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

Well, good morning, everyone, and let's continue our day 2 of the conference and [indiscernible] and presentations we have back-to-back. Our next presenters are from CF, CEO, Tony Will; and CFO, Chris Bohn. You, all of them, you know them well. Tony has been President and CEO and Board member since 2014. Chris Bohn is the SVP and CFO in the role since 2019. CF, I think, is a very nimble player in the market and -- in the nitrogen market and currently is working towards its green ammonia project in Donaldsonville. So here to give us an update on the fertilizer market, please welcome Tony and Chris. Good morning.

Good morning, P.J. We also have Bert Frost with us to the extent that you want to get into the nitty-gritty of the market details. So Bert joined us as well.

Hey, Bert. Bert gets all the tough questions. And we have Martin Jarosick as well. So it's at a good timing, Tony, with the CVD duties on imported UAN from Russia and Trinidad. Maybe we can start with that and [ we'll have a ] quick view on that.

Yes. I mean, I think we're pleased with the [indiscernible], roughly 10% on, Russian producers. This is just on the countervailing duties piece of the finding. There's still the antidumping piece to be determined. We think that's probably a kind of late January time frame on that. So that could further increase the aggregate level of duties. But this is a meaningful finding. And I think it certainly helps to [ a little ] playing field for us. If you think about a world of -- it's not the world we live in today, by the way, but in more of a tougher market environment where average UAN prices might be circa $200 a ton over the course of the year. 10% duty means $20. We make 7.5 million to 8 million tons annually of UAN. So on average, $20 a ton, that's real money for us. So we're pleased this is a step in the right direction. We look forward to the further finding on the antidumping piece of this, but we think it makes the U.S. UAN industry competitive and levels the playing field. So we're quite pleased.

Great. So can you talk about state of the current global nitrogen market? Give us a state of the union. We had crazy moves in oil, especially natural gas, all the coal news that is coming out of China. Just to set the stage for us with this sort of your overall commentary.

And back to your earlier comment about Bert gets the tough questions, this is actually a soft ball. So I'm going to lap this over to Bert, let him take it.

Okay. Well, P.J., it's been an active market. And I think what happens a lot of times in these situations is we tend to look at the current market in a very narrow or short-term outlook and say, "Oh my gosh, we're at $800 urea in NOLA, which is where we are today." And the first response is to look back at 2008 or 2012 when we had spiky markets, but this market has been different. We have to go back actually to January when the market went up almost $100, and it's continued a steady stream upwards. April it went to $450, and in June and July, it went up to $500, $600 by September, $700 in October, $800 in November. And why is that? Well, it's a supply/demand, and this is a global market. And in a supply-constrained market where we've had continued issues, whether that be our own with winter storm Uri or the hurricane taking production off-line or a series of turnarounds that we're not able to take place in 2020, brought into 2021. We ourselves have done that. And then you've had energy shortages in Europe where we've had this -- and in Asia, where this huge differential in the natural gas price we're paying today $4.50 to $5, they're paying $30 to $35. So the cost of production in those high-priced markets because of gas is over $1,000. So those plants have come off-line that has created a supply/demand shift that wasn't anticipated in the market. So supply had to move to Europe, has had to move to Asia and then China, Russia and Egypt and Turkey have all put on export restrictions, which is limited supply, and that is -- at least for the Chinese, that's been since November, and that will go through June. So just at the time when the world is saying, "Hey, let's bid in this marginal ton, which is China, 10% of the world's shippable supply from China is no longer available." So what has happened? Prices had to move even higher to bid in even more incremental tons or deferred demand. And so from an investor standpoint, the question we always get, or from a customer is when does this market break? And what we're looking at today is you have substantial demand still to be satisfied in India, in Brazil and in the United States or North America, which are the 3 of the 4 largest consuming markets for nitrogen and then there's Europe. So we see a very positive market and your question was, what is the market structure today. It's very positive, but that positive perspective continues forward well into 2022.

And I would just add, Bert, to that, on the demand side, just given where global coarse grain stocks-to-use ratios are and the fact that there is some challenges out there with availability of nutrients, we are not anticipating that within one growing season of 2022 that, that deficit really from a [indiscernible] perspective can get made up, which means that even when we get passed this year's harvest next year's planting, we'll still be in a pretty tight grain market, which means we'll see very strong demand out through at least 2023. And as Bert pointed out, given the energy differentials within a strong demand kind of tailwind, the fundamentals really set up extraordinarily well for us being a predominantly North American producer and having access to low-cost gas.

And the positive side of that with corn in $6 plus $2, we did $8, sugar at $20, cottons are high, soybeans are high. You're bidding in -- just as we're talking about bidding supply and for production of nitrogen, you're bidding in production of acres, and that's going to consume fertilizer.

Great. Do we have enough supply in the springtime for the U.S. given all the supply chain logistics on top of all the nitrogen issues?

We do. And this is one of the issues of the case, which we are fairly firm on is our capability alone to produce an additional 1 million tons of UAN. We did have the disruption of the hurricane, and we have had some turnarounds. So 2021, those are the negative impacts, but we're planning on 2022 full supply, and we're working with our customers and those in the value chain, the wholesalers, retailers, traders to make sure we're positioned well with inventory and we're -- we have a record number of barges contracted from the CF side to move product up the rivers as well as the pipeline shipments of ammonia, and we are doing very, very well with fall ammonia. So we believe that the system will be supplied and farmers will get their product.

And one of the things we've also done, P.J., is to largely pull ourselves back away from the export marketplace to make sure that those tons stay home and are available for U.S. growers. So we're trying to certainly do our part in terms of making sure that the American farmer has access to the nutrients they're going to need in order to grow a very healthy crop next year.

Sure. Now we know that nitrogen demand, you have to apply nitrogen. You cannot skip nitrogen like you can for P&K. So could there be some impact on demand through other means, so switching from corn to soybeans? Or is the rate of application go down, especially in countries like China? Can you talk about the sort of demand potential deferral or demand destruction that's possible?

I think [indiscernible] go ahead, Tony.

I'll just start off and then Bert, I'll throw it over to you. But I think one of the things that both you're seeing in China as well as Russia and then recently here in Egypt and Turkey is the focus on trying to make fertilizer both available and relatively affordable for domestic growers. And so when you put a ban on exports, that means that production is relatively available. And as a result, pricing comes down in the local marketplace. I think the places that end up kind of getting disadvantage to buy that are not going to necessarily be China, Russia, Egypt and Turkey, it's going to be, as Bert pointed out, Europe. So currently, in Europe, there's about 11 million tons of annual ammonia capacity that's off-line given the high cost of gas. You've also seen India not be able to source the volume that they've been looking to in recent tenders. And there's a potential shortage there as well as possibly Brazil and some other countries. And so I think it's those areas where you're likely to see -- and I wouldn't call it demand destruction, I would just call it unmet demand in the near term, and that we believe will have a potentially significant impact on yields for the crop year 2022, which further than put strain on global stocks to use and drives pricing up into 2023, which is really why we're looking at this being a multiyear, very, very strong demand side. And at the same time, you're not seeing a lot of new energy production and fossil fuels brought online. And so really until you get Nord Stream 2 up and operating and Russia turning on the gas spigot. I don't know that you've got a significant source of relief in sight for Europe, which means a lot of that production stays on the sidelines for a while. But Bert, go ahead. I didn't mean to jump in...

I think you've covered -- the last one is, if India is the largest importer and they have bid the price up over $100 over the previous international price, it's a good indication that a subsidized market is paying if you either bring in wheat or bring in fertilizer. And today, they've chosen fertilizer and Tony bounced through some of the markets. So we see a positive market ahead.

And any shift in the U.S. from corn to soybeans?

We're looking at that every day, and that's why you're seeing the bid up in corn pricing to bid in those acres. And like Tony said, the stocks-to-use ratio is communicating the need for corn, not only for ethanol, for feed and exports, but it's a profitable product. And when you run the numbers for a farmer who owns the land and is farming, it's highly profitable at $6, $5.50 corn. And I think on some marginal acres, you could see dry land, below trend yield, some shifts to soybeans. But again, that will just tighten the stocks-to-use ratio in the out years. So very positive. We're seeing -- we expect 93 million acres of corn.

93 million. Good to know. That's larger than the trade average, by the way. So...

And we're seeing an ammonia movement.

A question on sort of precision ag and some biological applications in the soil that are all sort of aiming towards reducing nitrogen fertilizer usage. It's been talked about for a while. We haven't really seen an impact. But do you think is there any potential that we could potentially see an impact going forward?

I mean, I think the value proposition even at today is nitrogen values tends to be about yield optimization as opposed to reducing nitrogen application rates. So let me kind of quick math on this, right, is even at, call it, $1,000 ammonia per ton, you're really talking about in the best growing regions, 200 pounds, plus or minus of ammonia per acre. So you're talking about $200 worth of ammonia. If you save 10% of that, you're talking about $20. On an acre, all you really need to do is generate an extra 4 or 5 bushels in order to generate at least that, if not more. And I think there's less risk associated with normal ammonia or normal nitrogen application rates and trying to boost yield as opposed to thinking about I'm going to short apply nitrogen and hope that the biologicals come through for me and I'm able to maintain yield. I think that's typically a pretty risk on move, and that's generally speaking, that what growers tend to do. And so I think the value prop for a lot of these products is going to be about yield improvement, not about nitrogen replacement. But Bert, do you have other thoughts on that?

We're clearly following these developments and potential is always a word of potential. And so we can talk about potential 5 years from now and still not realize it. The activity that we've seen with field work has not shown independent field work, the performance that's being advertised. But I would say, just like Tony, more to come, and maybe there's some other developments.

Let's move over to blue and green hydrogen, ammonia opportunity that you guys have been working on. Just walk us through sort of the economics of blue and green hydrogen first. And then we can talk about ammonia. And at what price does this project become economically feasible?

Well, yes, let's talk about blue for a moment. On the blue side of the world, we just announced 2 big CO2 dehydration and compression projects, 1 at Donaldsonville, which is the much larger of the 2; the other at our Yazoo City, Mississippi facility. And at Donaldsonville, we believe we'll be able to dehydrate, compress, transport and sequester about 2 million tons a year of CO2. And the 45Q tax credit under the current regs that continues to increase until you get about $45 a ton, we think the variable cost added to conventional ammonia to be able to produce blue ammonia is somewhere in the neighborhood of $20 to $30 a ton in order to the electricity cost to dehydrate, compress, the transportation cost and then the injection cost. And so that still leaves you $15 to $20 of value associated with 45Q at 2 million tons a year. That provides an adequate payment for those projects to be positive NPV, even if there is no ultimate premium on blue ammonia. If there is a premium on blue ammonia or other derivative products, blue nitric acid, lower carbon UAN, et cetera, then that just further adds to the economic benefit of those projects. Now the most recent language of the new legislation, recently passed by our House, includes an increase in the 45Q tax credit all the way up to $85. So if the projects look good at 45, they look really good at $85. And that's before you get the incremental margin opportunity on blue. So our belief is, at least in the United States, where you've got access to low-cost, plentiful natural gas that blue ammonia is the direction that the industry will use to decarbonize. I think it's a different question in Europe because gas cost, obviously, is very, very high over there. And what you might see is a broader adoption and move towards green hydrogen and green ammonia in Europe because although electricity isn't free, it's certainly potentially competitive against natural gas over there right now. And so I think you'll see sort of a different evolution of development on low carbon ammonia around the world depending upon availability and cost of natural gas, which drives really the economics of conventional and blue versus electricity, which drives the cost of green. We are putting in place a green ammonia project in Donaldsonville, as you talked about it. It's a 20-megawatt project. It's an important investment and first step for us. And I think there's a lot of learnings we're going to get for it. But as we look at the economics right now, at least being the U.S. producer, the costs around producing green hydrogen and green ammonia are probably 3x or 4x what it is to produce blue. And so that's really why our focus right now is continuing to move our network toward blue ammonia because we think the economics are so superior, but also gaining some expertise and capability on the green side.

So blue cost is, let's say, closer to $2.50 to $3 per kg. You were saying green is closer to $8 to $10.

I would say -- maybe I can jump in.

Yes, jump in, Chris.

I would say on that, P.J., that may be a little high for the green and a little high actually for the blue as well. I think the blue ammonia, as Tony mentioned, is going to be very close to the conventional, especially when you work in the 45Q. As you know, probably better than most that the infrastructure we have in place allows us with limited capital because we're already removing and capturing the CO2 to take advantage of that and to get to the blue. And as Tony mentioned, with the ability to take 2 million tons in sequestered at Donaldsonville had very cost economics, we'll probably see blue just be slightly above conventional. And then green, most of the green you look at right now is probably $6 to $8 per kilo. And there are some things in the current infrastructure -- I mean, I should say, in the bill that was passed by the House that would reduce that, whether it be through [indiscernible] with any type of green hydrogen reductions in...

And what end markets are you targeting for this blue and eventually green ammonia and hydrogen? Is it mostly transportation fuels market? Or would it also go into agricultural market?

Yes. I mean, I think there's obviously an ability to put it into the ag market. I think the challenge right now is without some sort of global standard or even a standard in the U.S. or a regulated price of carbon to go into the ag market, which you're primarily targeting there is a kind of a voluntary credit market, which trades at a pretty substantial discount to the rest of the world. So the voluntary market is probably $5 to $10 a ton on carbon and even that then the science around which get credit for in ag is still being worked out and agreed to by various parties. So there's, I think, more value going after other kind of new application developing marketplaces out there. Now we're really excited about our announced agreement with Mitsui, who is one of the companies we're working with on supplying ammonia into Japan for co-combustion with coal to produce electricity for that country and actually in other places in Asia as well. And we're also involved in the consortium at Itochu and several others around looking at ammonia as a marine shipping fuel. So we think both of those are developing marketplaces that have some real legs to them and some real growth. And I think those are also markets that -- for which there is a defined price on carbon and will pay a premium for a low-carbon alternative like blue or green ammonia. And so that's really our primary emphasis at this point, but we've always got the fallback of providing that product into ag marketplaces that either comparable or maybe a small premium to what people are paying for that.

Before I ask my next question, let me remind investors again, those who are listening, please, there is a link in the right-hand corner, bottom right-hand corner, please click on that and submit your questions. They'll come to me via e-mail, and I'll read them out. So thank you for that. What -- Tony, what are -- or Chris, maybe you can talk about, what are the capital requirements for this blue and green ammonia? Can you give us some idea?

Yes. So from the dehydration and compression that we just announced with the ability at Donaldsonville to sequester about 2 million tons CO2 and at Yazoo City, about 0.5 million tons, those projects are, call it, less than $300 million, largely because of what I talked about earlier, the infrastructure we have in place already with removal and capture of that. As we look at the green ammonia project that we mentioned that we announced last year, that is for about $100 million. So as you look at the projects in place right now that have been announced and our in-line at the site, it's about $400 million worth of CapEx over, call it, the next 3 to 4 years. So largely constrained within our, call it, $450 million to $550 million CapEx on an annual basis. So we don't expect to see a lot of expansion out that. I think where we'll begin to move forward is, as Tony mentioned, with some of the other potential incentives here is to look at other sites in which you could do CO2 sequestration. But really Donaldsonville and Yazoo City with the capital cost that isn't all that great and also their proximity to both EOR and also a lot of Class VI permits that are about to be filed, make those the most advantageous to move sooner rather than later on.

Great. So with this windfall that you get from higher ammonia and urea prices, what is the cash generation outlook? And then maybe talk a little bit about our capital allocation?

Yes. I mean, look, I think we were pretty strong cash generator even as we looked back in the last year, as we look this year and in particular, going next year. I think this year, even though we won't set an all-time record for adjusted EBITDA for the company, we absolutely should on a free cash flow per share basis because the number of shares we have outstanding is dramatically lower versus back in 2012, '13, '14 when current conditions were last sort of replicated in terms of pricing on our products. As we look forward, then we're entering the year in a very, very strong position. When we entered into 2021, UAN price was very low. As you -- as Bert said, urea was in the $300 range. And then we saw a pretty rapid run-up, ammonia was probably in the $400 range. And today, we're looking at urea values in the $800, UAN in the mid-$5s, and ammonia could be $1,000 a ton or more. So we're entering this year in a very strong position. We see very, very strong ag demand, strong industrial demand given the bounce back from the COVID economic decline last year, and we see that demand persisting. And so it's a really attractive profile from a cash generation perspective. As Chris mentioned, our normal CapEx is kind of in the range of $500 million, which includes the growth capital that we're talking about with green and blue ammonia. So that's nothing out of the ordinary. And we can fund those projects within our normal CapEx budget. And so this is going to allow us to take out the last $500 million of outstanding notes due 2023, which gets our gross debt down to $3 billion flat, really what we've targeted to be a very robust capital structure under all market conditions. And other than that, we're looking at a pretty sizable return of capital. So our Board just recently approved $1.5 billion share repurchase program. And we think we can make some pretty significant progress on that over the next 12 months.

Great. And I'm seeing some questions come in. So let me ask you my last question, which is about -- where is my question here. Yes. Overall, if I look at urea prices when they are $800, U.S. is still the lowest cost player. At what point people begin to expand capacity in the U.S. because U.S. is still the preferred place to produce this?

Yes. I mean, I think if you got comfortable with the notion that you could average $350 a ton on urea, I think you'd see people start evaluating some new projects. And at that kind of price realization, it pencils out to add some capacity. Now this is a relatively recent run-up, if you look at the average over 2020, 2019, 2018, we weren't really realizing those kinds of numbers. And so I think what you're seeing is people beginning to think about it, but it's still a little early on, and folks want to see how much legs and longevity this has and how -- why the energy differential stays and for how long. But certainly, you are seeing some announcements around the addition of ammonia only capacity, not necessarily fertilizer capacity, but ammonia capacity for Clean Energy application. So whether that's the [indiscernible] project or Air Products' recent announcement in Louisiana, a number of other I would say a little more vaporware projects have been announced around the world out there that we'll see whether they get funded and built. But there's certainly a lot of activity going on right now. And I think you'll see a corresponding amount of activity if these kinds of prices persist for a while around potential fertilizer announcement as well. But I think one of the things that we saw back in 2012 was, there was a huge appetite for development. I think there was no less than 26 projects that were announced in North America, of which only really 4 of them got built and all of them got built by entrenched players. So all of these spec plants that were being announced by new entrants never came to fruition. And so I think, I would add 2 bits to this. One is, when you see an announcement, I'd take it with a little bit of a grain of salt, it's not obvious, it's going to actually happen. And the second one is, it takes about 4 to 5 years to actually build an integrated plant. And so even if you see an announcement or 2, it doesn't mean the sky is falling tomorrow.

Yes. And maybe if I could just add to that, P.J, also, just with the energy differentials where energy globally is that price point that Tony mentioned is probably even north of their bed, and then you work in the inflationary pressures and also the logistics with just the timing to get vessels and everything out of -- primarily out of Asia, that I think you're going to see what used to be a 4- to 5-year term. Anything that would be announced to be even expanded past that, given the current environment, that really sort of expected over the next couple of years. So I think it's for fertilizer projects and maybe a little north. But as Tony mentioned, probably ammonia only because of new sources with the low carbon, you may see those be more prominent than fertilizer plants.

Great. So we've got a couple of questions here. The first one is, is there any scenario in which you could imagine sacrificing your investment-grade credit ratings? If not, what is different now and going forward versus 2016 when you were downgraded to high yield? And is it only market conditions -- is it only that market conditions are strong now and expected to remain so? Or is there now a stronger commitment to -- in the IG ratings?

Well, I think I will say -- I don't foresee a situation where we would sacrifice our IG rating based on what all of our plans are. We worked really hard over the last kind of 5 or 6 years to get back to this place. We would not be interested in sacrificing that. I think what really happened back in that time period was the confluence of a number of factors. We took on a fair bit of outside debt in order to help facilitate the closing of the OCI transaction. At the same time, we had 2 expansion projects that we're currently ongoing, one at Donaldsonville, one at Port Neal. Both of those projects kind of had pretty substantial cost overruns associated with them. And then the OCI deal fell through because the treasury got involved and changed the rules around tax inversions. And so that left us not only with the break fee, but a bunch of costs. We had overruns. All of that led to a relatively high debt on a gross basis and high interest cost. And at the same time, what you saw is Chinese exports were ramping up pretty dramatically and pricing in the marketplace globally was falling pretty fast. And so you had sort of relatively high debt, high interest costs during a period of relatively low margins and that led to the downgrade. Since that time, we've worked really hard to take out a lot of debt to get back to $3 billion of gross debt. We believe that that's a very reasonable place to be through a cycle and makes us a very strong business. So we're not going to be sacrificing that kind of level. And all of the growth initiatives that we've talked about, we can easily fund with cash flow from operations because they're just -- they're spread out, as Chris said, over 4 years. So what you're really talking about is incremental across all of those projects, $100 million a year, we can easily manage that through our normal CapEx budget. So I think we're in a really strong position going forward. We will be generating a lot of excess free cash flow based on market conditions and a relatively modest capital budget, but I think we're very committed to maintaining investment grade.

Great. And we're almost out of time, but I do have 2 more questions. So if we can do rapid fire. The next question is, I see Yara announced most ammonia restarted in Europe. What does CF make up this? And how does it impact near-term outlook?

Yes. I mean at $30 -- as Bert said, at $30 or a bit above that, you've got over $1,000 or $1,100 of gas cost content in a ton of ammonia before you got any of the other costs that go along with it. The Northwest Europe, ammonia price is not trading at that level, it's trading below that. My sense is, Yara, which is a very heavy CAN and AN and NPK mix, is able to bring in offshore ammonia and continue to run those plants, but there's a scarce availability of ammonia right now. So my sense is they may have restarted their ammonia, not for the ammonia value, but because they believe there's incremental margin by upgrading it. And if you can't get deep water ammonia, then you can't upgrade it. But I would say their decision has not necessarily been replicated across the industry. I think you still see a pretty sizable amount of European capacity offline.

Great. And the last question here is, is the value here really is an extra price? You get on selling blue ammonia to power companies as low carbon fuel? Or is it more from creating a new market that makes the global nitrogen market tight and forces agricultural turns to compete for capacity for that blue ammonia? And this seems like potentially a bigger impact for global supply/demand...

Yes, I would say yes and yes. I think both things are great for us. On the one hand, it's great to see incremental price realization and value associated with a product that basically, as Chris said, cost the same. But the fact that we see new alternative applications for our products means that demand growth is not limited to strictly historical industrial and agricultural demand but new sources, which means that what you really need to see is continued investment in supply side production in order to meet all of those new demand, and that should raise the value of existing assets up to replacement cost or darn close to it. So we think all of those things are very helpful for an investment case in our company.

Great. That's all the time we have. As always, thank you very much for your insightful and full answers. Tony, Chris, Bert and Martin, thank you all for dialing in, and have a great holiday season.

Thank you, P.J. as well.

Yes, thank you.

Thank you.