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

So next up, next up we have one of our top picks, CF Industries. Today, I'm very pleased to introduce CFO -- CF's CFO, Mr. Chris Bohn, as well as the SVP of Sales, Marketing and Distribution, Mr. Bert Frost. CF is one of the largest producers of nitrogen in the world. But what's truly impressive is the consistency of their execution over the past several years as well as CF's ability to flex capacity to one product or another in order to max profits and ultimately cash flow. With that, we're going to be doing a fireside chat today with both myself and Chris and Bert. And I think we'll just dive in some questions. So first of all, gentlemen, thank you very much for taking the time to do this with me. Hopefully, everybody is doing well. It seems like the office is at least, let's say, somewhat open.

Yes, good morning, Chris, good to see you.

Good morning.

Good morning. Thank you. So start off, there's been a lot of noise just throughout the U.S. growing season, I guess, the Northern Hemisphere growing seasons at large relating to COVID factors such as ethanol demand, feed, U.S.-China trade relations. So it's been one thing after another starting in 2Q. Just given what you're hearing from your own customers, what your own assessments of the marketplace, can you just give us just a very brief state of the union on the ag macro and outlook for '21? It does seem like things have gotten reasonably a bit better since some of the 2Q scares. Bert, can you give us your own perspective, please?

Sure, when you look at where we were just in March, April and May and some of the [ depth ] of this crisis and where we are today, it is 2 -- like 2 different paths. We feel positive and believe positively about outcomes for this growing season and into 2021. When we were looking back at the application time of April, May and June, we weren't sure what products were going to be consumed and what the acreage level would be. Turned out pretty well in terms of 92 million acres of corn. Yield looked to be, from the USDA, about 178 is the yield expectation average, which is lower than they had initially put out which is why you're seeing some of the positive dynamics is the price of corn. And so 3, we were in the lows of 320s, 330s just a few months ago, they were in the 360s, which for [ a farmer ] when you're looking at revenue per acre potential. We're in the kind of a range that's acceptable, where profitability is at the farm gate, but also allows ethanol to be profitable in terms of, at this current level of $40 a barrel for oil, ethanol is a key component in terms of the demand for corn. So yields are going to be [ big ] or acceptable. Some problems, [ I was ] the derecho that came that knocked the corn down, took a few million acres out probably. But that's what prices we think that's stable. And now when you look to 2021, you've got a good price structure today in the 380s. So something that's tangible for a farmer for their costs. When you look at ethanol, we're probably running now at 90% of capacity, which is a very nice recovery. When you looked at where we -- the pit of hell when everything collapsed. And now we've had this derecovery in ethanol, still not as profitable we're approaching profitability or just on the positive side. And that's great for demand for corn. The next area is when you look at the protein sector, and we're very concerned with some of the virus outbreaks that took place in some of the processing centers for pork, beef and poultry. And we're seeing a lot of that movement in a lot of those operating units running well and running at capacity. But what's really positive is the cattle on feed number. So when you look at the feed loss, when you look at the total numbers that, not only are the cattle coming in younger, which will mean longer stays in the feedlots, but the total cattle on feed is up like 2%, which is probably 200,000 heads, so demand for corn in that sector. Those 2, ethanol and cattle, are probably the big drivers for corn and then there's exports. So China has come in, where I think we're at around 8 to 9 million metric tons of commitments. And that's against a 10 million-ton commitment. So big, but not that big in the overall demand, but it's the overall corn exports rising from the 2019 levels of 43 million, up to 60 million tons. So when you look at those 3 sectors, pricing obviously drives demand. Pricing got low. That incentivized production of ethanol, that incentivized protein and now we're incentivizing exports. And you look at the Asian price right now per bushel is about 5 50. So an arbitrage opportunity just in terms of buying U.S. corn or Brazilian corn and moving it East. So we look at those factors that are driving demand for fertilizer, and we've seen very good uptake in Q2, and now we're seeing inventory builds in Q3, but imports are sort of some of the positives. Imports are lower, which is good. Inventories coming out of Q2 were lower [ with the head ] space. So we believe we have a good runway ahead of us. Allowing us to position our product. And that's what we're focusing on now as we go -- start into Q4 and then start preparing for first quarter and second quarter applications in North America.

One of the things naturally every investor is focusing on is the global nitrogen and supply-demand dynamics not only 2020 but also for the next year or 2. There's been a -- we haven't heard a lot about new projects for various reasons in 2020, and those that have even been kind of almost towards the end of completion, we haven't really heard any news on. On the demand front, the news has actually been pretty good. I'd say you've seen a lot of positive news in places like India and Brazil into their initial planning season. And then also some select markets even in APAC. Can you just give us your own assessment of the current global supply dynamics? And more importantly, how that's really going to affect your outlook for 2021 and maybe even 2022?

Yes. So the 3 components, I'd say 3, there's obviously a supply and demand, then there's the energy structure, which we'll get into also that are important going forward. Looking at supply and demand, I'll start with demand in the first, and it has been very positive. Not only has North American demand been steady and stable, but you're seeing exactly that issue of record demand in India, fantastic monsoons going into the second season now, tender after tender, and India's the only country in the world that tenders. And the last one was for over 1 million tons, I think, 1.7 million tons, substantial amount of volume being tendered in a month period and shipped. And so we're expecting another tender to come out this week or next week. And so that continued demand keeps the supply position, the longs it sometimes develop in the Arab Gulf or the Asian markets probably balanced. And so you're -- we're looking at India having record import demand of up to 10 million tons. And that has been as low as, let's say, 6 and as high now as 10. That's a substantial amount of demand. And that will carry into -- probably into March, February or March, consistent pull. Good support base for the global shipping, because you got to remember only about 46 million, 45, & million tons are exported and India is taking 10 of those. The next one is Brazil. And Brazil is up probably 15% over last year. With also consistent demand, they're going into their peak application season or they're already in it now for corn, which starts in August and then cotton in November; and then second crop corn in December, January and February, those movements. So we see the consistent demand coming from Brazil over the next several months, which also helps balance the world market. And then we go into our position in our import peak period of Q1 and Q2. So demand has been, I'd say, solid. And then we're -- I would look forward to continue. On the supply side, I think the surprise has been the Chinese production and how they stayed out of the market and some of these runups in India. And then it became more active once the price level got to something that was acceptable to them. And this has been one of our stories is you have to bid in the Chinese ton, and that comes at a price. As the marginal producer and marginal economics are working in this case, where at lower levels, they were unwilling to participate because it wasn't profitable. Once we got in the 260s, 270s, that tonnage was starting to come out because it was bid in and needed. So that to me [ signals ] a fairly healthy supply and demand position today. And I think what you have coming forward, you talked about some new supply coming in there are, but a lot of delays in those plants, whether it's Iran or India and the 5 Indian plants that are either being built or revitalized are delayed. And I think part of that is due to COVID, part of that is due to construction. And then a part of it is just due to the pipeline infrastructure that needs to be built to support that. We've looked at LNG demand for just the LNG terminals that are already up and they're operating at 5% to 20%. Why? Because the ability to pull that LNG then through the country is just not there. And that's going to take a couple of years to materialize. Then you look at Nigeria and some of the delays there. So these are fairly common, these types of delays. And then you throw in COVID, just probably adds to it, they're out. We just don't see the construction or the new plants proposed which we would say is a longer-term positive for the industry, at least in terms of that supply and demand balance.

Bert, I think we've been doing this too long because you actually just took my next 2 questions. So we'll skip ahead one. So along with the ag macro, there's been a lot of input volatility across the cost curve. You saw, especially in March, April, and we really know what's happening in the world. But this has happened in natural gas, and it's happened in regional LNG prices. And to a lesser extent, a little bit even in Chinese coal. So can you just give a quick -- and you mentioned it inadvertently, but can you just give a quick assessment to your current cost crop dynamics, specifically in China? And just maybe lock in just what your expectation is, just given what the RMB is doing as well, roughly around 6.8 right now versus earlier in the year?

Bert, I'll start and you can add in with anything. So as Bert said, we still believe that China's anthracite coal producers are going to be the marginal producer. And right now where coal is there, it's pretty much an equivalent of about $6.50 per MMBtu on an energy equivalent. What you've said with the strengthening of the won or the weakening of the dollar, we've probably seen something in the range of about a $10 increase in their cost structure as a result of that as well. If that holds it's been a pretty drastic move just over the last 6 weeks, so we'll have to see where that stands. But I think as we look at the cost curve, the marginal producer is not going to change. But what was interesting is what you mentioned earlier in your comment, which is what's happened in Europe over the better part of this year where you saw actually Europe energy prices being equivalent to what Henry Hub or North American producers had. And in some cases, in the U.K., at our sites there, we're paying less than Hub for gas, which seemed very strange given that LNG was being exported to Europe. I think what we've seen here now is a return to rational economic behavior where those rents for liquefaction, transport, regasification and transport to the plants, that rent is being added in. And you're beginning to see European prices definitely start to move up considerably over hub. So if you look at December on NBP or TTF, I think they're at almost $5 right now compared to where we sit here at around $2.30. So you're starting to see that differential gap back out. And why that's important is because while China is still the marginal producer, when we went to export portions during the year with having that low energy cost in Europe, it reduced the price that urea was trading at during that particular time. So moving back to more rational economics with LNG trade and energy trade in Europe should provide a little bit a higher price floor in urea during those export markets. So as I look at it, the cost curve from bottom to top really hasn't changed, but it's that midsection that's steepened, and that's helped us out, I think, not only just right now, but in the future here because we expect that to continue.

So let's just stick with that in a moment. It's a good leeway into the next question is. Naturally, once again, back in March and April, there was even a lot of debate about U.S. gas production in '21, '22 and the potential for inflation. Can you just give us an update on your own thought process there now that the dust has settled a little bit? And then also just quickly comment, naturally -- CF, you naturally consume a lot of gas. You have Henry Hub exposure, Oklahoma, AECO, et cetera. Can you just comment on anything -- any differentials in that basis as well?

Bert, do you want to take that one, on the gas?

Go ahead, and I'll fill in.

Okay. Yes. So from a gas perspective, we have seen a pretty steep contango throughout the year. And as a result of that, we are playing more in the daily market in first of month purchases that played out very well for us because as you got closer to each of those months, the price actually collapsed and didn't go to what the contango was. So we're continuing to do that quite a bit here in North America. So when you have a resource base that's 2.4 Qcf, and you have the innovation that you see, we still have 89 Bcf per day of production. Now everyone has been saying that production would go down as you saw CapEx cuts by the E&P, but we're continuing to see that. But the other side is demand has gone down significantly. We had LNG go from 9 Bcf a day down to 3 Bcf a day. It started to recover now, where we're closer to 6 or 7 Bcf per day. But there's a lot of different things that are happening from the demand side that doesn't really require that much supply. And I think as we're seeing that and we step into each of these months rather than hedging forward, we're seeing lower prices, as we've seen just over the last couple of days here. You've gone from $2.60 to $2.30. So from a U.S. standpoint, we still feel very constructive about gas. If there are some excursions during the winter, I think those are going to be short-lived, like they are just during any winter. But as you mentioned, Chris, the one thing where our sites are located across North America, we do do some hedging related to basis, and that we put in place for winter at what we believe are pretty attractive rates at some of those sites like Port Neal or Courtright that are more exposed to freeze offs that could occur.

Very helpful. Just -- and sticking with just the macro and cost curve, the next topic on that is that's very popular among investors is trade for development and this has been more prevalent in the UAN market. And over the last couple of years, there's been some pressure in UAN on a parity basis versus urea due to trade flows evolving, a lot of the tons coming back that were previously going to Europe. Can you just comment on where we stand, let's say, right year right now, what is it September? Yes, September 15, 2020, and in terms of the effects of that. You're also -- I think Bert's been working on some market development opportunities in Latin America in an effort to offset at least some of that. But just how should we think about how this affects your overall production ideas as well as where you think UAN could potentially be trading once you're on the parity basis? It's been at a discount. It seems to be narrowing now little bit. So just any comments on that would be greatly appreciated.

When you look at UAN, obviously, we're a big factor in that market we produce -- we have the capacity to produce almost 8 million tons. And today, we're probably in the 5.5 to 6 million tons. And you're right, about 800,000 tons that we were sending to Europe had to be repositioned due to the sanctions. And the sanctions were fairly onerous on us in terms of the cost. And so what we have done in the United States in North America is work to -- and this was before the sanctions came in place is to develop new opportunities, new terminalling opportunities, new logistical options, which we're going to start merging [indiscernible] They were implemented this year, but you'll see more of that in '21 and '22 sending more product out to California by rail. We've got some good options there, moving more by the barge up in the Midwest into a few larger terminals we've constructed and then to continue to utilize our vessel, our U.S. flagged vessel to the Texas and East Coast. So those are going to help us position North America and continue to leverage our platform. But we do when we look at UAN, we look at it on an end basis and what does that product provide us against the other and options of urea, ammonia or ammonia nitrate or DEF or nitric acid. And that's the [ leverageability ] of both on the whole platform is what we're working towards. And that's why we're investing in nitric acid and we continue to grow in DEF. You mentioned internationally, where we are growing, and that continues to be South America. Brazil is now over 100,000 tons. Argentina continues to be a good destination for us, good partners down there. And we'll continue to focus on different South American countries that we believe have the long-term possibility, especially with the changes probably coming in ammonia nitrate over the next couple of years with restrictions on imports and then a need to grow something that replaces that, and we believe UAN is a good option.

Got it. And I understand it's only mid-September, Bert, but what are the -- your initial thoughts on the U.S. fall application? So kind of an obvious question this time of the year. But there also should be some decent underlying demand due to the significant amount of [ nutrient ] uptake, just given the positive correlation with yield. So what are you hearing on a preliminary basis from your customers? And then also just as a side note, I'm going to just sneak it in now, the present NOLA has been very healthy. It's moved up, but at the same time is you're not really incenting a lot of tons to be coming in the market. So what would be your assessment of where inventory levels are versus what they could be given your views on demand?

Yes. Looking at North America for the fall, I think we're encouraged, and we've seen good retail participation in our fall programs, but that's mostly ammonia focused where we've got a good [ gone ]. We'll have open tons available for that time period. We believe that's a better option for us. But looking at the fall, you're right, this has been an exceptionally good growing season. The seeds were planted early. The weather helped significantly with warm dry days and then the rain would come at a good timing. So yields reflect that, but you're also seeing the corn coming off and soybeans coming off early which then leads to a very wide-open window for applications. And traditionally, good fall application with adequate moisture and colder temperatures, ammonia is a great product to apply. Today, it's at a good value. So we're anticipating that. But then your -- second part of your question regarding inventory levels, as I said earlier, I think coming out of Q2, inventories were lower. Lower imports have been a consistent -- a theme right now because I think U.S. is trading at a discount, and that has incentivized other destination markets, as we mentioned earlier, India and Brazil. So I think we're going to have probably a positive market coming our way as a result of that. Just because you're going to have the need to get, one, bid those tons in and then physically move them, and we're already approaching river close in a few weeks, and it's more expensive to get those tons up the river by barge or it's actually cheaper by barge, and that option will be limited now until spring. So then you have to go to rail and truck which [is expensive]. So we see for our in-market production, very good healthy margins coming. And as Chris mentioned, the way we've structured our gas contracts, good cost position for our main raw material. So we're, I think, well positioned for this fall as well as the spring that will come.