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

Thank you, and good afternoon, everyone. My name is Adam Samuelson. I'm the agribusiness analyst here at Goldman Sachs. I'm very happy today to continue our Industrials and Materials conference with CF Industries, largest nitrogen producer in the United States, in the world actually. From CF today, we have Chris Bohn, their Senior Vice President and Chief Financial Officer; Bert Frost, their Senior Vice President of Sales, Development and Supply Chain; as well as Martin Jarosick, who heads up their Investor Relations effort. So just for everybody on the webcast, there is going to be an opportunity to solicit questions electronically. You should see that in your webcast window, and I'll [indiscernible]. But I think we're just going to dive right into the Q&A from my end.

So maybe, Chris, we could start. I would love to just get an update on the spring as you see it today. It's obviously been a volatile global economic environment with COVID, but how do we see the fertilizer markets and the nitrogen markets playing out as corn planting has progressed across the Midwest?

Good segue. As you talk about volatility and strange markets because this has been an interesting spring, albeit good, though. I think we've been in the nitrogen business, at least, we're one of the economic safe harbors and we've had good demand, good pull. I think because of the things that CF Industries has put in place with high investment levels, we have good operating rates. And we've been able to position our products in position for this spring. I think as we rolled into this COVID issue, we were, I think, our concern rested mostly with logistics. We had a lot of confidence in our ability to produce and position the products at the plant. And so then the question was, could we get that product into market and be ready for spring and serve our customers. And so we worked very closely with our logistics providers, the railroads, the pipeline, the barges and the trucking companies to do that and anticipated -- and you saw that in Q1, where we moved a higher volume of Q1 product as compared to the previous year. And that's a reflection of that. That's a reflection of working with our customers, working with the channel partners to be in position. I think the surprising issue for -- I don't know if it's that surprising, maybe outside of this group, but how high the USDA projected corn acres to be at 97 million. That's a significant increase over last year. Our number's lower, but we're more in the 94 million -- 92 million, 94 million acres of corn, still an increase over last year, which means an increase in nitrogen, which positions us well. So as we roll through Q1 and now into Q2, volume pull has been good. Movement has been very good. And compared to last year, we had such a late spring due to weather issues. This year has been more of a, I'd say, "normal", whatever that means, because we had plantings as early as March and plantings late as June in the last 10 years. And this has been more of the normal, where April ammonia applications were able to go down in the central part of the United States, and now we're seeing that activity in the northern tier, North Dakota, Canada, where that movement is continuing, and you're going to see emergence coming out. I've traveled through the Midwest over the last couple days and had a chance to see some of the things that are going on through Illinois, Missouri, Kansas and Oklahoma. And we had a good amount of rain come through, cooler weather. And so emergence has been a bit delayed, and that's going to compress the last part of the application season for UAN and top-dress and side-dress ammonia and urea. So I like where the spring has unfolded. I think, again, economically, fertilizer has a very good value this year. When you look at the total cost of a farmer and what they're able to do, we're in the camp that farmers will fertilize for yield. That's a very good proposition for not only our company, but our industry, and that's the one thing they need to do if they want to achieve a level of revenue per acre, you've got to have the yield to be able to do that. And there are other issues, which I'm sure we'll get into, whether it's government payments or crop revenue guarantees, that we think position the farmer much better than what is being reported in the press.

All right. Well, that's a great overview. Maybe before we get into some of those kind of the opportunities to mitigate the corn environment as we get into the back half of the year, let's try to round out the discussion a little bit on the spring. And just kind of how you see the channel sitting kind of today across your key products, kind of what you're watching from an activity-level perspective over the next kind of 3 to 4 weeks before kind of all the nitrogen is in the ground and where you're kind of most optimistic and maybe the areas of the country you're most -- you're watching most closely.

So rolling into the spring, we believe that the inventory levels were lower than needed for a crop this size or an acreage planting level that's been expected in the market. And why? That's because we've been tracking the vessels that have been coming in, the amount of urea that has been imported, and we are an import-dependent market. And so when your imports are trending behind and you're planting or your applications are ahead, that sets up for a good market. And that's why you saw U.S. pricing or at least NOLA-based pricing in the kind of the application areas trending pretty significantly above the international market as represented by Brazil, India and a few other countries. As we've rolled into some additional vessels because of those higher prices have come in and the back half of Q2 has trended lower, but in the Midwest, and this goes to the premium that the Midwest achieves over NOLA, has held predominantly in most of the -- in all the areas that we participate, and so that's good. What we see for spring, inventory levels were, I'd say, adequate. We've had good pull all the way through to today from our customers, and we're anticipating coming out of this spring season, and we want to do this with low inventory levels, principally to utilize our inventory space, if needed, depending on what the pricing level is in Q3. And from our customers, the communication we're receiving is that they also anticipate to be at low inventory levels because of -- I think this is just a risk-off time for all markets, whether that be equities, commodities or whatever you're going to participate in. So those customers of ours have communicated they plan to be at lower levels coming -- going into Q3. And at that time, we'll have discussions about fill programs and what they will be. So this -- so that was inventories. That was demand, imports. That's where the market is today.

That's incredibly helpful, Bert. So as we -- I mean, is it too early on that point to start thinking about kind of the shaping of a summer fill program? I mean it feels like every year is different. And maybe any compare or contrast you can provide about the setup as you move into summer fill this year versus the last couple?

Sure. Over, I'd say the last maybe even 5 to 10 years. I've been with CF now 11. And looking at the different fill programs, they do flex, expand and contract based on -- and this is how we look at it, the economic opportunity and the positions that we want to put CF in and how we work with our customers through that time. Fill programs have started as early as early June and as late as August. And why early June? Well, that was in 2012, I think, when we had a very good early planting season and application and very good emergence. Why August? Well, that was last year. We had a very late season, and we had good demand all the way through July. A fill program is -- it's called the fill because you're literally filling up space of your own or your customers' inventory, and it's a program -- it is a good program or a good thought because you have logistical assets you want to move. And many of our customers can only receive so many tons on a per-week basis. And so you want to work logically and in a timely basis. So if you start a program in, let's say, July, you're actually receiving that product on a ratable basis through Q3, Q4 and into Q1, preparing the customer for spring. So we have different fill programs with sort of major 3 agricultural products. Ammonia, that inventory largely sits with the producer, ourselves, in our dispersed inventory and tanks throughout the Midwest on the pipelines and the rivers. So we will move that inventory into our own space. And because we've had a good ammonia pull, we anticipate having a good amount of space, and we'll be ready for the fall season in November. Urea, a dry product, we really don't do too many fill programs with that because we have our own space, and the market just tends to move on a ratable basis. So that falls to UAN. Now we're the largest UAN producer in the world, and we make about 500,000 or 600,000 tons per month. We have space for a period of that. And then we generally do a fill program. They've been as small as a month or about 600,000 tons, and they've been larger, 6 months, maybe 2-plus million tons. So when it gets to that point where we will evaluate the opportunities, look at the imports, look at what our customers want and what the value is there and what is the most attractive for CF to produce on an economic basis, and take all those components together, work with our customers and then put out a program. And where it's leading this year, I'd say probably be a smaller program based on what we know today just because of the value. Now however, gas being so low in North America, it's very attractive, and we are the low-cost producer in the world, especially in our home market. So put all those together in the soup and stir it around and come out with a program probably end of Q2, early Q3.

Okay. That's great. So maybe it's a good segue to start thinking about the global market as the global urea market starts to become a bigger factor into North America pricing again out of the spring season. And maybe just help us think about your framing of the -- so to start with urea, the seaborne urea market through to the end of the year, kind of what you're watching from a supply perspective? Any demand impacts on the industrial side to be mindful of? Maybe we'll start there.

When you look at the global market, the production and the supply points, it's the Arab Gulf, North Africa, the Baltics and the Black Sea represented by Russian production and then some of the destination markets, Brazil, India, ourselves, and it actually ranks in volume, India, Brazil, ourselves. And so we're tracking those markets. In the past, we would have talked a lot more about China. Several years ago, China was almost 14 million tons of exports falling all the way to a low 2 million and last year, probably closer to 4 million or 5 million. And we've come out this year, we think those tons will be -- they'll be at a lower level, the export ton out of China, which is positive for the market in 2 ways. One, it's positive that the level to bid in the Chinese ton as the marginal producer in the cost curve at today's price is higher. So if demand were to be such that you need that ton, that's the price level to attract that ton into the market. So that's one positive. The other positive is that those numbers are lower because there has been additional capacity that's come on in places like Nigeria that has moved into the international market. So the supply, we think, is fairly consistent. What we are expecting I think, because of what we're hearing from some of the equipment manufacturers and difficulties of thinking about turnarounds and bringing in contractors to plants, you're probably going to see a lot of folks defer maintenance. And that gets to the ability of some of the lesser maintained plants to run. We think that will impact supply going forward. The international market on the demand side is still fairly positive. You're seeing good pull from Brazil. We just finished up a tender in India, about 700,000 tons have been nominated and agreed to. And that's the second tender of their fertilizer year. And the positive of that is most of the tons that were awarded were for North African, Russian and ag tons, which then consumes the long position in the market and moves that long forward into the June or July period. That's structurally positive for prices. Prices, however, are low right now and low represented in in the major markets, NOLA, India and Brazil. And so what we see going forward, again, as we roll into the next phase of the market of a possible risk-off, prices probably will stay at this level for a period of time. And then as other demand points come in and global demand, we'll see those prices, we believe, improving on the back half of the year.

Okay. That's -- maybe that's a good segue just to help us think about the cost curve a little bit. And I mean, we've lived in an environment for a number of years where we thought that Chinese anthracite producers are the high-cost producer and do help set kind of global urea pricing. Do you think that's still true today? How would you assess Chinese producer economics and export economics? And just again, you talked about them not participating in an Indian tender. And just maybe anything you can add on that just that you think is noteworthy.

So there are a couple of vessels coming out of China, but we believe those are Iranian tons being reexported. Actual Chinese production, we do not believe, has participated in this tender. So looking at the China market of kind of 1/3, 1/3, 1/3, 1/3 thermal, 1/3 anthracite and 1/3 gas, with many of the gas-based plants exportable, built for export or either attractively able to export, have not participated in the recent market. And so in the cost curve, if you take out the anthracite ton of their supply of, let's just put 1/3 at 15 million-plus tons per year, China would very quickly become an importer of urea. That would be great. If the anthracite ton disappeared and China had to import, that will be fantastic for the international market. But the China -- the anthracite ton is in the market and does get exported at times, and that is a good sign of, again, bidding in the supply. We haven't seen, compared to other nutrients and other markets, this collapse of demand, again, because nitrogen is the nutrient you do need for many of the nitrogen-consuming crops, corn, sugar, cotton, canola, wheat, and those are consistent around the world and basic feedstocks. And so over time, when the anthracite and the cost curve ton is priced in probably in the $260 to $285 a metric ton range, we were there last year in that price range, and we kind of move into it about every year, and then that ton comes out. That's great. At that level, we're very profitable at the gas ranges that we are today. Now that goes to the gas side of China and/or even around the world, gas prices are low. The LNG price and what we're paying in our facilities in the U.K. as well as available to Europe, China and other markets, is very low. However, we don't believe that's sustainable and we don't believe $25 oil is sustainable, nor we believe $2 LNG is sustainable. But that is sustainable in the United States based on our gas basin and based on the recovery costs that have really fallen over the years. Now does it stay at $1.70 where it is today? Probably not. But does it rise to $2 or $2.50, and the rest of the world goes back to $5 and $6, $7? Probably, something like that. And that's still a good place for us to be. That's longer term.

Okay. And that's maybe a good segue. We want to make sure, Chris, we haven't forgotten about you. And just thinking about more high-level CF, kind of the company in this commodity market, kind of just help us think about your sources of your lasting differentiation and competitive advantage, both particularly and versus your international peers. Bert as well, feel free to jump in [indiscernible]

Yes. Adam, thanks. I think it starts where purchase left off, and that is with the marginal producer in China being anthracite coal. As you said, one of the things is that those tons, given that you have a nondiscretionary product in nitrogen, you'll see other nutrients maybe not be applied as the farmer tries to cut back cost. But nitrogen is going to be applied. And what that means is the world needs those Chinese tons to be bid in. And by bidding those in, we're going to be bidding in a higher-cost supply, and therefore, we'll see prices move up. And so you hear about some of the lasting effects of maybe what lower oil prices that you're seeing, anthracite coal prices go down quite a bit. The thing I would mention is while they have gone down some, they've gone down from a MMBtu equivalent of $8 down to something in the $7 to $7.25 per MMBtu. So to Bert's point, that implied margin gap between the marginal producer, which we're going to bid in some of those tons from China, whether that's 3 million or 5 million this year is yet to be seen, but that's going to be supportive. So I think that's the first structural advantage is that the marginal producer is significantly higher cost than North America's low feedstock that Bert talked through. Additionally, the import dependency, as we look at the U.S., where our plants are located within really in market, we receive a premium for that. And because it's an import-dependent market, you're bringing product, as Bert said, from the ag or North Africa over here, has to go up the river, get staged, and it's really as the farmer and the retailers moving more to adjust in time, that creates even a greater advantage for our in-market network here, where we can achieve even higher premiums than what we have historically. And if you go back a few years ago, the bare thesis on CF was the Midwest premium is going to go away when our new expansion projects come on along with the others. And that hasn't been the case at all. If anything, what we've seen is there's more dislocations in the timing as farmers have moved to more just in time, and it's actually accentuated and benefited that Midwest premium and what we're able to capture through our network, and which is specific only to CF, given that our peer group in North America doesn't have that vast of an infrastructure. Additionally, as we talked about the thing that Bert was mentioning with nitrogen being a nondiscretionary product, if a farmer wants yield and is going to plant, they may make decisions on P&K., they may make decisions on what type of seed grade they're going with, but they're going to put down nitrogen. And as you look, a lot of people are looking out to 2021 and saying, "Well, it may be sub-90 million acres," well, we had sub-90 million acres in 2015, 2018 and 2019. And all those years, we generated very strong EBITDA. And I think that goes to one of our operational advantages as well, Adam, and that is really our low-cost structure not only from natural gas. But when you look at what we do from our controllable costs, as we talked about on the earnings call, controllable -- manufacturing controllable costs per ton, we've reduced by over 10% quarter-over-quarter from last year. And then additionally, our SG&A, we're looking at being somewhere south of about $25 million less than where we were last year on that with some of the programs and initiatives we put in. And that's really pre the pandemic piece here that's come out. So when you look at that low-cost structure, import demand, and really, all that leads to is the free cash flow generation. And here, if there's something that really people should look at, it's -- we had posted the other night and along -- in our earnings call, it's really the free cash flow we've generated over the last 12 months which has stayed largely consistent over the last couple of years. And what that means from a free cash flow yield? We're almost at a 20% free cash flow yield. And I think that's something that really shows the conversion from EBITDA and to free cash flow that we have is one of the highest in the industry. Actually, it's the highest in the industry. And that helps support a lot of the programs that we're doing, both from our capital allocation. And specifically, when you look at our dividend yield right now of being 5% and as we go back to the trough period back in 2017, there was some discussion by investors what would we do with our dividend. Well, it remained constant then, and it's even a stronger company now. And sitting there with a 5% dividend yield and a 20% free cash flow yield, I think, really makes us a compelling story given all the things that Bert said from an international marketplace and definitely what's happening here in the first half of the year. So I think as I look at both the structural advantages we have as a company and the operational advantages and how that generates the free cash flow and what we look to do with that over these next few years, it's really something that we see very supportive, very strong balance sheet. That allows us the flexibility not only to grow but to return cash to shareholders.

And that's, Chris, maybe a great segue. There's a question that's come in from the audience, and I'll encourage anybody. Feel free to type those into the question box in the webcast window. But the question is really around the share repurchase and the decision to pause them in the near term. Given the liquidity profile that you have and just, yes, the view that the cash flow should be strong under even pretty draconian scenarios and just people -- the question is just trying to reconcile that. And is there a signal of any worry about free cash flow kind of becoming significantly more constrained as you think over the next 12 to 18 months?

Well, I would just start with -- there isn't a concern with free cash flow being constrained. I think, again, when you look at our operating structure with our SG&A being 3% to 5% of our sales, our manufacturing costs, really, the cash cost of that being the lowest in the industry. And then also if you look at the ratable CapEx program that we've put in, we've actually moved the range down from 400 million to 450 million to 350 million to 400 million. And the utilization rate we have, you can still see that we have very strong free cash flow. The thing that Bert was alluding to, and I'll be more explicit in it is because we're the low-cost producer, and we're an import-dependent market, we're going to produce our 19.5 million to 20 million tons year-on-year, no matter what the market looks like. And based on that, with our cost structure being in North America here, call it $1.70 Henry Hub gas, you're going to have a very good free cash flow generation that comes out of that. Now what I would say is, when you look over our share repurchase program, we've purchased nearly since we announced last year the new program, almost $0.5 billion worth of shares. In fact, we did $100 million worth of shares here in Q1. It would like to have been at a bit of a lower level. But over the last 2.5 years, we've taken out over 20 million shares, and I'd point people to the slides that we put on our website and I think we had an 8-K go out just the other night related -- really looking at our industry fundamentals, the CF financial strength and our valuation metrics comparing back to the trough of 2017, in which case, we're actually trading lower today than we were during that particular time frame, even though we have 20 million less shares we have free cash flow that's over $700 million greater than that time frame and almost $2 billion less of gross debt. So I think when you look at that, it's a pretty stark comparison. It shows that, one, we still have a lot of free cash flow generation to do things. But now getting on to where we look at for the remaining part of the year, as we've always said, share repurchases are our preferred method to returning cash to shareholders. We have a very strong dividend, which yields 5% right now. But right now, that's where we intend to stay at the $0.30 per quarter. At least that's the Board decision at this particular time. But as we look at the first half of the year and the strength that we had there, there's still a large amount of uncertainty that remains for the second half of the year. And as Bert said, in the next few months here, we're going to have much more clarity on what's happening from fills in the balance of the year, and we see how much free cash flow that we're generating. We'll base our decisions on share repurchases at that particular time and being, in some cases, maybe a little more aggressive or -- but right now, I think it's prudent for us to be a little cautious on that.

Okay. And then just on the alternative uses of cash, just CF has thought about or have been engaged in discussions about a number of different kind of consolidation actions in the industry over the last 5, 6 years, and some of them haven't come to pass for a variety of reasons. But as you look at the market today, maybe changes in the global cost curve today, just any view on kind of scope or appetite to pursue additional consolidation?

Yes. I mean I think when you look at the nitrogen market, you see it as a very fragmented market, and it leans itself to consolidation happening. I think in the current environment we're in, you would think that there would be some stressed assets that may look more attractive given that. But I think we're still finding some of the same situations that we've talked about over the last several quarters, and that is the assets that are worth owning, there's probably still a little bit of a bid-ask spread there. And obviously, we don't want to enter into anything that's going to be what's going to be financially punitive to us. So we're being very cautious from that. And when you look at I think assets that are somewhat distressed and you look at their utilization rates and stuff, and that may, on the top line, look appealing from a financial acquisition piece, as you dig deeper into them, you may find that there's a little more CapEx needed and requirements to get them to sort of the utilization rates in which we run the safety standards, et cetera. And that, in itself, almost becomes another piece of the purchase price. So I think we're still in the same dynamics that we've been over the last several quarters with sort of the valuation spreads that we see on some of these assets. Now in saying that, we continue to be active in looking at what's out in the market, trying to understand what could be advantageous to us, both from a synergy standpoint and also just with some of our expertise in our manufacturing and how that would work in Bert's group. But some of the smaller projects we have done organically have allowed Bert and his team a little more flexibility, and things like that are -- the DEF project we did at Donaldsonville, we're doing in industrial nitric acid project at Donaldsonville. And all that does is, as Bert talked about, sort of the mix of product, it allows he and his team to chase the highest netback and the production flexibility we have where you can make those changes that quickly just allow his team to maximize the free cash flow generation for the company.

And on that point, I mean, are there internal investment opportunities? It's been a couple of years since really we've seen any growth CapEx from CF, and you guys actually brand in the capital spending this year a little bit, just given the environment. But internally, if you looked at debottlenecking or expansions, is there anything internally you could do that could be a more meaningful use of cash?

Yes. I think when we look at the type of projects we have internally, it's probably not doing ammonia debottlenecks. We have a good length in ammonia position. It would be more of the upgrade projects that we continue to evaluate and you evaluate those versus the alternatives. And right now, the alternatives is we just got done talking about, is looking at our own shares. And that maybe being a stronger financial return than necessarily doing a massive upgrade. But we do continue to evaluate those just based on the margin spreads and also the flexibility we could add to the company that has benefited us in the past both from a logistics and also from a production standpoint. But right now, it's tough to move forward with those when you see sort of the attractiveness that resides in our own shares.

Okay. And I guess, I got time for about one more question. Maybe I'll just make it just a market structure one. Just given some of the changes in the UAN market over the last couple of years with the EU sanctions, just what do you see is the -- do you -- or what time period can UAN go back to actually trading at a premium to urea? Maybe I'll simplify it to that. Just how long do you think that will actually take to get the supply and demand really properly in balance there?

So UAN is -- we consider a specialty product. It's a lot of water, and there's logistical constraints to shipping it in inventory, not as easy as urea, and so there are issues going with it that we think deserve a premium. And so we've been tracking pricing. Obviously, we've had decades of pricing history, and we look at various times when we had consistent expansions above on an end basis compared to urea and ammonia. And you're right, as of late, since the changes to the EU, well, the tariffs that went in place because there has been a tariff in place for a long time since I've been at CF, and they just obviously increased it significantly. So what happened with that was, at least on our own and with other international producers was a reorganization of where those tons would flow. And so UAN is a smaller component of the global end consumption and has traditionally been consumed in more sophisticated agricultural markets, principally the United States, Europe, Argentina and where we had some development work going, which is proceeding very well and Brazil and some other smaller countries. And so for us, before the sanctions kicked in, even paying a tariff, it was more attractive for us to ship to Europe than to some other places in the United States, principally the East Coast and West Coast, which required U.S.-flagged vessel to move those tons. It's quite a significant cost. The tariffs came in. We fought them. They're unjust. It doesn't make any sense by any economic measure. But I think these were some retaliatory things that were put in place, and we'll see how they unfold. Then what happened is you had Trinidadian and Russian tons then directed towards the United States, and an increase in imports, which when you factor in the amount of capacity that we have in North America and what we added and some others, really weren't needed to the level that have come in, probably double what was needed. So what we did, not because of just the import, but we look at our opportunities holistically, and we have since that time, since even before the tariffs firmly went in place, we saw them coming, we took measures to take the next step in our development of looking at new terminals to invest in, terminals to upgrade or terminals to change maybe from ammonia to UAN as well as investing in a U.S.-flagged vessel, or it's called La Louisiana, that's able to quickly move tons from NOLA up to the East Coast, even as far as Canada and as well as serve the Texas Gulf Coast. So we've taken some measures in place. We were at the height, shipping about 800,000 tons of UAN to the EU. That's fallen to 0. And so we have repatriated those tons, but not all of them will be made into UAN. We are going to -- we will -- you'll see us move our production. We have quite a bit of flexibility between ammonia, urea and UAN. And we have been favoring urea over UAN. So in the peak, we're probably at 7.2 million tons of commercial product of UAN. And today, we're probably more in the 6.5 million or maybe more or less of that number. And so over time, we believe that we will position the company well, and that will -- I think there will be a return to the premium. But right now with, I think, these oscillations and disruptions, that we're still in the rebalancing phase. Acron, a producer in Russia, has dropped a urea plant into their complex, which will allow them to produce less UAN and taking that urea liquor and granulate it. That's, I think an economically positive decision for them. And that might happen in other places, too. And so that would improve the supply and demand imbalance. So we're positive going forward. But right now, it's not trading in a premium to urea.

All right. Great. Well, I think we're just about out of time. So I think we'll stop there. Bert, Chris, Martin, I want to thank you and CF for participating today, and thank you, everybody, for joining the webcast. Thank you, and have a good afternoon.