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

Thank you, and welcome back, everyone. Our next fireside chat is with CF Industries. And with us today from CF are Chris Bohn, Chief Financial Officer; Bert Frost, Head of Sales and Marketing development; and Martin Jarosick from investment -- sorry, from Investor Relations. Before we get started, I have to remind you that for important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative, and they can help you further. I'd also like to ask you to submit your questions in the question box on the web browser. You should see it right there in the lower part of the browser and don't hesitate to ask. We will ask them anonymously. And the sooner you put them in the better because sometimes there can be a lag in getting them to us. So with that out of the way, we get with the fireside chat. Gentlemen, good morning. Thank you for joining us. I had the pleasure of being with all 3 of these guys yesterday in our New York headquarters, where we did some live meetings for the first day of the conference, which was great. It's great to see everybody in person. So now we're going to test out whether it's better to be in person or better to be on Zoom. And we can all vote afterwards. But thank you for joining us again today. Appreciate it.

Why don't we just dig right in? There's obviously a tremendous amount going on globally in the nitrogen space. A lot of things have happened. I'd like to start with what's going on with the cost curve because I think that's probably where we're seeing structural change that I think is really worth digging into. And we can look at the gas market, we can look at the coal markets, whether it's Europe, whether it's Asia, there's been a lot of movement. And so maybe you could just sort of walk us through sort of what's transitioned. And obviously, we've had fly up in prices and beginning to see some reversion. But the curve unequivocally has steepened. And so maybe you could just sort of bridge where we were, where we've gotten to and where you kind of think we'll settle out as we move through probably next year and into 2023.

Do you want to take that?

Let me take the...

Do you want to take the cost curve? Or...

Yes. So the biggest impact on the cost curve has been the increase in natural gas prices and coal prices. But the shift of the gas-based producers to being on the high side of the cost curve in Europe and Asia has really steepened the curve. We've seen some modest -- relatively modest increases here in North America, but nothing compared to the $25 to $30 per MMBtu natural gas prices that impacted Asia and Europe and caused a lot of production to shut down. And in China, you've had a lot of tightness in coal and resulting increase in coal prices there. And then when you add on to that kind of supply restriction, just from the cost of energy, then the cost of freight has moved up materially. So that's stacking on top of that. And now you're seeing supply constraints out of some of the exporting regions, China, Russia and Egypt that are restricting supply and really pushing prices to pretty high levels.

So when we think about sort of where the pressure points are in the system, on the cost side equation, I think for a number of years, we were talking about that, anthracite coal producers, the marginal exporter, and those tons would either be bid or not bid into the market at different times of the year as seasonal demand played out. But demand's obviously are very strong right now. And so how are you assessing where the marginal ton is coming from? Or is it just a situation where we're in a sold-out position, so everyone's got to participate? And now we're seeing tons being pulled off the market, whether it's in China with the lack of exports, the recent announcements in Russia, in Egypt as well. But what's actually driving and setting the price right now?

You have so many constraints and here, it's the latter, where we are now in a supply-driven market where a lack of supply, a few nationalistic moves, as Martin mentioned, being China, Russia and Egypt to take tons off the market and then the further exacerbated by the gas limitations in Europe where 11 million tons of ammonia are off-line. Now some of those will come back up or probably, at least by spring, will come up. So it's not an annualized impact, but 1 million tons a month in October and November are taken off the market. So as that supply has been limited, demand is still continue to march forward. You can see that in India and Brazil and in the United States with bidding up different values and vessels as the supply has moved one direction, we've had to have a whole supply shift on the demand which normally isn't supplied by certain supplying areas. So let's say, North Africa has traditionally gone to South America or to North America and some to Europe is now needs to go almost all to Europe to cover that shortfall, and that's created in shorts in other locations. So we're in the middle of the storm you see right now. And so what have you seen, prices rapidly increase at pace of -- at times, $100 per week, something we have never seen. So you're now at $900 a short ton in NOLA for the United States. India is going to pay $950 to $1,000 a ton in this tender coming up. And that's just a bidding process for those tons to make it to market. And you have some countries that probably will have an inability or a lack of supply in their peak demand season, at least into 2022.

Yes. So maybe let's walk through that. So we're obviously in the fall application season here in the U.S. and a lot of those tons that the farmers are working with now, they've been purchased over the preceding months at sort of the run-up of prices, but not so much at the spot price and the availability for fall seems good. How do we see that in other areas? You referenced India continuing to tender. They're obviously a net import region. Their imports year-to-date have been running behind probably where they would want them to be. And now things have gotten a bit perilous in terms of where they can get supply from with China not exporting a very traditionally large supplier in there. So as we go through the end of the fall application season and the U.S. is trying to stock up for spring and you had India tendering. So this tug of war, how is it going to play out? And we're also seeing the same dynamic as South America trying to pull in as they get ready for safrinha and so forth.

Well, that's exactly what's happening. And so your 3 largest import markets being India, Brazil and the United States. Last year, India imported 10 million tons. They have not been able to increase their domestic production because much of that is purchasing international gas at $25 to $30 a level, and they are probably 3 million to 4 million tons short. And that's why you see them tendering now, if not once, but twice a month. And so they're bidding those tons in. It looks like they will increase but they already have increased their subsidy budget. So they will be buying those tons. And we expect them to be tendering now every month into next year. Brazil is the second largest import market. But if you combine that with Argentina, it clearly is the second largest. Consumption there is up 15% year-on-year, and we expect that to continue. The values for domestic farmer in Mato Grosso is still positive even at these levels of urea. And because safrinha is a second crop corn is more of a cover crop. They need to plant it. They will plant it, but they will do that initial fertilization. So we see consumption maintaining its current pace in those 2 countries in South America, and then you come to the United States. We're about a 5 million ton importer, and we're continuing at pace. You're right. If you're a retailer, you've got blended cost all the way from $450 now to $800 in your warehouse, you probably sold much of that down for spring. The fall application for CF on nitrogen is ammonia, and we've seen substantial -- as a matter of fact, this will be probably a 10-year record of fall application weather permitting. And so farmers have stepped up. Those are cheaper priced tons sold in July. They will go down on the field. And then it moves to spring. We're already taking orders for spring, Q1 movement at these levels that you're seeing in the market. So we're seeing healthy demand in those 3 large markets. And so I don't think this -- again, if the supply situation probably does not settle itself out until mid-2022, if then, and the demand side of the equation is just demand deferral, there you need to apply nitrogen or we're going to have a feed grains shortage being wheat, corn, cotton and sugar on the food stuff side, which then extends us out on the stocks to use ratio. So it's a -- we're watching this very, very closely in terms of our production staying up and running at full speed. That's why we brought one of our turnarounds forward. We're preparing for this kind of market, and we'll execute against it.

So you referenced sort of the 3 top importers. It sounds like they have the wherewithal and the financial capability to get what they need, even at very high prices. But obviously, that means they're taking away from other folks if we're going to be supply constrained. So what are the regions that you think we're going to wind up seeing the shortfalls in terms of being able to -- [ vending ] up the product they would ordinarily be able to use. Is that another parts of South America? Is that in Southeast Asia? Where will we see those shortfalls?

Yes. There are a few obvious ones and then not so obvious. Ethiopia just tendered for 800,000 tons of urea, the government is in an absolute crisis and is collapsing. I don't know if they have the credit wherewithal nor the ability to pay that price. Pakistan just imported from Saudi Arabia, 100,000 tons, they need a lot more than that. Turkey, I don't even know if they have much urea or fertilizer in place, a substantial production region. So there are, yes, specific areas that either would have to delay or do without, and we're still analyzing that situation.

Okay. And then on what's going on in China, China restricting exports. How do you sort of tally up, well, okay, what are they doing with that product that they ordinarily would sell to somebody else? Are they actually consuming it themselves? Or are they just allowing it to stay in-country to keep the Chinese price at an affordable level for their farmers? And then maybe some of that product will wind up getting sold later in the year once their season is over, and they are assured that their farmers got what they needed, and it didn't get yanked out to some other country that was willing to outbid their local farmers. How are those -- how is that actually do you think it's going to play out within China?

Well, the stated goal of the Chinese government to decrease the price or the value of fertilizer to the Chinese consumer was stated and has happened. Today, in China, probably the domestic price is around $400 a ton. The international price is $800 to $900 a ton. So the SOEs got the mandate early, stopped exporting. And we've seen a ramp down in production. We estimate they're operating between 55% and 60% today. Why? Because there's not an economic incentive, an inability to export the marginal ton. And so that's not going to come out this year. So we see a flat line domestic market, but they've also had a tremendous inability to procure the coal needed to run those plants and gas on an international level has been very expensive for them, not economical, it's $400. So you see, again, a ramp down in production. We've seen many different chinas over the last 20 years, not only the international face of the Chinese government and their activities, but also the economic impact of the various industries from being the largest importer of the urea, taking this to fertilizer, largest import of urea at the end of the '90s to building up the largest capacity in the world at 90 million tons of static capacity to being the largest exporter and now ramping down. And now taking, it seems to, environmental decisions combined with economic decisions and some nationalistic moves to limit those exports. And our stance has been for several years, why are you importing coal, having a negative economic impact, having a negative environmental impact to export that same form of energy in the form of urea. And that viewpoint and that -- or that position seems to have been adopted in the current position of the Chinese government of not pushing that product out in the international market. And that's been the marginal ton, the incremental ton that has balanced the market. And I would say we're going to lose 2 million to 3 million to 4 million tons from now until June when the export restrictions come off which we need to balance the market. So back to the supply limitation, demand is still there, hence price has to come up.

And so they have no capability just to produce in-store excess product and then sell it in June. It just doesn't work...

I mean I think they would have the capability to do that, but at something that's equivalent to $14 per Mmbtu gas. I mean for any company, that's a big working capital through for 6, 9 months. So I think what Bert said is exactly correct, that you're not going to have this inventory build that also next June is going to flood the market with additional. It's actually a contraction in their utilization and operating rates. And therefore, you are seeing this tightness, and that's why we suggest that this is going to move past 2022 into 2023.

Then on top of that, Vincent, you're going into a period where those -- if they were going to build inventory, they'd be competing for natural gas with home heating. And so a lot of those natural gas plants are going to be shut off at some level for some amount of time. So you don't really know how much of that capacity is there. And then on the coal side, same thing, you're allocating coal for power generation. And I don't think that the central government would appreciate taking those precious resources in winter and then just putting them in inventory.

Very clear. And what about the dynamics in Russia? They recently announced some limitations, different structure, but some limitation on exported nitrogen products. What impact do you think that will have on the market in the next couple of quarters?

Yes, less so than the Chinese impact. Russia is a net exporter and will continue to be. We had seen indications of this through our channels and conversations with some of our customers on export limits. I think this is going to be an ammonium nitrate story, so maybe less availability to Brazil and to Europe. I would say the overall impact is 1 million tons of ammonium nitrate that would be kept in Russia. Egypt, the same thing. Egypt just announced export restrictions. That would be probably 50,000 to 100,000 tons a month, not a lot, but enough to tip a market to the positive.

Okay. Now maybe if we just sort of switch to how we should think about this all flowing through your P&L, obviously, in a very dynamic and high velocity price market. You guys obviously run a forward order book and you baseload and do all the things that the company or yourself need to do to manage your organization. So how should we think about it? I think, in the third quarter earnings deck, I think you showed the cost into NOLA at, I don't know, $410 to $545 on a cost curve. Obviously, we're way above that. Latest prices are well into the $700, maybe even $800 today. I haven't see a price today, but very well could have done that. So how is that going to feather into your book? And when should we start to see these spot prices really in earnest flowing through the entirety of a quarter for you guys?

Do you want to take it?

Yes. Well, I mean, I think it works on what Bert said earlier that he's already beginning to fill Q1 order book with these type of prices that you're seeing today. So it will be more along the Q1 line of where the spot prices that you're seeing today are worked in.

We have index values on urea that we book weekly. So as you see that weekly price escalate, that feathers into our book for Q4. But we're pleased with our order book and what we've accomplished and we are positioned, and we are capturing these values today. And that's why I think we're super positioned for 2022.

It sounds like there are people that would like to place orders with you for the second quarter at current prices, but it also sounds like if you kind of digest the dynamics that we just spent the last 10 or 15 minutes talking about it, it seems quite plausible that there could be higher prices in 2Q than there are right now. So how do you think about the balancing the risk reward of the potential for -- if we have a cold winter and Europe produces less or China produces lesser, all the things that could happen on these choke points that we talked about, how much of the 2Q book do you want to build out now versus kind of having a little bit more of a wait and see approach?

I think you did hit on the point, risk reward. And we've just been through a very risky year in 2020, where we weren't sure we could get truck drivers or the railroads would operate and cut our plans to operate through COVID. And so we took a very focused approach to our business. We were all here, hands on deck, making sure that those operations were safe and operable, and our teams were safe. Rolling that into this year, we have different risks. And as we saw with storm Uri and the hurricanes, sometimes that's a gas risk, and sometimes that's a logistics risk. So what we've talked to our customers about, let's price Q1 first because we want to make sure that we're marrying gas and orders just to derisk the company and be able to operate through that any potential storms or issues. We will price Q2, whether that's higher or lower, we believe that it's going to be very attractive. But we'll start doing that probably as we get into Q1.

Okay. And how should we think about your overall volume? You mentioned you were pulling a turnaround forward into this year. Obviously, there were some production issues with urea and whatever else, Ida, this year. So as we look into 2022, presumably production, maybe you have some issues with Ince. But how should we think about the volumes that you can put up in 2022?

Yes. I think you're correct. When you look at 2020 and even 2021, some of the events that Bert mentioned here with lack of turnarounds and maintenance events in '20, significantly more in '21, 2022, we view as getting back to more of a historical norm. What -- the best way to look at it would probably be on a gross ammonia production basis, 9.5 million to 10 million tons as we talked about in the earnings call. The product tons out of that, we had said 19 million to 20 million, it's really going to be based on the margin potential. So as you're well aware, Vincent, our ability to flex our plants very quickly to a higher-margin production. So it's really based off of a weekly, if not daily discussion with Bert's team as to where is the highest margin where we want to go with our production. So the actual product tons will be based on, do we go heavier UAN and probably given where we're seeing the premium to urea versus where we were in some years past where [ urea was in ] higher premium. And then as you mentioned, with the U.K., the U.K. is a bit of a fluid event. Right now, we are operating Billingham, and we have been still halted. But whether the U.K. production is in or out, really doesn't change what we believe our EBITDA will be in 2020. I think it was 2% of our gross margin. So the metrics we put in our earnings deck still holds true for EBITDA, whether we have production in the U.K. or not.

Okay. And you mentioned UAN and sort of where the premium will be versus the other products. Obviously, that's been a new transition over the last year or so, in part, because of the strength of the market, in part because the countervailing duties proposal that you put in there. So can you just give us an update on where that stands and how the market is behaving and how you expect to behave into next year?

Today, we are trading at a premium to urea, and we expect that to continue. We expect to hear the initial findings of the case from the Department of Commerce this month. So I'd assume that it's probably for Thanksgiving or just after Thanksgiving, given the holiday. But it's been -- we've seen some changes in behavior because of the case with less of the product coming as aggressively as it had '17, '18, '19 and '20. And so we'll see how that unfolds, but we have always believed that UAN should trade at a premium, and now we're heading back into that territory.

And do you think that, obviously, the prices for all the products were a lot higher today than they were when you filed your request and UAN as you say is back at a premium. Does that have any impact on how the ITC looks at these issues? Or they just look at sort of the complaint period? Or are they taken to account sort of what's happened since then?

I think it falls right into our case because this is a global commodity. It is a commodity. We're very clear about that. But a global commodity based on supply and demand, based on cost factors, based on different timing issues. And what happened in '17, '18 and '19 is a clear reflection of trade activity that is not fair. Over importing, offering consignment, offering trade or price structures that are not -- that are more related to keeping the market down. And so you saw the price and the value of these products or at least of UAN trade significantly lower than any other nitrogen product for a period of time. And then you correlate all that data directly and map it out, and you can see the impacts of when they happen and why. And so that is, to me, the case study of trade remedies that need to be put in place, and that's why we ask for them. And again, the pricing today is not a reflection of the case. The pricing today is the global market. And what we've described as you first asked is it's a supply-driven global issue and were you're going to take care of our customers. Number one issue for us is to take care of our customers in North America. We are doing that. We are working with our retail, wholesale and trader friends to make sure that happens, but at the value of the international market that a commodity should be priced.

Okay. Chris, maybe we should get into sort of the capital allocation strategy as well as the nuclear energy strategy. So maybe, obviously, there's a lot of free cash flow being generated now, a lot more than we would have guessed, 12, 18 months ago. You have announced some new clean energy plans. You've also reloaded the share repurchase program. So just talk to us a bit about how all this free cash flow is going to get allocated.

Yes. I think it is exactly what you said. I mean the free cash flow per share and the free cash flow we expect next year is going to be pretty significant and even going into 2023 as well. We did -- the Board did authorize starting on January 1 another $1.5 billion share repurchase program. And then we have about another $500 million worth of debt that we like to pay down to get to our target $3 billion number. And then we also announced another roughly $300 million for dehydration and compression unit that will allow us to sequester CO2 from our Donaldsonville and Yazoo City site. But based on that, with the amount of free cash flow coming in, whether we pay down our debt, the $500 million remaining in 2022 or in 2023, really is sort of a nonissue given what we see as the free cash flow for next year. The amount of cash that we believe we'll have for return to the shareholders. In the past, we've said we wanted to be a little more opportunistic with how we go about our share repurchase program, just given the volatility in our shares that sometimes dislocate from the fundamentals. I think given the amount of free cash flow we're going to be generating over the next couple years, we've -- as Tony mentioned on the earnings call, probably have to do a combination of more of a structured approach through the year along with an opportunistic. So sort of shifting from what we had said prior from just an opportunistic to a little bit of a combination of both. And then as far as it goes with the low carbon strategy, I think the announcements we made here recently, along with the green project we're doing, sort of over, call it, the next 3 to 5 years has line of sight of about $400 million of CapEx. So nothing too significant right now. We continue to look at a lot of different opportunities, whether it be debottlenecks in our own inorganic or just organic, whether it be with partnerships or different elements that work within our core competencies. But to date, right now, there's nothing to discuss on that.

Maybe just to dig in a little bit on the clean energy CapEx. You referenced about $400 million. There are lots of projects being announced globally on almost a daily basis, and a lot of them have price tags that are well in excess of what you referenced. So maybe you could just help us better understand why CF has the ability to play in this arena in such a capital-light manner?

Yes. I think it's really our existing asset base, right? So whether you have a green, blue or conventional ammonia molecule, it's the same. It gets stored the same, it gets transported the same. It gets produced largely the same in a lot of cases as well. So when you look at CO2 capture -- removal and capture, we already have that in place at all our sites. So you're talking hundreds of millions of dollars of capital that don't need to be extended by CF. What we have to do is remove some liquid, compress it so it can go and be stored whether through EOR or the Class VI permits that are beginning to be filed now where we could sequester it to achieve the 45Q tax credit. Given sort of that lower capital base, given our existing assets already, we're able to achieve a pretty sizable ROI on these particular projects compared to other peer groups. So I think when you look at CF, the one thing I think we're very disciplined at is we stay within what we do well. We're not trying to go too far afield. We'll partner where that -- where we need that expertise for field. And as a result of that, it keeps our capital expenditures in and our returns higher.

Okay. And just to clarify on the share repurchase program, when you say sort of a structured approach, that means you're sort of just kind of dipping your toe into the market on a regular basis rather than doing some type of accelerated share repurchase or something like that?

Yes. I think that would be fair to say, that along with probably where we do see some volatility in our shares maybe going in a little deeper with that. But I think the important part here is given that type of strategy, while we'll be in the market, you probably are going to have some swings in cash balances on our balance sheet that traditionally maybe we haven't had.

Okay. No, fair enough. Well, thank you very much, guys. Appreciate your time this morning, and look forward to the meetings the rest of the day.

Great.

Thanks, Vincent.

Thanks, Vincent.