CF Industries Holdings, Inc. (CF) Earnings Call Transcript & Summary

Good morning, everyone. My name is Gunter Zechmann. I'm senior analyst covering chemicals at Bernstein, and it's my great pleasure to have full team of management of CF Industries here today for the next 50 minutes, where we'll conduct a fireside chat. We've got Tony Will, CEO. We've got Chris Bohn, CFO. We got Bert Frost, SVP for Sales and Market Development. And we also have Martin Jarosick in IR on the line today. Tony is President, CEO and Member of the Board of Directors of CF Industries. He joined in 2007 as the company's first VP in Corporate Development. He was promoted to VP of Manufacturing and Distribution in '09, Senior Vice President, Manufacturing and Distribution in 2012. And he also serves as the Chairman, President and CEO of Terra Nitrogen, which is wholly owned by CF Industries. Tony, welcome on the call. It's a great pleasure to have you here. Chris is CFO and Senior Vice President of CF Industries, which he has been since 2009. And I will not go through all the palmaris, but fair to say, it's a fantastic opportunity to have you on the call here today as well. Bert Frost is SVP for Sales and Marketing or Market Development, as I just mentioned, and also responsible for the supply chain. So basically, the Chief Commercial Officer. The format we'd like to run is that Tony will give a short introduction, some 5 minutes of business update, and we'll then follow-up with a live Q&A, which I will moderate. I invite all the investors on the call today to submit their questions via the live Q&A. You simply submit your questions through the link that you've been provided with. And you can ask your own questions, which I will then incorporate in the Q&A, and you can also vote on the existing questions. So that's enough from my side. With that, I'd like to hand you over to Tony.

Good. Thank you very much for having us on, and welcome, everybody. We're excited to be here because it's really a terrific time to be in ag right now. Stocks to use, of course, grains around the world are at decade lows. Grain prices are extremely high. And the weather in much of the world has been challenging from a yield perspective. So that means that demand for our products and nitrogen fertilizer are extremely high. And we don't see that situation resolving itself in just 1 year. We think that's a multiyear situation given that we don't think yields this year are going to be bumper crops. And given how low existing coarse grain stocks to use inventories are, it's going to be at least another 2 years, we believe, to replenish those. So that means we've got a long runway ahead of us, where demand for our product is going to be very, very strong. At the same time, you've seen operating rates across the industry challenged because a number of turnarounds and maintenance activities were pushed out of last year, given the challenges of COVID. Many producers decided they didn't want to take large turnarounds and have thousands of contractors enter their sites and potentially put at risk their employees to exposure. And so what you've seen is a much higher rate of planned and unplanned downtime this year, which means that stocks to use on fertilizer products are also very tight. At the same time, you've seen a recovery in economic activity and, therefore, a much stronger gas price differential between the U.S. and much of the rest of the world, particularly Europe and Asia. And as a result, nitrogen price is very high because demand is strong and the marginal cost of production is very high. So we're in really a sweet spot in terms of high demand for our product, low-cost for our production and high prices globally for nitrogen. And that sets up for a couple of years here where we see really strong operating performance. We're also excited, we spoke earlier with some individual investors in small group setting, about a number of the clean energy initiatives and the ESG initiatives we have underway. We're very focused on carbon capture and sequestration to be able to begin producing blue ammonia or net carbon 0 ammonia, and we've also begun construction on our green ammonia project in Donaldsonville, Louisiana. So we've got a lot of things going, but the strong tailwind in terms of the market environment we find ourselves in.

Great. Thanks, Tony. And just as a reminder, again, to investors, and I can see this a question being submitted already. Please use the live Q&A, and we use that as a format, and I'll include those questions, in the fireside chat.

But just to kick us off, Tony, what are the biggest opportunities and concerns for CF Industries that you see over the next 5 years, please?

Yes. I think within the next 5 years, the opportunities are, as I mentioned, both the core business from an agriculture standpoint. But also in 5 years, we would expect to have dehydration compression in a number of our plants and begin doing carbon capture and sequestration to produce net carbon 0 or blue ammonia. And we do believe that there is going to be margin expansion opportunities for blue ammonia, both in terms of agricultural applications as well as others. And the others could include being used in power generation in Japan. And also, we think there's developing marine applications that are very likely for using ammonia as a fuel. So we're really excited about having the strong base business behind us to support and sustain the transition as we move into clean fuel and clean energy from a standpoint of blue and green ammonia production.

You mentioned already that grain values are at 9-year highs. Stock-to-use ratio, you referenced at 5-year lows. Ag fundamentals, the most favorable since probably 2012, at least. How long do you think those conditions will last?

Yes. Again, I think given the lack of rain and kind of drought conditions that you're seeing in Brazil and Argentina right now, our expectation is for relatively lower yields on second crop corn. That further is going to, I think, pressure kind of where stocks to use are. And given the huge appetite China has had from the standpoint of importing corn and beans in order to help replenish the hog herd. Again, I think that, that sets up really well for a strong demand environment over the next 2, 3 years. So we think it's going to be out at least till 2023, if not beyond, until we get back to kind of equilibrium from a stock-to-use standpoint, and that really sets up well for that demand environment around nitrogen fertilizer.

So on that point of strong demand out of China, rebuilding the hog cut, particularly for corn, you don't see that normalize, that specific point for another 2 to 3 years?

Well, I mean, I think China has had some challenges in terms of domestic production. Water availability is an ongoing challenge. They had a central government initiative around not only net carb -- net nitrogen 0 growth, but it was actually negative growth. I think all of those things have really impacted the yields that they've been able to produce domestically. And at the same time, what had been referred to as a very large kind of strategic inventory of corn, I think, has been determined to either be nonexistent or completely rotten and relatively worthless. And so our expectation is their demand for imports is not going to moderate anytime soon, particularly with trying to rebuild the hog herd. And again, I think that, that sets up really well for just the global ag environment.

For sure. A question for you and maybe for Bert as well. What is your view on Digital Agriculture Precision Act and its impact on your markets?

Yes. I'll start off and then I'll hand it over to Bert. I mean, I think digital agriculture is a natural evolution of continuing to get better input use efficiency. And whether that is getting tighter proximity in terms of plantings or whether that's better nutrient use efficiency and uptake into the plant, so lower runoff. I think all of those things are a natural evolution and ongoing outgrowth of application of technology. I think overall, that's going to help us, not hurt us. I think it's a societal necessity to reduce nutrient loss to the environment and eliminate runoff. But I think as the world population continues to grow, and there's more mouths to feed, we've got to find ways to get more yield intensity out of the same amount of land, which ultimately, that means more nutrients going into the same acres in order to generate more yield. And again, the fundamentals of mouths on the planet means more demand for food, and that's growing demand for our products. Bert, do you want to jump in?

Sure. Yes, the whole concept of digital ag, vision AG is exactly, as Tony said, it's a maturing and an improving of our industry. We fully support and obviously, the good and proper use of our products, but correlated to a healthy yield and healthy use of the environment. And it works right into our ESG goals of working with our customers, working with the NGOs, the different constituent groups to protect the water, protect the land, protect the air and it's in the products that we produce and the investments that we're making that will lead to that, along with our retail partners and farming partners that are utilizing precision ag.

What gives you the confidence that this will not meaningfully impact or decrease demand for your products?

Well, I mean, I think we've seen over the last several decades an ongoing improvement in terms of the amount of yield versus the amount of nutrients that go down on the field. And while that improvement continues, it is starting to become more asymptotic, I think, toward a theoretical limit. At some point, you can't get more nutrients into the plant than what you put down plus what's already embedded in the soil. And so I think there is an absolute limit that you get here, too, which is 100% nutrient use efficiency. And while we're not there yet, we're getting to very good levels of nutrient use efficiency, particularly with some of the, as you said, precision agriculture technologies and methodologies that are being employed today. And our view is, again, this is a social license to operate issue. We've got to reduce the amount of nutrient loading in the rivers and lakes. We've got to reduce the hypoxias, lowering the gulf. I think that's a societal requirement. And so I think that this is good for our business, not harmful for our business.

Great. On the financial side, you're one of the most efficient cash converters amongst your peers in the industry. You have very strong free cash flow yield. First part of question towards that is, how do you plan to allocate that capital going forward, please?

Yes. And I'm happy to have Chris jump in here as well. I'll start. I think, first and foremost, we want to keep our plants operating at a very high on-stream factor, high reliability, good asset utilization. We want to make sure we continue to improve on our already really outstanding safety record. But that's always the first call of capital, and we're really focused on getting investment-grade rating back. We believe that our financial metrics deserve investment-grade rating today, but we're focused on achieving that. And then we've got a whole host of opportunities around reducing our carbon footprint, and we're excited to begin getting after some of those, including, as I mentioned earlier, the carbon capture and sequestration projects and finishing up our green ammonia project. But Chris, why don't you?

Yes. Yes. I would just add to that, Gunther, you bring up a great point. We have been consistent at converting our EBITDA to free cash flow at over a 70% efficiency rate over the years. And as a result of that, that provides us a lot of free cash flow. As Tony mentioned, really, the first call is obviously going to be on our growth projects and also are sustaining. And then to get back to investment grade, which we have some 2023 notes that go current next year, those would more likely than not be taking down some of that in order to assist that move to investment grade. I think the one thing is from -- even with those 2 metrics or 2 actions, we're going to have some excess free cash flow, just given what's in front of us right now. And unlike in the past where maybe we're a little bit more ratable with our share repurchase program. We'll probably build a little more cash and be a little bit more opportunistic when we go in and take out larger amounts of shares when we do than in the past when there's more of the ratable type of program we had in place.

That's great. I think at this point, I'll take some of the questions that's coming -- that are coming in from the audience as well. And the first one is, can you compare and contrast today's operating environment to that 2012 time period, please?

Yes, Bert, do you want to talk a little bit about that?

Actually, very similar. What we had going on was early planting. We had early applications and expected yields in, I think, the 177 trend yield type number, hot June and July came. And we were ended up yielding, I think, 153 bushels. Went into a very limited stocks to use position globally, driving up the price of corn further and really setting out a very positive 2013 and 2014, with also some limits coming out of Russia in terms of production of grains. And what we have this year is a very similar position, early planting, healthy applications, good acreage in the -- probably 92 million to 94 million acre range, and guess what? We have a very hot June coming right behind us. I just read the reporting, that could be the hottest June in decades. And that will stress the corn crop. And we need to get the nutrient still down and then we'll see what happens in July. So we are in a very tight position globally based on some of the things that Tony mentioned, tremendous import demand from Asia, limited stocks in South America, the likelihood that they can run out of soybeans before harvest and -- or before planting. And the same thing with corn. So it's the farmer globally is going to be well compensated based on the Chicago Board of Trade values that are out there today and the forward market for December '21 and '22 and '23 are all very healthy by historical standards. So that kind of market, that's just a very positive forward market. Go ahead.

Yes. And I would just add to that. I mean, there are obviously a couple of differences, one of which is back in that time frame, I think North American natural gas was in the range of about $6. Today, we're less than half of that. And back in 2012, what we saw was really a demand-driven part of the cycle from the standpoint of all of the capacity that was available globally was kind of up and running and price was really arbitrating, I think, where a lot of that tonnage ended up. There was, I think, excess demand versus production capacity. I think today, it's a little bit different than that. But what you see is a very high energy cost spread in Asia and in parts of Europe. That means that in order for those plants to be able to run, the price has to rise up to the point where they've got a positive margin structure to turn those plants on. And so while we're -- it's still, I would say, very, very strong demand for our prices, which -- for our products was really helping us from a price environment as the energy spread today. And the fact that we're at a much lower cost structure than we were back in 2012 also adds to the benefits that we have today.

Tony, can I jump in that? Sorry, go ahead.

Just structurally as well, we have 25% more capacity than we did back during that time frame, too, because it is in 2012, where we announced our expansion projects, which were completed at the end of '15 and into '16.

Good point. Yes. Tony, I was going to pick you up on the natural gas price comments and the differential geographically. Europe and Asia, seeing much higher gas prices than this time last year. That's elevating the high end of the cost curve in global nitrogen. Do you think there will even be a traditional summer reset in pricing in North America?

Well, it's interesting. We've talked about this, and I'll give just an anecdote and then turn it over to Bert, who handles all of that for us. But I think publications indicated that some Egyptian cargoes were sold in the over $400 range for August deliveries. I mean that's pretty strong indication that the typical third quarter lows are not nearly as low as what they've been historically. But Bert, why don't you go ahead and manage that one.

Yes. So it's an interesting place where we are today. The supply and demand balance globally for fertilizer is very low, its supply and demand is very high. We're going to trend out of Q2, probably at the lowest inventory level throughout the system, whether that be producer or retailer then in my recent memory. And the global impacts of either turnarounds being pulled forward or just the demand that we're seeing is going to keep that in a very positive way. And so when you look at the fill program that traditionally happens in Q3, Tony mentioned the pricing that's today offered and has been transacted in Q3 as close to that $400 a short ton, that's $440 a metric ton. I think we're going to be in that type of environment. Any kind of range around there, quite happy, especially considering the gas pricing that Tony just mentioned earlier at below $3. So a very attractive financial spread for the company. And you're going to see, again, who is driving this is the farmer, who is being able to sell his corn at, let's say, $6 in the fall of '21 after harvest. He's going to want to replace and get ready for planting next year and that inventory needs to be built. And so we have a very positive pricing environment as we roll forward.

And I would just add, and I know Bert alluded to this, but at $6 corn, growers have every incentive to do side dress, top dress later into the season than maybe historically they've done in the past. So we're seeing sales for June into July being going into prompt application as opposed to going into storage, which also indicates then that we're much deeper into the year for product going on to the ground for this year's crop. Meaning that we're not much further behind in terms of beginning to build inventory for next year's application. So I think all of those things set up really well for an environment that you don't see the traditional big lag in pricing going into Q3 that many years a shell.

And that, you already mentioned currently a tight supply, very strong demand, can you share your views of supply-demand balance near term and longer term? And what incentive price do you think will draw new construction of ammonia and urea complexes space?

Yes. I mean I think one of the challenges that's going on from an S&D balance is despite the fact that India has added several new plants, their aggregate production has not gone up. And in fact, our expectation is it's actually lower year-on-year this year. I think part of that is due to the high cost of LNG and energy going in. I think part of it is due to older, inefficient plants. And part of it, clearly, I think, is challenged with the difficulties India seems to be having with managing through COVID right now and availability of workforce, disruptions to the supply chain. So along with the rest of the world having generally higher maintenance and downtime, lower operating rates, I think there's been a big disruption in India. And I think that, that's going to persist into next year. As we think about incentives for building new plants, based on where pricing is currently, I think if you're a Russian producer, you've got opportunities in places like Nigeria or Iran, you'd have to be thinking seriously about adding capacity at these values out there. I think despite how relatively cheap gas is in North America, given the difficulties of the way that labor is contracted for in the U.S., in Canada on a reimbursable basis, I think it's very difficult to make the math work on thinking about doing a new plant here, which is really one of the reasons that all of the more recent plants that have come on have been in those low cost, low labor, low construction labor regions of the world like Russia and Nigeria, Iran and so forth. So I would expect there to be those being the regions where you'd continue to see incremental capacity expansion. But I think where our pricing is expected to be over the next few years, you'd have to begin thinking about it.

Yes. The one thing I would just add to what Tommy said is the nice thing about this particular industry is the transparency you see going forward, when those announcements do occur that you have a 4- to 5-year time line before that supply comes on. During that standpoint, you have demand, which is a very ratable growing up into that. So it's not as if there's this huge slug where supply would outstrip demand during that time frame.

The other thing, Gunther, that people don't talk about but is very real is the amount of capacity that seems to come off-line on an annual basis. So Brazil has shut down the Petrobras assets. I think Bolivia is really thinking about the San Juan plant. You've seen Venezuelan plants come offline. And I think there's some real challenges in terms of gas availability in places like Trinidad, where we've also seen some disruptions in terms of a number of those plants have been announced coming down. So the fact that you get some plant additions around the world, to Chris' point, aggregate demand continues to rise. And when you see some of these other supply points come offline, it just further stresses the S&D balance globally.