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

All right. Thank you, and good morning, everyone. My name is Adam Samuelson. I'm the agribusiness and packaging analyst here at Goldman Sachs. I'm very happy to continue our Goldman Sachs Industrials and Materials Conference this morning with CF Industries. And we've got the whole team. So we've got Tony Will, their President and CEO; Chris Bohn, their Chief Financial Officer; Bert Frost, their Senior Vice President of Sales, Market Development and Supply Chain; and Martin Jarosick, who heads up their Investor Relations effort.

So we are going to solicit questions from the audience on the web. There should be a box in your webcast window, please do type questions, and they'll come to me. And we'll get to those as we go through our conversation. But I think we're just going to dive right into questions for everybody here. And so maybe I'll start with just to Tony, Bert, maybe just a high level, just let's talk about the spring. I mean plantings' about 2/3 complete. How is the nitrogen market looking out there in the Midwest?

It's been robust. We've seen an amazing start to 2021 with the price increases that came through in the first quarter. And what's a pleasant surprise is how that trend has continued into the second quarter and will probably be through the majority of the year. There's a lot of strength with where we are with supply and demand. But where planting has been and is gone, it's been very fast. A lot of nutrients have been going down, high demand for our products. When you have $7 corn, and there's just the opportunity to incrementally apply fertilizer for an additional yield, especially when the pivot run hits in the next month or so, you're going to see, I think, this demand trend continuing well into Q3. And that's exciting for us. It's been several years since we've had this kind of market where the whole grain and oil seed sector is strong, the pricing are strong, so farmers are happy. And that's just going through the value chain in a very positive way.

And I would just add to that, Adam, that not only are we seeing really robust demand and good pricing for the growers, but also given where energy spreads are, particularly in the Europe and parts of Asia, the cost curve is much steeper than it's been in recent memory. And so you've got strong demand, at the same time, the high-cost producers need a very high price in order to be able to operate, and that sets up really well for us.

That's great. So maybe let's just -- let's get through the kind of near-term kind of discussion a little bit and thinking about that domestic season. I mean, what are you -- from what you -- from the volumes that you're pulling from your contacts with your retailers and distributors, how does that -- what's the implication of that for corn acreage? And how do we think about the duration of that prolonged spring as we move into top dress, as we move into June and prolonging into the third quarter?

Yes. So officially, we're in the 90 million to 91 million acres of corn. We believe that with a positive incentive as being sent from the market for corn, it's over $7. You're going to see incremental acres coming in, especially as we move North, and applications are going today in the North Dakota, Minnesota range as well as into Canada and heavy use of ammonia, which signals additional either corn or canola acres, both are at very high prices. And so for the spring, on the demand side, I think that's what trends us forward. And as you look out into 2021, '22 and '23 with corn at $7, $6 and $5, a trend we haven't seen in over 10 years. And so there is ample opportunity for farmers to hedge forward their grain and buying their inputs. And then it gets to the demand side of the equation, that drives the demand side. The supply side is a little bit trickier because of what happened in the freeze offs of February, there was a supply hit to the North American production base, ourselves included. And then when you look at kind of all the roll-offs of what that meant, we think you're going to be in a very tight market and probably shortages in some places as we roll out of Q2. And so there'll be an empty inventory in the back half of the year that -- something else we haven't seen in quite a while, which we think sustains a positive pricing environment well into 2022.

Well, and I think the other thing that adds to the positive pricing environment is that 90 million to 91 million acres of corn, you can't make up the deficit in terms of where stocks [indiscernible] a on a global basis right now. And so it's not like we're looking at 98 million, 100 million acres. So we see this clearly running not only through next year, but into '23. And I think that's where the market is sending price signals as well. And given where the strength of beans are from price, you're not going to see huge rotation directly out. I think both corn and beans are going to be competing for acres, which is really great for our business.

Actually, all the nitrogen-consuming crops, wheat, cotton, canola, sugar are all in very good shape.

And -- clearly. And so in that context, as we think about especially the winter storm and how that's disrupted the planning for the U.S. season, for the U.S. industry. How does that cascade into the different products for ammonia, urea, UAN, there was one of the ammonia industry, one of your new plants that is still offline in an update last week. How do we think about that impacting U.S. inventories as we go through the rest of the summer into the fall?

I think inventories are going to be at historical lows trending into Q3. We saw the impact on ammonia with the different operating plants that did go offline and the difficulties of some of those plants to come back online. So 1 week, in many instances, turn into 3 weeks and suboptimal performance. And then even before the freeze off, many of the Gulf Coast plants have been offline. You can name different names. And that just further tightened up the industrial market. And so you're seeing a very robust time frame here for the ag side as well as the industrial side, and it's going to take a while to replenish those inventories.

And I think that's true globally as well. So if you looked at last year, when the energy prices were low everywhere, you saw almost historic high operating rates and just excess abundance of supply. And any time you follow a very high operating rate year, you're going to typically end up with more both planned and unplanned maintenance next year. So not only have we seen shutdowns and operating challenges for some domestic producers. I think that's the theme globally, which is also helping the whole situation of it. It's a tight supply chain, not just here but everywhere.

Yes, I was just going to add, additionally to what happened here in North America, Asia had very cold weather in January, which saw a lot of their plants go off. And as Tony mentioned, a lot of what happened last year with COVID, you saw a transition of those turnarounds into this year, which is just going to tighten the market even more so from a supply standpoint.

All right. No, that's really helpful. So maybe bringing that conversation to the global market. And Tony, you alluded to this already, the cost curve is steeper. How do you see the cost curve sitting today? And how do you -- how is that -- your view on that for the next 6, 12, 24 months kind of...

I'll start and then Tony and Bert can maybe add into it. But I think what we've seen is, as Tony mentioned, the Eastern Europeans and some of the other European producers who were producing last year at really full capacity because TTF was right on top of Henry Hub. That has now changed significantly where you're seeing European energy at about $8 per MMBtu plus. So as a result of that, you're starting to see lower production rates there. And one of the things you're seeing is actually the European producers have probably become the marginal producers in this particular spot market. So they're very similar to China. So when you add in additional freight costs that are going on now, a strengthening currency or a weakening dollar, I should say, and also just higher energy spreads, you're probably adding $30 to $50 on top of what the cost curve looked like just 6 months ago.

Got it. Got it. So as we sit here today then, either it's Eastern European or Chinese, how do you -- where do you think their kind of FOB export prices are from a cost curve perspective?

I'll just tell you from a market perspective, the cost curve is what it is. But the behavior with the recent India tender was, you had some low offerings that weren't accepted by some of the bidders. And so it was expected to be at 1 million to 1.5 million tons of supply coming to India during the month of May and early June, they're only going to get less than 600,000 tons. And they're going to have to rebid possibly as early as next week because many of those high-cost producers that would have participated and would have supplied maybe an additional 0.5 million tons, didn't. And so those tons are not moving to the ports, those tons are not ready for exports. So that just kicks forward the opportunity in the positive price environment that we have. And those tons, as Chris said, for the cost curve have to be bid into the market.

I think that's an important point is that we're in a more demand-driven market now. So while the supply curve has moved up or we're over and above that because a lot of the supply issues we talked about when that deferred turnarounds from last year or some of the weather events that occurred in Asia and in North America this year.

But I think the other benefit that we have, Adam, really, is that because nitrogen is a variable cost business and not a high fixed cost component that we don't anticipate, given, as Chris said, the very steep energy differential, we don't anticipate there being a substantial reset in terms of price because what you'd see just like what we're seeing right now in Eastern Europe is a turndown on the supply side, if that were to happen. So it sets us up really well for the back half of the year, not only our crop prices very high and demand expected to be there, but you've also got a steeper energy curve. And that puts a floor underneath pricing for us. So we're looking at a really positive environment.

And is that -- any differences in that discussion? Or think about ammonia and UAN, which obviously have slightly different kind of regional supply and demand kind of different dynamics and how you see those prices and for those products developing?

I'll start with ammonia first. And I think what Chris laid out with the situation we're seeing globally on costs, whether that's gas to Asia, gas to Europe, you're going to see those plants that have the opportunity to purchase ammonia, and they have done this, purchase in some of their -- or all of their ammonia for operating, which has tightened up the ammonia market, which is a great position for us, our industrial book as well as just going forward for the pricing structure for agriculture. And so a year today in the $500 range, whereas 6, 8 months ago, we were in the $220 range, so almost a doubling of ammonia values with good demand supported globally. For urea, we've already gone through kind of where we are. We're ending our season in about a month for urea, and then we transition to the full time, as we said, with very low inventories. And again, with the cost structure currently in place by the cost curve, you're going to see prices at least today maintain above that $300 price position on a short ton. So let's say, $330 to $350 globally, and that's what's currently trading today for June on an FOB basis is $350-ish. And so that equates to a fairly high number into [indiscernible] or some of the demand-driven markets. So then you have to look at UAN, and we believe UAN will also have very low inventories coming out of Q2. And then that starts the fill season, where we have the tanks of our own as well as customer tanks throughout North America as well as other markets we ship to. And you're going to have to fill those in time for next year, which we expect to be a heavy demand here, again, based on the corn wheat and cotton price structures. So if you take some of your ammonia or ammonia and urea values and just for a nutrient value, you can divide those out and get to a fairly healthy UAN number for fill.

That makes sense. So maybe shifting a little bit longer term. And it ties into capital allocation, but I specifically want to first talk about the green/blue ammonia strategy and the opportunities around hydrogen. What -- why do you think CF is so uniquely positioned to satisfy kind of the opportunity here? What gives you -- why is this your -- the right path for the company in terms of your capital allocation, your asset base? Help us frame kind of where you think the future is here?

Yes. I think it comes down to several things. One of which is the locations of a number of our plants are in places where the subsurface geology is appropriate to do carbon sequestration and that sets us up for being able to produce blue ammonia or net carbon zero ammonia, which really is the same as conventional ammonia where you're capturing the CO2 process gas and injecting it back in the geological sequestration. And the overall cost of that when you include the federal tax credits is very comparable to just conventional ammonia. So on the cost structure side, it's roughly equivalent, and we believe there is going to be a premium placed in the demand side. The second issue really is because of the locations of our plants, we're in a position where we can export to international destinations as well as hit all of the major consumption regions and within the U.S. And then third, really is the scale of our network and our distribution platform allows us to make commitments and to have redundancy and backup supply and different points of storage and ship from, so that we can offer guaranteed delivery, which are critically important for certain industrial kind of customers that other people just really can't match. So I think it's that combination of things that make us uniquely suited to really rise to the top in this area. And we certainly expect, at least with respect to blue ammonia, that you would see traded values of conventional ammonia plus wherever carbon is trading in those local markets. Now unfortunately, the U.S., it does not have a mature sort of structured carbon market yet. We're hopeful that as part of the Biden administration's commitment to reduce emissions by 50% by 2030 that along with that goes, both the carried and the stick program because I think putting a higher price on carbon, helps people get there faster and also puts a higher demand profile on low carbon alternatives. But within Canada and the U.K., where we also have access to developing carbon sequestration programs in both of those areas, there is a much higher cost on carbon that provides real economic incentive and should provide a terrific opportunity for us.

So I actually was going to get to my next question, which is what -- you've introduced the strategy and kind of opportunity set last year, you sounded very optimistic and bullish on it and CF's position and capability to capture it. The investments to date have been more modest. And I guess, what has to -- what really has to change from a policy perspective, both domestically or abroad, for you to be more aggressive in terms of going after it? Is it just time and technology on the customer part? Or what has to -- where is the bottleneck before you really go after it full bore?

Yes. I mean, I think let's kind of just go region by region. So in the U.K., the government has come out and put forward significant dollars behind a Net Teesside Zero program for carbon sequestration in the Northeast and Teesside areas where our Billingham facility is located. There's also been money allocated. We've contributed, and the government has matched those funds along with several others to do what's called the HyNet North West project, that's also a carbon sequestration. Our in-facility is part of that program. So what you're seeing is, as governments are moving with real momentum around decarbonization. A lot of these projects are beginning to gain critical mass and speed and technical development. And it really is, as those things begin opening up, we're able to access them. So we're developing our own internal capabilities and requirements around dehydration and compression, commensurate with the ability to inject into some of these locations. And I'd say the same thing that's going on in Louisiana. So there are, what, 6 or 7 Class 6 permits now in or about to be filed in Louisiana to do permanent geological sequestration. We have opportunities in Madison [ and ] Alberta, both for EOR as well as we've been talking to some other folks around just permanent geological sequestration, not EOR and then Oklahoma similarly. So I think what you're seeing the development of the technology and the ability to do permanent sequestration is going kind of hand-in-hand with how we're going after these things. And you're absolutely right, the front end of all of this is engineering feed studies quotes. But the dollars associated with these carbon capture sequestration projects are not huge. Part of the ammonia process already extracts the processed CO2 out of the syngas stream. So we capture that in all of our facilities today already, which means that ammonia production is 2 steps ahead of virtually every other industry out there. And so our focus really is on, again, dehydration and compression to be able to inject it. And we're still very bullish about that and really excited about the progress happening in all of our major manufacturing locations.

And I would just add to that, that component that really resides with CF, the dehydration and compression can be done in a time line that's shorter than what the permitting process is. So the permitting process here in North America, once that begins for the sequestration, we'll be able to match that. And that's really when you'll see blue ammonia take off.

That's really helpful. And there's actually a question that came in from the audience. Just you guys did announce a still fairly small green ammonia project at your Donaldsonville facility recently. Have you -- have there been any additional inquiries from companies who want to JV with you to do something larger or by incremental output. There was also an announcement this morning from Yara and the Japanese customer on this topic. Just help me think about kind of what the inbounds are you're having with customers and potential partners to go after this?

Yes. So there's been a host of inbound inquiries, as you said, a Japanese, particularly on the utility side of things, a number of potential marine propulsion applications and several others. I think for green ammonia, we believe it's really important for us to do this first plant and develop the internal capability and understanding the knowledge that goes along with it. I think the challenge for green ammonia really is the economic proposition is quite a bit higher on the cost front than production of blue ammonias. Again, as we talked about earlier, blue ammonia is very comparable to conventional ammonia. But with green ammonia, you're talking about 2, 3, maybe 4x as high from a production cost just because the energy intensity, the electricity intensity of that process. And so before we go out and continue to replicate and expand our fleet of green ammonia production, we want to make sure that the market is developing in a way that recognizes, appreciates and pays for that incremental premium. And there will be a set of customers for whom green is really important and are willing to pay that premium. And our suspicion is there's going to be an awful lot of customers that when looked at that incremental cost will say, no, blue is just fine for us. And so we're proceeding with both of these, but we don't want to get too far ahead out there with the size and scale of green ammonia investments until we see how the market continues to develop, whereas we're getting daily, if not hourly, inquiries around the blue side.

Got it. That's really helpful. So maybe tying it together then, right? So we talked about how constructive the market outlook is. We talked about the kind of hydrogen strategy and the green and blue ammonia, we're making investments, but more measured for now. Trying to think about kind of the implications for cash flow and cash deployment because you guys, I would think, are going to be generating pretty significant amounts of EBITDA and free cash flow over the next couple of years given the CapEx that you've laid out. So help us think about how that gets deployed. Specifically, on the most recent earnings call, there seems to be a more heightened focus in terms of trying to get back to investment grade. And talk about why? What the value that is to the company going forward? Just from a cost of capital perspective, it doesn't seem that big at this juncture, and we can follow-up from there.

Chris?

Yes, I'll start. So I'll just start with the investment-grade question why we want to get back to investment-grade. I think investment-grade gives us a couple of different benefits that are out there. One, just purely monetarily, we'll probably see about $10 million of frictional costs go away. That being some costs we have to pay because we're not investment-grade with our partnership with CHS, along with letters of credits that we have with some of our bigger suppliers. Once we lost investment-grade, those costs came in. So we'll be able to eliminate that if we return back to investment-grade. Additionally, as Tony mentioned, we're getting a lot of inbound calls, a lot of different partnerships, looking at things. Do we move into partnerships, do we go alone with the whole new low carbon strategy. And based on that being investment-grade allows us a lot more flexibility related to that strategic push from that perspective as well. I think additionally, as we look longer term, and while there's not maybe identified projects today that are significantly greater from a CapEx standpoint, having that dry powder with lower debt, giving us some access to that later on, whether it be through acquisitions or whether it be through organic growth, provides value as well. I think given what you said, though, with the amount of significant free cash flow we're going to generate, we can do a lot of things. We can continue to do our growth platform. We can reduce some of our debt to get to investment-grade. We believe our metrics are there right now already, but to make that final push. And we think we'll have opportunities to do share repurchases. I would say the difference is a little bit that maybe we'll be more opportunistic at what price points we go in rather than what we've done over the last several years, which is more ratable purchases from that standpoint. But I think we're in a great shape, given the market environment, Tony and Bert have laid out here, that we'll see significant cash flow to do all 3 of those.

Okay. And so in that vein, then if -- I mean, there is funds for cap for repurchases, but I desire to be more opportunistic. I mean, how do we think about how much cash you're willing to let sit on the balance sheet because it would seem that it could pile up reasonably quickly. I mean, I'm just trying to get a sense and make sure people are readjusted and prepared if the cash balance does rise for a period of time.

Yes. I mean, I think we're certainly willing to let more accumulate than we have historically thought about letting accumulate. As Chris said, as we think about further debt reduction opportunities, we've got $750 million coming due in 2023. That would probably be the logical tranche to begin taking out. But again, we want to leave ourselves ample opportunity to be opportunistic or different things that could develop, whether they be share repurchases, some capital projects that we're thinking about and/or acquisitions. So you'll probably see us grow our cash balance to levels we haven't been at historically.

Great. Okay. I have a question that came in from the audience, coming back to the blue/green ammonia kind of topic. And just thinking about how increased demand for those products, how does that impact the global -- the demand for the global ammonia market over the next few years? Does that create opportunities? Does that create challenges? Just how do you think about the mix shift and what that does over time?

Yes. I mean I think that's one of the things from our perspective that's very exciting about the development of the hydrogen economy and ammonia's roll in that, which is kind of any demand that pulls existing production of ammonia into a new avenue does create absolute growth and all boats float, which is -- I was getting questions a couple of months ago around how do we view, [ if someone says ] announcement of a green project or a blue project. And my perspective is, I think that's great. I think the more supply that's available, the more demand that can develop kind of commensurate with the availability of supply. And again, in the notion of all boats float in a rising tide, I think the more that all of the participants can decarbonize their network, can do their part for climate change and can make product available to help develop demand, is good for all of us. So I think what you'll eventually see is a requirement to build more production out there.

Okay. I got another question that came in from the webcast, and it comes back to something you discussed on the earnings call around a possible UAN antidumping case following kind of what happened in the phosphate industry with Mosaic. Can you talk about how seriously, you're looking at this? Kind of if you're looking at it, why haven't you pursued it already? Just help us think about how -- about the approach and what could really happen here?

So when you look at the UAN market and where we are and where we are on imports, there clearly has been a push that drove prices much lower than they should have been. And historically, where UAN has been over the last couple of years at a differential -- negative differential to the other products based on that high level of imports. And what we found with the Mosaic case, you're correct is that they were based on subsidized gas. So we're investigating that. We're investigating kind of our situation and more to come.

Okay. And then another question, just thinking about kind of COVID and the aftereffects that obviously hit the industrial nitrogen market quite hard in 2020 on top of impacting the cost curve. It seems like we're on the other side of that from a cost curve perspective, but also from a demand perspective. How do you see kind of an improvement in recovery in industrial nitrogen demand impacting balances over the next 6 to 12 months?

Yes, your first point, what I say internally is just throw away 2020 because it was such an anomaly for so many reasons with energy spread collapse. And then it was a risk-off position for our customers in the globe. And so that drove an imbalance in the supply-demand position and then drove prices for all the products lower and lower longer than probably they should have been. So 2020 was a tough year. And what happened is as we've had this recovery and it's across the board for industries, industrial products, as you mentioned, but as well as just demand for feed grains, oilseeds and then protein, every aspect for freight, every aspect of our business is positively impacted, and you're seeing that in the resulting price structure. And so today, we have high demand for our industrial products for explosives, for resins, for fibers and for as just a feedstock as ammonia. So that is a very healthy, supportive part of our business that we think it will obviously trend forward into 2022, just like we believe the agricultural side of the business is on the same trajectory. So it's a nice place to be.

Okay. All right. That's really helpful. And then there's another question coming from the webcast on China and really thinking about kind of some of the structural changes that have happened there with capacity rationalization over the last several years. Where do you think operating rates in China go from here? Just trying to stay a small net exporter? Or does it -- do you -- could they become a net importer of urea over time?

I mean, I think the operating rate question is a little bit of a -- I would almost say a red hearing because it supposes that the people really understand what the denominator in that equation is in terms of capacity. And I think that's a number that has continued to fluctuate. And to the point that you raised out, it's come down quite a bit in terms of the real capacity that's available to operate compared to where it was 5, 6 years ago. We would anticipate that China wants to continue to be self-sufficient from a urea production standpoint. And we have seen -- although they were on a -- it was called a net zero growth on nitrogen, and there was actually pressure to make it a reduction in nitrogen application. And that's had a corresponding impact on yield, and you've seen then what China has done in the way of the importing soy and corn and other grains. And so our belief is application rates will go back up. We are seeing very strong demand in China, not only on the ag side, but also on the industrial side. And in order to have a healthy kind of self-sufficient industry, there will be times in the year where they'll need to export. So we continue to think somewhere in the 4 million to 6 million tons a year is actually going to be needed coming out of China, just based on where global demand is. Again, you look at the most recent tender coming out of India, and China didn't really participate in any great way in that. And so the world is -- pricing is rising to the level that you will start seeing exports out of China, we believe, in the $4 million to $6 million range. But that's not -- the sky is falling. That's because pricing has risen to the point that it [ incense ] that production to be exported.

Great. Well, look, I think we're just about at the -- at our time limit. So maybe we'll stop there. Bert, Tony, Chris, Martin, thank you all for joining today. Thanks, everybody, for being online. I hope everybody has a good day.

Adam, always a pleasure. Thank you.

All right. Take care, guys.