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

All right. Next up is a fireside chat with CF Industries. Of course, a leading nitrogen producer, which has been generating solid free cash flow through the cycle. We have a full team here from CF today. And so please welcome Tony Will, who's President and CEO; we have Bert Frost, who's the Senior VP of Sales, Market Development and Supply Chain; we have Chris Bohn, who's the CFO; and we have the Investor Relations team as well. [Operator Instructions]

So let's start off with a question, which is CF has been able to generate strong free cash flow throughout the commodity cycle. You've achieved high reliability in the operations over the years. Talk about how you've been able to do that?

Well, I think it's one of those things that doesn't happen overnight. We spend a lot of time. It goes hand in hand really with safety and investment in spare parts and just overall philosophy around asset utilization. And so we're equipped to take a plant down using predictive analytics, as you see vibrations go up for temperature differentials go up or pressure drops go up. And our belief is you take things down instead of run them until they break and then you're able to get them back up more quickly. And overall, you have much better on stream and reliability as a result of that. And I think we've worked really hard over the last 5 years to dramatically reduce our fixed costs so that as we've gone through bottom parts of the cycle, we've still been able to generate pretty significant free cash flow because the charges have come down so much. And then during better parts of the cycle like we're in now, and we see for the next couple of years, that much lower cost structure really pay significant dividends for us because we're able to generate just that much more free cash.

And what do you see as the greatest risk and opportunity for CF over the next 3 years?

Well, I think from an opportunity standpoint, a couple of fold based on where stocks to use are and energy spread differentials, we think that the strong market conditions that we're seeing today is a multiyear phenomenon. This is not a quick flash in the pan. We also think that there will be substantial growth in terms of demand, particularly for ammonia, but for low-carbon products going forward. And I think we're in a really good position to capitalize on a lot of that. On the risk side, I think if certain governments do not take a thoughtful approach around the way they implement carbon regulation and pricing, for instance, if you expose energy-intensive trade-exposed businesses like nitrogen to high type costs associated with carbon reduction but you don't put border adjustment in place, and what you're really doing is setting up a situation where domestic manufacturers are disadvantaged and offshore importers are advantaged and you end up with carbon leakage, which is worse for the planet and the climate overall. And so I think -- and governments have not always done the best job of being thoughtful end to end about what policies are going to translate to. And so that's clearly an area of concern. I would also say, as we look around, we're excited about the potential growth opportunity, but cost of construction for new facilities is very, very high. And despite the fact that North America has very low gas cost and great infrastructure and high demand and is in a net import position, labor costs are so high over here. It's really unlikely to see greenfield expansions or even brownfield expansions in North America as opposed to other parts of the world. So that does create some challenges for us as we think about trying to grow our network, which we're clearly interested in doing. But the cost of construction in the U.S. and in Canada, North America, in general, was very, very high.

Yes. Let's continue that side, I'll probably get into a bit later in the conversation. But you obviously are doing some green projects and the capital intensity of a small project is quite high on a per ton basis, but it's early, and it's starting off this. Is that, now as you think about it, putting a bit of damper on your plans? And what you see could happen if the labor inflation is so expensive in the States, some of the green, blue could end up -- what we're seeing out of the world would end up being more in other parts of the world?

On the -- as you say, the capital intensity per ton is relatively high on this first implementation of the green ammonia, but a lot of that has to do with some common infrastructure that we could leverage if we do subsequent phases of expansion. The construction piece of it is not a huge lever relative to the green plant. The internal componentry and precious metals that are part of the electrolysis system are pretty costly. But the bigger issue, frankly, Joel, on green ammonia is the energy intensity, which means the variable cost piece of it is quite high. And relative to do we see a damper, do we see more opportunity there, it really is a function of how the marketplace develops and demand for green ammonia develops. And I think to the extent that there is ample demand, we stand fully ready to continue to replicate this first project multiple times and meet that demand. But the price point is significantly different between the variable cost component of green ammonia versus blue ammonia.

You definitely have a global footprint, but it's mostly the States, you have a little bit in Alberta and Trinidad and the U.K. Would this inflation environment make you consider investing in some green and blue projects elsewhere?

We continuously look at other opportunities and other geographies. And I think there are certain parts of the world that, from a political risk or state department perspective, would be difficult for us to get our mind around doing business there. But there is big sections of the world that we would be absolutely open to exploring opportunities. Our belief right now is that it's more efficient to be buyers of assets than builders of new greenfield partly because it preserves the SME balance globally and partly because in general, assets trade at a discount to new construction costs. And so right now, anyway, we're more evaluating what potential returns would look like for existing assets as opposed to thinking about doing a greenfield somewhere.

Yes. The other part I would add to that with the blue ammonia, the asset base we have already in place in our network is already removing and capturing CO2. So a large component of the capital that you see with the blue is already existing in place for us. And the incremental capital we would need beyond that isn't all that great. So while, as Tony said, we look at things around the world, from a blue perspective, our asset base here is pretty well primed to move forward in low capital costs.

I mean as you look at ways to be able to charge premium prices for blue and then maybe green, even pushing into new demand and applications is also when I think about the farmers really now trying to give out pressure on them or to really manage carbon and monitor carbon and then figuring out if that's going to be a burden or a benefit for them. And then if it's a benefit, it's how they're going to get monetized being better on carbon. Does the government -- different governments are going to pay them or food or ingredient or energy companies are going to pay them some premium to be more sustainable? How does this all tie together in what you're doing and thinking about?

Well, you're raising a very interesting point about the value chain. And each section of the value chain is participating in their individual areas but as well as the collective. And we've already highlighted where CF has focused on our own carbon capture and how we're going to manage that. And we have different paths in our capability to do that, and we believe we're on a good path. But as you roll through, what that would mean, and let's just take blue ammonia to agriculture and what that could mean for corn, wheat or other products that use ammonia canola and have a zero carbon footprint of the growth of that product. And then you look at yield and the carbon capture you get from bringing carbon from the air into the ground and then different farming management practices that you're right, the farmers should be able to monetize and put together a profile of his inputs, his outputs and the net carbon capture profile and what that is and how that is valuable. And I think that would be a natural way to be monetized and develop a quantitative way of doing that, which we are working on. And we believe that there's steps then -- the next step would be. And then corn used in ethanol, that would be a zero carbon input into the ethanol production. And I think the ethanol groups are working on their own CO2 profiles. And so you can take that and then I'm sure they're working on it from a protein perspective. So there are some exciting things coming from the agriculture that might leave this whole carbon movement, at least be the first adopters as we then move into energy and transportation in later stages.

But I think a little bit of the challenge though is because at least with respect to crop production, all of those benefits are, for the most part, in the voluntary market today. And whether it's quantifiable or semi-quantifiable sequestration in the soil or a reduction in carbon footprint, that's clearly kind of voluntary credits that are being traded, or even if it's food companies that want to put labeling on packaging or others that want to use lower carbon input. That's, again, within the sort of voluntary consumer preference arena. We think that for this to become mainstream and meaningful and impactful to the climate, that you really need a more structured regime from the government around what is considered to be verifiable credits and what's the price of carbon and how that gets traded and monetized. Because once that happens, then I think you'll see a lot more activity in this area.

And then like talk about the dilemma, trying to balance, you want to maintain market leadership in a growing green, blue market over time, but you also have to ensure sufficient return on investment. How do you balance all that?

Yes. I mean our focus has never been market share. Our focus is trying to get the best return on investment possible. We think that we have certain capabilities in the way of running assets that are better than most people or everyone based on our asset utilization and our safety numbers. And so we think we're the logical owners of assets, but that doesn't mean that we're chasing market share just for the sake of market share. And again, it comes back to what I said earlier, which is the cost of construction in the U.S. is -- and Canada is very high. And so even though we would like to expand our network and leverage the assets and the infrastructure we have in place, it's difficult to get there from a return on investment perspective. So as we're thinking about growth and expanding our network, as I said, we're in the buy-and-build approach. It's very much from a rigid philosophy of a disciplined capital philosophy of what is our return on that investment. Can we see accretion to our shareholders? And that's one of the reasons why you haven't seen us announce a lot of deals lately because the math doesn't pen out right now.

And what do you think -- you've got a lot of stuff going at D'ville or starting at D'ville. What do you think like what is the next site that could make the most sense of the second beachhead for all this?

Well, I'd say both Europe/U.K. and Canada are much more structured from a cost of carbon and a trading regime. And so as you think about opportunities for sequestration, be it blue or potentially green ammonia, those locations come top of mind, plus, particularly in the U.K., we've got opportunities for export and movement into the continent. The challenge a little bit is electricity cost over there is so high. And at least for green ammonia, electricity is such a large component of the overall cost structure that makes it a little tough. But fortunately, in both of our facilities in the U.K., both on Teesside and on the Northwest [Audio Gap]

Infra producer ESG panel tomorrow, mid day. Let's talk about the nitrogen markets right now. Obviously been a very strong market. We've got $7 corns, is it the corns? It's been quite a recovery the last year or so. What do your outlook look like right now for the summer and fall markets? And how do they differ by UAN, ammonia and urea?

Yes. So we are in an exciting time, and it's really, again, going back to the value chain analogy. Each section of the value chain is doing well. And that hasn't happened in a while, whether you go all the way to the farmer and you mentioned $7 corn, but each of the feed grains and oil seeds are doing very well price-wise on an economic basis and that's globally. Then you step back to the processor and all the way back to the fertilizer producers. So today, where nitrogen pricing is for urea, it's at an elevated level that we are obviously benefiting from. And you're seeing that globally with a lot of demand from India, Brazil and some of these big consuming markets. And we're going to trend out of our spring application season in North America with very little inventory and the need to replenish that inventory. So a lot of demand support that will continue to lift that price or hold that price and value is now being communicated to the market, whether that be from Egypt, Algeria or the Arab Gulf. For tons that are already being sold for July, show that this current market plans out rather than has a normal drop like we see for the fill season, which is traditionally in Q3. And so if you look at urea on the world market today and equate that to UAN, which is more of a product consumed in North America, Europe and a little bit in South America, you see a very, very healthy price trajectory for 2021 and into 2022, which will be sustained by those grain prices. And so we -- there's not a lot of new capacity coming on. You're not seeing China export inordinate amount of product. You're seeing high demand from these markets that we talked about. And so you've got really, as Tony mentioned earlier, a platform that has multiyear sustainability.

I mean typically, the last few years, you've seen about $100 a ton drop from kind of peak-to-trough pricing, different types of parts of the year. This year is obviously different from a good way. We've seen prices of urea stay up. I'm talking about urea price, of course. Urea prices stay up. And we're seeing India did another tender, just a couple of weeks after the last tender. They seem to -- you guys called this out on your call [ this week ] so they seem to be very hungry for urea. Could we see a very muted decline this year, obviously, to higher lows, but even off the peak, just even a smaller peak to trough than usual?

I think that's where you're heading. When you look at what's in the paper market, what's in the forward market, what's being transacted today, short ton NOLA is about $3 -- $370, $380 a ton, and that is being offered for Q3. And that has been transacted, so there's actually no drop-off. Now over time, you're asking a retail or a wholesale customer to buy that product and hold it over an extended period of time. And so I would expect there to be some level of discount, but not like you've talked about in the past where a substantial level. And again, the inventory is not there in North America. And you need to have the freight movement and the demand movement and the inventory build to be prepared for spring. And this application season is going to extend probably into July just due to the cool, wet weather that we had on the growth cycle and then the further demand for additional application due to the high price level. So we're feeling very confident and comfortable moving into the fill season and the expected price level.

You think we're in an ag supercycle? I mean all we can do is assume weather is normal everywhere going forward. But to get normal weather going forward, like do you think we're in a supercycle? Or do you think we'll see pricing kind of moderate over time, but higher lows than we've seen for cost prices the last 8 years?

I mean I think based on where you're seeing global stocks to use, our expectation is this is not a flash in the pan. We've talked about it. I think we're talking about a multiyear period here in order to replenish overall global stocks. And I think the appetite on the demand side is increasing, particularly as you look at rebuilding the hog population in China and other parts of the world. That is going to consume, I would say, more than what we consumed last year. And so we are certainly looking at a couple of years of what we would say elevated grain prices relative to recent history. And certainly, that portends well for input providers.

We're in a consumption-driven market with a weak dollar and a global issue of, as Tony mentioned, stocks to use, but a global issue of low inventory levels for fertilizer, and now the energy spreads are back in place. So back in place probably to an expanded degree, so -- and then a high freight market. So you have several factors that are moving this market and then you have the psychological impact of inflation, but I think you're going to see this market continue to move or hold and that's across ag, each part of that ag part.

And Joel, along with that, I think we're also seeing a resurgence in industrial demand. I think for the most part, many economies are beginning to come out of the hangover of COVID. And we're seeing increased industrial activity and increased demand for our products going into that channel. So it's not just kind of an ag supercycle, it's robust demand across all facets of our business.

You guys still see me? Maybe not. And I guess no.

Yes, we can hear you.

We can hear you.

We can hear you and we can see your picture.

My internet dropped for the first time in 7 months. That was great. But I'm [ still impacted ] by audio, so we're okay. We'll figure this out. So I got a question from the app and it's basically asking, so applications should extend -- application season should extend, but how long will it last? And how quickly can inventories go back?

Yes. So what you're seeing is when you factor in all of the impacts of what's available to the retailer to supply to the farmer, so domestic production, imports and then it's a calculation of average applications and what -- how can yield be impacted positively or negatively by additional applications. And for the feed grains, in nitrogen, again, if you planted a good time and you've used quality seed and if you're in irrigated or in unirrigated areas, there are options for yield increases on the margin. And it's not a big increase, but it's -- when you factor in all these puts and takes of the losses of the industry in February due to the freeze-offs, the levels of imports and this additional application, we're going to drain inventory. And that allows CF at least to extend the application, the movement time or period to the farm, and we expect that to be well into July. And so with our inventory at low level, we would expect to launch our UAN fill at least probably in August or late July, and the same issue will probably happen for urea. We'll have very little inventory, and we have quite a large capability to store it. If the pricing is right, we will be active in the market. If we believe there are better opportunities going forward, we'll maybe sit and wait a little bit.

Yes. And just to build on that, the one thing Bert mentioned earlier is you did see a lot of turnarounds from 2020 across the globe get pushed into 2021. So some of that supply response is in there like it's been historically. That will tighten things a bit as well.

Yes. I'd say operating rates globally are, this year, are lower than they were last year, partly because of energy costs in high-cost regions. Last year, we were paying less for gas in the U.K. than we were in the U.S. Today, gas in the U.K. is $9 per MMBtu. So I think it's a combination of deferred turnaround activity that is leading to incremental downtime as well as just makeup turnarounds that have to be done now. But also, you're not seeing the same level of operating intensity given where variable costs are. And so for all of those reasons, on the supply side, it's tight, inventory is tight.

My video is back. [ Because last night probably were high in that picture to make a new split. ] Okay. It's going to be a leading question we're going to go. Like when you got UAN duties put on you in Europe, talk about how that changed. How you have to run your business and how you've been able to adapt?

Yes, I'll start off, and then I'll hand it over to Bert. The UAN duties into Europe didn't affect only North American or U.S. producers, that also affected the Russians and the Trinidadians. And so our view of that, it was very much a protectionist move by Europe because their producers were high cost, given where the cost of gas was, and they were really struggling financially. I don't think there is any merit in slapping antidumping duties on U.S. producers because we were getting better price realizations going into Europe than we were going to the East Coast or the West Coast. But what that did is there's only a certain number of markets globally that use UAN as a fertilizer. North America does, Europe in certain areas does. And we're starting to see more development now in South America, but that's been on the increase largely because of what Bert and his team have been doing. And when you take away one of the regions where a lot of production was going into, now all of a sudden, Russian production, which absolutely is subsidized gas can't go into Europe anymore, and it's coming in a big way into the U.S. We've been using the growth in demand in South America to offset that a little bit. But clearly, price realizations over the last few years have come down dramatically in North America as a result of competing against increased imports from Russian producers, subsidized Russian producers. And so at the same time then, what we've done is adjusted our production mix to dial down UAN production and increase granular urea production because the margins make sense to do that.

So what we did is it was a whole relook at our business. So we built the Donaldsonville facility to basically supply the North American needs at the time of that construction. With these additional imports around Russia, as Tony said subsidized, that forced us to do a lot of rethink around that asset base, including some exports to South America, which we've been working on, but we build a nitric acid [Audio Gap]

at least a couple of weeks ago when you talked about looking at the President with the Mosaic countervailing duties case or successful case against PhosAgro and EuroChem from Russia about maybe considering giving us some petition against Russian UAN imports. What is sort of your willingness to pursue that? Where are you in kind of your process?

Yes. I think to the extent that the findings were in the, as you said, the phosphate situation, the gas that went into the ammonia production, that was part of phosphate production was subsidized. And therefore, overall phosphate cost did not represent market-based cost structure. I think if that's true in phosphate, it's more than doubly true in UAN production as well. Because 70% or 80% of the cost structure of UAN is going to be gas as opposed to a much lower percentage in phosphate. And so I think that on the face of it, subsidized Russian gas into producers creates an unleveled playing field. That's not the only criteria that's used to determine whether countervailing duties or other trade remedies are available. There's a lot of other kind of hurdles you have to cross, and it's a pretty data-intensive exercise. And I think the way I would talk about this is, I'm going to borrow a line from Joc actually who said, "We didn't make the determination that it was or not. We were basically throwing the red flag to the officials in New York, or in this case, Washington, D.C. and asking for a review, a factual review of the circumstances and let kind of the chips fall where they may, but we were just highlighting the fact that there was a problem." And I think that, that's very much our position, which is we're trying to evaluate whether or not that the comprehensive data when looked at reflects what we would say, a situation that needs to be reviewed. But we don't want to be frivolous about it, and we're mindful of kind of all of the hurdles that have to exist in order to be successful. So we're in that process.

Okay. That's really helpful. And since you came out with those thoughts, did you hear any feedback from various stakeholders related interest party?

I think in these instances, it's -- let's see what happens. This is a process. As Tony said, we're still evaluating what our position is and how this will unfold. So I think it's too early to have that type of feedback.

One question I'm getting a lot the last couple of weeks is sort of the Iran question, if more -- if it's easier to get product out of Iran in various commodities. What is -- so what is your view? You talked about kind of balanced supply/demand dynamic for nitrogen going forward. I think you said earlier, I think that's your view. If Iran get some handcuffs off in terms of being able to export more, what could that mean for the urea markets?

Yes. I mean realistically, whether it was Iran shipping to China to be unloaded and reloaded and re-exported as Chinese product or whether it was direct barber to Brazil or into India. The fact of the matter is that the Iranian plants were running, and that product was finding its way into the global marketplace anyway. I think the one area where maybe you'd see some slight uptick is access to technical resources and expertise and probably spare parts that may have been a little bit more constrained for the Iranian producers historically than it would be if those sanctions were dropped. But I think that, that's a relatively small piece of the overall production story. And so I don't view whether the sanctions are there or aren't there as being a major change in the overall S&D balance on urea. In fact, in some ways, the fact that they have to discount that product to get it out in the marketplace, muddies the water a little bit with respect to what true economics are around globally traded urea. And as the sanctions come off and they're able to realize full value, I think it actually tightens up the market from the standpoint of price signaling, and you don't get this sloppiness kind of discounted product floating around.

I agree, right. And that is the point that's been going into the market, where the 3 flag becomes Chinese. So I think your next part of the question on the global S&B, we are in a surprisingly balanced market. And Chris's earlier point on turnarounds or Tony's on energy spreads or the freeze-offs, if there are any number of issues, but the net effect is we are tight everywhere and it's going to take a while to rebuild those at least fertilizer stocks and very positive market.

So look, I've asked this -- we have a couple of left. Look, I have asked this question of the people in this room every year, probably at this event. It feels like this year is a bit different. The question is sort of like nitrogen demand down the road as nitrogen demand get crimped by things like precision ag, nutrient management program systems. Now with carbon management being more in focus, so maybe there being a time lag into more blue and green nitrogen products are available, like do you -- is there any concern that we see a push to be to really conserve nitrogen and use digital tools, other things and to help that way?

Yes. I mean I think if you track over time, there has been ongoing improvements in nitrogen and nutrient use efficiency in terms of per bushel of yield. And that is a trend that we think is continuing. And I will say,that the improvements are beginning to slow down and becoming more asymptotic. And at some point, you hit kind of a theoretical limit of 100% uptake by the plant. You can't do better than that. But since nitrogen is the energy source of the plant, and actually, your nutrient use efficiency is pretty darn good, so your environmental losses are pretty low. You're getting near kind of theoretical limitations on that. And if you see a reduction in nitrogen, you're going to see a corresponding reduction in yield. And the fact of the matter is one of the best things we have going for us is the population of the planet continues to increase, and people continue to enjoy a better diet. And so as a result of that, we think we've got a very sort of sustainable growth pattern around demand for our product into industrial app or into agricultural applications. And then again, the more people that are on the planet, the more requirements there are for industrial goods that get made, whether it's fibers or emissions abatement to our mining for metals, all of those things require nitrogen in one form or another. And again, that is good for our business. So we think that despite the fact that, as Bert characterized it, we're in a kind of a tight supply situation, we think demand for nitrogen is going to continue to increase, not only from traditional sources, but also in clean energy sources and low-carbon sources. And all of that's going to mean that more new plants are going to be required to be built, which again is great news for us because if you can incent an appropriate economic return on new capital that meets existing plants, look really good.

Hey, Tony, thank you very much. We'll see on our ESG panel tomorrow. Thank you, Chris. Thank you, Bert. Thank you, Martin and Casey as well on the background of your conference.

Great. Thank you.

Thanks all.

Good.