertilizer should receive a premium price, but more importantly, if we do go to a net zero carbon economy, everyone will have to install equipment to remove the carbon to sell their products.
So, we start with Wever's sale price of $3.6B. Wever has a higher nameplate capacity, but CVR is actually producing a lot more than Wever's nameplate. On the other hand, Wever can upgrade more products. I am going to call this a wash, although some would say that Wever is worth about 5% more than CVR based on this. Based on locations, Wever's higher average prices than CVRP are worth about 5% more. The age of the plants is a little hard to judge, but I am going to say that it makes Wever worth 5-10% more than CVRP. And finally, the head start in carbon reduction that CVRP has is worth about $50MM in equipment cost that Wever will have to install someday.
So, I start with $3.6 billion and subtract anywhere from 10-20% and add back $50MM, which gives a comparable valuation to CVRP of $2.93-$3.29 billion. CVRP has a net debt (debt less cash on hand) of about $480MM now, so the equity value of CVRP would be $2.45-$2.81 billion. There are 10.57MM units of CVRP outstanding, so on a per unit basis, this means $232-$266 is the comparable value.
This is a bit easier. The average estimate by three fertilizer analysts on Wall St. is that the "normalized" or average prices of UAN and Ammonia for the next few years are $306 per ton and $625 per ton, respectively. At these prices, under current conditions, losing one plant down for a month each year on average, CVR would have a free cash flow of about $264MM per year. If you capitalize that at 10% (which is very reasonable for this kind of business, particularly if the underlying asset prices are rising), you get an enterprise value of $2.64 billion, or an equity value (after deducting net debt) of $204 per unit.
A lot of numbers have been thrown around by people trying to peg a replacement cost for CVR's assets. But the best number starts again with the Wever plant in Iowa, which was started in 2013 and finished in 2017 at a cost of $3 billion. Now, in the time since it was finished, inflation has been at a little over 30% and will certainly keep going up for the next few years. It takes at least four years to build a new plant from the time that the final investment decision is made. So let's say that inflation will be 2% per year for the next four years (the Fed's target, but almost certainly low), and we are at over 38% since Wever was finished. Add 38% to $3 billion and we get a cost of $4.14 billion. But that is not the end. If you have the money to invest, your new plant won't generate any income for four years. In the meantime, the same investment in CVRP would generate a cash flow of $264 million per year or $1.056 billion for a total cost of $5.2 billion. Now, maybe a new plant is worth 10% more than CVRP's older ones, but you are still at $4.7 billion. Which after the debt is still $400 per unit. And this should tell everyone that no one is going to build a new fertilizer plant while anything is available for sale.
This is not my favorite valuation method, since it assumes that the stock market is currently fairly valuing other fertilizer stocks (which I don't agree with), but it is still a valid method. I will use a very simple method of comparing trailing 12-month price/earnings ratios. There are lots of other metrics, but this is by far the easiest.
CF Industries is by far the "purest" comparison since it is 100% nitrogen fertilizer. It does have, however, a couple of uneconomic plants in Great Britain, and its plant locations are not as good as CVRP's, but it is still the best available. Its current P/E is just under 11X.
Nutrien has both nitrogen fertilizer and (less profitable) potash. It also has a retail network (CVRP and CF are wholesale only) which is actually more stable cash flow-wise since they just take a spread, rather than living with commodity price swings. So it is not perfect, but still close. Its P/E is currently 12.2X.
LSB Industries is also a pure nitrogen producer, but only about half of its production goes to fertilizer. The rest is used for industrial purposes, and while more stable, is also less profitable. I am also not a fan of their management, but that is another issue. Nevertheless, it is a comp, and the current P/E is exactly 20X.
CVRP has trailing 12-month earnings of $16.31 per unit. So at the same P/E's as the above three stocks, it would trade at $179 per unit; $199 per unit; or $326 per unit.
So, based on these different methods, I get a range of valuations from $179 to $400 per unit. But no one is building a new plant at those prices and CF's management is screaming to everyone who will listen how underpriced their stock is (which is why they are buying a lot of it back). A more realistic range is $206 (based on cash flow) to $266 (based on recent sale). This is what CVRP's assets are really worth. My own expectation is that they should get at least $225 per unit.
As I stated numerous times, OCI sold its Wever plant to Koch in December. They stated at the time that there would be multiple rounds of bidding which leads me to conclude that there were multiple bidders as well. So there still should be at least one, and I think several, other fertilizer companies out there who would like to add the CVRP plants to their assets. I think that Nutrien and Yara are the most likely ones, but Koch and CF remain possibilities if the anti-trust attitude in Washington DC changes. There are, of course always others (such as mining companies who have started to get into Potash fertilizer) who may be looking as well.
But it is clear that CVR Energy wants to maximize the value of CVRP and I do believe that there are buyers out there willing and able to pay the price.