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

[indiscernible] Morgan Stanley Global Chemicals and Agriculture Conference. Our next company is CF Industries, and we're fortunate to have with us today, Tony Will, CEO; Chris Bohn, CFO; Bert Frost, SVP of Sales, Market Development and Supply Chain; and Martin Jarosick from Investor Relations. Before we get started, I just want to remind you of 2 things. One, please read the research disclosures on the Morgan Stanley website at www.morganstanley.com/researchdisclosures, and please reach out to your Morgan Stanley representative with any questions. Secondly, we will do Q&A after the fireside chat. You can enter the questions through the web browser. We'll ask them anonymously. Likewise, if you want to send them to me instead, I'll have -- I'll ask them for you, if you like, also anonymously. And if you do have questions, just best if you put them through sooner rather than later because sometimes there's a delay. And with that, welcome to the CF team.

And maybe just to get it started, about a week or so ago, you made a very big announcement about your intentions in green ammonia. So why don't you just set the table for us, then we'll dig in on it. So what is it that you're doing and why?

Well, thanks, Vincent, and good morning. Our announcement covered a broad spectrum of topics around decarbonizing our entire network and a number of ESG-related initiatives we had, one of which was a new green ammonia plant that we announced at our Donaldsonville, Louisiana plant. So we're putting in electrolyzers to generate hydrogen without any kind of carbon waste stream, and then that hydrogen will be put directly into the back end of our existing ammonia plant and create carbonless ammonia. And really, the reason kind of why now is a combination of factors. The first is there's clearly a huge seismic shift going on globally around decarbonization and search for clean energy. We believe that hydrogen is going to play an increasingly important role in that energy complex going forward, and that ammonia is the critical enabler for hydrogen because it allows for the transport and efficient storage of hydrogen, and ammonia can be used as a fuel in its own right. And then the second reason is not only kind of the giant sort of momentum around decarbonization and lowering carbon footprint, but our belief was that it was a matter of when, not if, in terms of Democrats taking the White House, and we'll see by what happens with the Senate. But the Democrats had made it very clear that climate change was going to be a top priority for them and, along with that, a number of regulations. So this was something that we wanted to get out ahead of. And then I think the third issue really was that beginning about now is the first time the technology has been there to allow for the economic return profile on electrolyzers, both given the efficiency and the cost profile of the electrolyzers coming down and also the value of hydrogen in the marketplace. So that combination of things really said to us now is the right time to go and go in a pretty big committed way to allow us to be part of the group that is going to be setting standards and putting in place the certifications and so forth. So it's really that combination of factors.

Okay. And maybe just more specific to CF because we do see a variety of announcements. They seem to come at a regular basis these days for whether it's hydrogen or ammonia. How do you see CF's particular competitive advantage going into this process? And what is it that you think is going to help you become one of the leaders of this movement?

Well, I think it's a combination of things again. We are currently the largest ammonia producer globally. We've got the largest distribution network and storage infrastructure. We have 5 deepwater docks that we can export out of. And it's not just the green ammonia for which we can go ahead and leverage existing infrastructure, but there's also the opportunity for us to expand what we call low carbon, some people call it blue ammonia production that has to do with carbon sequestration and -- capture and sequestration. And so as Chris has mentioned a couple of times, we already capture and extract the CO2 out of the process. In a number of our locations, there are CO2 pipelines or other disposal mechanisms that we can access pretty inexpensively to get to geological sequestration or EOR applications. And so we've got an opportunity to be very large in the blue or low-carbon ammonia production as well. And I think that combination of having the logistics infrastructure and just the scale of our network gives us a huge advantage in terms of how quickly we can scale up and the size we can get to for pretty low dollars of capital.

Okay. And it doesn't sound like there's other than maybe the pipeline, which you have easy access to at reasonable cost. It doesn't sound like there's something else you need to bolt on to this or somebody you need to partner with or anything like that. It sounds like you have it all under your tent.

Yes. I mean, we've certainly got it all under our tent with respect to production of green ammonia. Blue ammonia, we've got different pathways around accessing existing pipeline and takeaway capacity versus partnering with other folks to do that for us. And then there's a question downstream in terms of how far down do we go, do we stay pretty much at the production and maybe wholesale distribution like we do today with ammonia or do we play a different role in the overall supply chain. So I think that, we're still in a number of discussions with different potential partners around what that might look like. And I think it might very much depend upon the application in terms of the role that we would play.

Yes. I kind wanted to get into sort of that interplay between sort of what you think your cost profile is going to be and how do you think that stacks up to others versus your sort of being landed here in the U.S., having the logistics infrastructure versus others that may want to be making product somewhere else and bringing it to the U.S. And why are you in the U.S. versus, you have a U.K. asset, it's very close to Europe, which was a little bit more advanced in the U.S. So how did you weigh all those different features in making this initial decision?

Yes. So one of the commitments that we made was 25% reduction in our carbon footprint by 2030 and to be net 0 carbon by 2050. And so the way I would look at this first plant at Donaldsonville is the first of a long string of many projects. And so for us, the issue is, let's make sure we can kind of walk before we try to run. We've got the best technical expertise in the company at Donaldsonville. It's the largest facility. We just recently completed the huge expansion project that we had going down there. And so we've got a lot of people on the ground that are very familiar with kind of construction and plant build out and how to tie in to an existing operation. We did a DEF, diesel exhaust fluid expansion down there, along with the nitric acid expansion down there. And so our ability to execute this project on time, on budget without disrupting current operations is very high in Donaldsonville, and we wanted to make sure we got the learning in a place that it was easiest to do. But our view is absolutely to roll this out. And in fact, the U.K. does offer a number of advantages for us as well. There are not only, as you said, with Europe and the U.K. being more advanced in terms of carbon regs than the U.S. is, but also access to a higher percentage of renewable power in the U.K. and easy tie-in to the national grid, where we've got those access points at our facilities, make the U.K. a very logical place for us to look at these kind of projects as well.

Okay. And then just looking at the cost footprint at Donaldsonville. How will that start with the first project versus as we look out over the next 5, 10 years and you've scaled this up? Presumably, the incremental cash investment goes down, so the returns, all else equal, go up. Will you start to see a cost benefit as well?

Yes. So the initial investment is about $100 million for, call it, 20,000 tons a year. Subsequent investments, we should say probably about between 25% and 30% of the capital cost in terms of being able to reuse existing infrastructure. And our expectation is based on what the energy efficiency of the electrolyzers has been from a trajectory standpoint. We'll go ahead and continue to get more and more efficient as we go, and so the up cost benefit should increase as well, meaning that the differential between green ammonia and conventional and produced or blue ammonia should continue to compress over time.

Okay. And then maybe it sounds like this is maybe an early question, but when you think about the customers and the target markets that you're looking at, there's a lot of focus on transportation, commercial vehicle. Some folks talk about marine. Where do you envision your product going? And what are the different types of conversations that you're having now with potential customers or in potential end markets?

Yes. So direct application of ammonia as a fuel, there's 2 that are kind of, I think, ready today or almost today, and the first one is in marine application because the conversion from a -- some of the internal combustion engines to be able to burn ammonia instead of conventional hydrocarbon fuel is relatively understood and it's an easy migration path, and that makes those vessels then IMO 2030 and 2050 compliant. In addition to that, there is a power gen segment that is principally in Japan and other parts of Asia. Obviously, in the aftermath of the tragedy of Fukushima, Japan decommissioned their nuclear fleet, and that met a heavy reliance on coal-based electricity generation. They're trying very hard to get away from that, and being able to inject ammonia as part of that process is a way to do it. And so that's a ready demand that we think could exceed 2 million tons a year here ramping up very quickly. So initially, I think it's probably headed to Japan. But we've also seen certain municipalities and others in California and other places really look hard at buses and transport and infrastructure that would be hydrogen-powered. So our belief is this is only going to accelerate, and there's a real advantage to being at the front end of it.

Okay. And so from Donaldsonville to Japan, how do we get there? And when is it going on?

Bert, do you want to talk about our logistics capabilities?

Well, globally, we're already an active participant in many markets. A few years ago, we exported to 26 countries, all different -- all of the products that we produce. Ammonia, specifically, has already moved in a small scale from Saudi Arabia to Japan. But like Tony said, the vessels that are being tested to use ammonia's fuel, but then you would just take ammonia in its current state, which is you have kind of small coasters up to large handy-sized vessels for ammonia that will be moving around the world. The ports exists, the production exists, the ability to offload it. And so tying some of these facilities in for full-scale use is more of like building out the pipeline network at a destination.

Okay. I think the important thing is there's over 120 seaports globally that already handle shipment and receipt of ammonia, and so that infrastructure already exists. And in Donaldsonville alone, we've got several docks that we can use to load those should go in ammonia vessels. And, as Bert said, we export it currently.

Okay. And just when we think about the big picture strategy, clearly, you're planning your flag. You're making a statement. You're moving the company in a direction, and that's both for us to understand, it's both for the rest of the world to understand as this industry builds out. But when we think about getting bigger and bigger in this, do we think about greenfields? Do we think about this evolving to kind of take-or-pay contracts and industrial gas-type business model where you're not going to put money in -- big money in the ground until you've got the back end already tied up and you've got a return lock in? Like some of the things you've done, you have an agreement with Orica. You have an agreement with Mosaic and probably one other folks that I'm forgetting about where you have type of locked in return agreements. Do you envision transitioning this type of business in that direction? Or do you think it's going to stay more of a merchant price depends on the market type business?

Yes. I mean, I think you'll see part of the market go the direction of long-term indexed kind of take-or-pay relationships like you're talking about. I think other pieces may end up being more fluid and market-based. Our expectation is that based on the developing demand for hydrogen, we believe that low carbon or green ammonia demand could easily exceed what the global consumption of ammonia is today, not cannibalizing existing ammonia production and demand, which is about 180 million tons annually. We think low-carbon, energy-sourced ammonia could easily be at that level or above, and so that's going to necessitate greenfield plants going in. There just doesn't enough capacity globally to be able to meet both needs. And as a result, I think we're in a prime position to participate in that. How much of that gets done on sort of spec in terms of market pricing versus committed volume? I think we'll have to see, and that will play out over time. But I certainly think that there's a big piece of the market, particularly that tied to electricity generation and clean power that is ripe for being back-to-back in terms of a take-or-pay off-take kind of deal.

Yes. Maybe the only thing I would add to that, as Tony mentioned, is this industry is developing here. We have plenty of avenues early on here, both through green with our 17 ammonia plants that we have and then also the blue aspect, the low carbon with the amount that we can sequester, the amount of low-carbon ammonia we'd have there that, as the market develops, we're going to know when we want to enter in with significantly more capital rather than doing that right away.

And I think what you've seen from CF over the years, as we kind of stay in our lane, we know we're good at, we're the safest, best producers of the products that we produce. We're partnering with those who we believe are good channel partners for the next step in whatever direction we've gone, whether that's industrial, ag or exports. And each one of those, we pulled people in that have benefited us, and they have then brought their expertise to the table. We envision the same thing taking place with this venture.

And then maybe I think you've referenced that you could transition 1/3 of your ammonia production to green without impacting your upgraded products. Is that just a limitation on not wanting to disturb the upgraded fertilizer product business? Or do we envision ourselves in a situation where the world's going to have to compete for your ammonia, whether it goes into urea or UAN or whether it goes into a green ammonia application? Or is there a hard stop at the third for structural reason?

No. There's not a hard stop at the third. The third is kind of the amount of CO2 that we currently capture that's processed gas that we end up venting because there's no other use for it, whether it's upgrading to urea or selling it to folks that buy compressed CO2, so we end up venting that. And therefore, the third is very much just you take the amount that we're currently venting to atmosphere, you find geological sequestration for it. It does not affect the slate of upgraded products that we currently produce. And we envision the fact that, over time, we will need to build new ammonia production. Most of that production, I think, will be very much green or tied directly with carbon sequestration projects. So I certainly think that there's a possibility, as you go over time, that there might be a push and pull with respect to energy markets versus the ag market in terms of where demand is for the product. But I also think that, particularly given a more climate-focused regime in Washington, you may likely see carbon sequestration credits going to growers for the carbon that gets sequestered into the soil based on the crops that are grown and the inputs that are used and the farming practices that are that involved. And in that situation, using a lower carbon input, like a green ammonia or blue ammonia, could easily result in a very economic decision for a grower to be willing to pay quite a bit more for that product, assuming that there is some credits that come their way.

Okay. And maybe just to close off on this, when we think about sort of use of capital going forward, I'm pretty sure the message was committed to the dividend. But cash flow after sort of regular CapEx -- maintenance CapEx, and after paying the dividend is largely going to be going towards these initiatives going forward. Is that correct?

Yes. Again, I think we want to walk before we run on here, and the first installment is not a huge bite. But I'm excited of the fact that we do have a path in front of us where we can deploy a lot of capital with really attractive returns. And I think that continues to scale up and get better with each subsequent iteration of this. So if you're asking are we pulling back from buybacks, I would say that's probably not top priority today given what we believe is a very attractive slate of investments back into our own business.

Yes. And I guess, what I'm asking is just you've got the initial commitment that's within the existing CapEx framework. And you obviously can generate more cash than that over the next 12 months. So should we just anticipate that cash building until you find another alternative use for it within the green construct? Or is there a transition away from buybacks towards green that will take place over the next year or 2? You have debt to pay down as well, but...

Yes. The other -- as you said, the other priority for us is to get back to investment grade, and we've committed to taking out $250 million of notes that come due at the end of next year, so there's that chunk of cash that's already been earmarked. But I do think that there's going to be then a suite of additional projects that we'll be able to look at, whether it is partner with someone and go that direction, whether it's basically rent access on an existing pipeline and pay a little bit of higher op cost, but no capital versus putting in capital investment on our own and paying lower op cost at the back end. And those are purely just economic decisions on lease versus buy and partnering and so forth. So as Chris and Bert talked about, we're in a number of discussions with different folks, looking at all the different options, so some of which are going to be more capital-intensive, some of which are going to be a lot less capital intensive. And I think, at the end of the day, it's just going to be whatever we believe the best economic return for the shareholder is certainly going to be, it's going to drive us one way or another.