2 ways to profit from low natural gas prices
Cheap fuel boosts prospects for select chemical and fertilizer companies.
Unless you've been on the moon, it won't be news to you that natural gas prices are close to record lows and are likely to stay down for a long time.
How can investors profit from low natural gas prices? Here are two ideas: chemicals and fertilizers.
Assuming that natural gas prices will stay low for the foreseeable future, we're adding two picks to our income-generating portfolios that are likely to benefit. One is a chemical company, Dow Chemical (DOW), and the other a fertilizer maker, Rentech Nitrogen (RNF).
The low price of natural gas is due to the development of new methods for extracting natural gas from deep underground rock formations. Thanks to these new techniques, called hydraulic fracturing, or "fracking," U.S. natural gas production has soared more than 25% just since 2005. With supply now exceeding demand, natural gas prices have dropped from a peak of around $13 per million British thermal units in 2008 to $2.50 or so today.
Natural gas is the fuel that powers almost all chemical plants, plus it's the key ingredient used to make plastics and other chemicals. When it comes to fertilizers, natural gas is the major ingredient in nitrogen fertilizers. With that in mind, we’re adding Dow Chemical to our Manufacturing & Services portfolio and Rentech Nitrogen, an MLP, to our Partnerships portfolio.
Founded in 1897, Dow Chemical is the largest chemical company in the U.S. and second only to BASF worldwide. Dow produces plastics such as polystyrene, chemicals used in pharmaceuticals, paper coatings, paints and advanced electronics, and for water purification. In agriculture, Dow makes insecticides, herbicides, fungicides and genetically modified plant seeds.
Dow owns 50% of silicone plastics maker Dow Corning, which makes sealants, lubricants, cookware, and other products based on its silicone-based technologies.
In 2009, Dow acquired specialty chemical maker Rohm and Haas, and in 2011, formed a joint venture with the Saudi Arabian Oil Company to build and operate one of the world's largest integrated chemical facilities on the Persian Gulf Coast of Saudi Arabia.
Lower natural gas prices should make Dow more competitive in global markets. Backing up that point, Dow recently said it would spend $1.7 billion to construct a new world-scale ethylene production plant in Freeport, Tex.
Dow moved to the top of our chemical makers' candidates list in April when it raised its quarterly dividend by 28% to $0.32 per share, bringing its yield up to 3.8%.
Dow can afford a dividend hike. Last year it generated $3.9 billion in cash from its operations compared to $1.3 billion paid out to shareholders.
Rentech Nitrogen, a November 2011 IPO, is organized as a master limited partnership (MLP). Although not corporations, MLPs trade on major exchanges just like regular stocks.
MLPs often pay high dividends because they don't pay federal income taxes. Instead they distribute their earnings to shareholders.
Typically, the general partner receives a percentage of the profits before the limited partners get their cut. However, Rentech Nitrogen is the exception to that rule. Its general partner, Rentech, Inc., is not entitled a cut of its cash flow.
Rentech Nitrogen produces nitrogen fertilizer products at its facility in East Dubuque, Ill. Although U.S. natural gas prices are near historic lows, that is not the case abroad.
For example, in Europe natural gas is going for more than $11 per million BTUs and in Japan, they're paying close to $16 per million BTUs. This U.S.-based fertilizer maker enjoys a huge cost advantage.
Even better, since Rentech's plant is located in the farm belt, close to most of its customers, its finished products transportation costs are nil, giving it a competitive advantage over other U.S. producers.
Based on current forecasts, Rentech will pay distributions this year equal to a 10.6% yield and we expect around 10% annual distribution growth.
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John Stumpf acknowledges that growth has been slow, but he says he's still optimistic.
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