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

Okay. Welcome back. Next up is CF Industries. We have Chris Bohn, CFO; and Bert Frost, SVP of Sales, Market Development and Supply Chain. I suppose -- I don't know where you went, Martin. But Martin, there he is, from Investor Relations, as everybody knows. Before we get started, let me just read some important disclosures and ask you to see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. And if you have any questions, please reach out to your Morgan Stanley sales representative.

So maybe just to get started, I mean, the thing that we talked a little bit about this on the call last week, but the thing I think I've been wrestling with and a lot of folks have been wrestling with is to try to sort of understand the architecture of the market today because there have been so many changes from a cost curve perspective, from a trade flows perspective and how assets are being run with the run-up in European gas prices, the lack of exports from China, and we've seen some volatility in pricing this year. Really big highs, and then we've come off more recently, some of that is seasonal, some of it is the movement in the energy market. It's become very unpredictable. And I think for the first time in a long time, I really struggle on a daily basis to have some point of view right or wrong about what is setting the price and then just sort of be able to have some predictive idea of what's going to happen into next year. So maybe you could just help us sort of reconcile what's changed in the cost curve and how that's driving the pricing mechanism globally as well as in the North American market and how you're managing the business to try to optimize your profitability around that?

Yes. Great question. There's -- the one great thing about commodities and specific to our commodity nitrogen is that volatility and how you play in the specific spheres of the market because what has happened in Europe with the gas, well, there are several things, and you hit on them, gas in Europe and then shutdowns of capacity. Russian and Ukrainian product being curtailed in the market, out of the market going to specific markets. China moving out of the urea export as being a large participant in the agro market to not really as much. And then you throw in drought, river conditions, logistic conditions and then the disruption in logistical flows for things that have been probably been pretty predictable for 10 years are not as predictable as some of these trade flows change. And so one of the -- if you go to the cost curve with TTF and European gas being in the $60 range, complete shutdown. So depending on how you look at Europe with what is the capacity that you would allocate, what countries you put in the European, but is it 15 million to 18 million tons of ammonia and the estimates of 50%, 60% of that being down, some of it being operating just because of DEF and CO2 and nitric acid, but there's been a tremendous amount of flow moving to Europe and ourselves being one of the participants in that. And so that has changed to trade flows a little bit. We don't see China coming out with many tons, maybe 1.5 million to 2 million tons. And then you look at the structural nature of what our tons are consumed for, which is grains and -- or feed grains and sugar and cotton and things like that, we see a longer-term trend of lower stocks-to-use ratios for each of those products. And so very good demand agriculturally and then industrial demand being weaker in Europe being -- still being for the products that we make that are consumed as a feedstock or for explosives being very healthy. So a strange convergence of events that have put the high-cost producers now Europe, tons flowing that way, Russian tons making their way to South America and to the United States, not going to Europe and then China not supplying makes this market very tight. And then you throw in the river conditions and some of the traders and players that import tons having an inability or a cost disadvantage for those tons sitting in NOLA makes for the North American market as we move into spring, we predict to be very tight. And the benefit of having capacity that's in the Midwest, where a lot of our capacity is probably going to be advantaged as we roll into spring just because of that cost differential of bringing tons into the river system or even the rail system and getting them distributed. So tight market, inventories are tight but some locations globally that are causing some of these things. And then India steps in the next week for another tender keeps that Middle Eastern Asian ton market as well tight. So an interesting market to play for come as we roll into 2023.

So the fall season, right, which is obviously underway. We've heard from some other folks today, it seems like there's going to be a good pull on ammonia. So probably clear a lot of inventory exiting this year. So we probably have a pretty open season for the fall. So is your take that we're going to enter next year with sort of low levels of inventory in country and in the U.S. And then if we get a good start to the season, winter ends early, guys are on the field early, that we'll get a nice pull up quickly.

So the fall application season has started actually in October, and we're seeing very healthy demand, but we don't believe that the tons that were available last year, the amount of tonnage will be available this year. So more demand moving into 2023 for spring. Yes, the weather window has been opened and looked at our tonnage yesterday, we're moving a substantial amount per day and think that will -- the season can go into the first week of December. So still quite a bit of time to move the remaining order book out. And so looking at what could be an early spring, if that were to take place with less tons going down in the fall, needing to move into the spring of 2023, lower tons imported, more tons exported, you'll probably have a very tight window and the spreads will widen for spring.

And how has the supply chain been operating or the channel have been operating. Now we get higher prices. We've got higher interest rates. We've got price volatility. We've got geopolitical instability. So have your customers change the way that they want to transact in terms of how much inventory they want to hold or when they want to buy it, how is that playing out?

Yes, I think you're spot on. And the volatility does play towards that nobody wants to have a negative position. So a little bit of trepidation of taking those forward positions. But as the window narrows, you have to be in a position. So we believe farmer money will come in once harvest and playing the tax gain, and that should take place over the next 1 month, 1.5 months. Those positions will need to be covered with us and other players. And so that's a North American situation. The global situation is we dig it a little bit plugged in Brazil. That was more a relation of over imports. And earlier in the year, we think that's being discouraged and applied, and we'll have -- see good demand through February for their second crop corn. And Europe also got a little bit plugged. Europe was not set up to be a big import market with all these tons production being down. They've had to import, but then they have to logistically move that and we still believe Europe needs to import more to meet their demand. So some -- again, dislocations and things taking place in the world today, but we believe that spring will be solid.

And how do you think about the U.S. natural gas environment? Obviously, the cost curve spread has moved nicely in your favor, but there's been a lot of volatility in Henry Hub prices year-to-date. I think we're in a 3% to 9% and change spread. Winter is coming. Are you guys -- I think you've historically hedged a little bit just to remove some of the winter risk, but is there anything changing about how you're thinking about gas, just given more LNG into Europe and everything else?

So Chris and I and as well as Ashraf sit on the gas committee, along with the folks who buy the gas, and we talk about this probably too much. It is the driver to a $2 billion depending on the price of $3 billion -- it can be $1 billion to $2 billion cost. And so buying gas right is as much as margin gets focused. This is the cost as well as CapEx and other issues. So we pay very close attention that we buy 1 Bcf a day. And yes, we do hedge and we have looked at hedging winter. And when we look at winter to Dec, Jan, Feb, those are the critical months as well as basis in uptake. And so gas has been -- and since you and I have been around this has been the most volatile year with seeing let's say, $20 to $80 in Europe as well as the U.K., but the JKM, which is Asia and how these hubs have traded over the last year have been amazing to watch. And subsequent to that with the COVID shutdowns, a lot of Asian gas has moved to Europe. So Europe looks well supplied for this year, and that's why you've seen the level on the gas daily come down to $10 to $15 and the forward being $30. That's still $1,000 ammonia. And so at $5, $6 gas, that's $200, $250 for us, very attractive back to the cost curve market. So -- but LNG is not growing. And in the short to medium term, there is only a finite amount of LNG that can ship. And when we believe China comes out of COVID, this lockdown and their economy begins to take off, again, gas will be demanded there as well as in India. And so you'll probably have a more balanced market and the longer term gas spread will still be there. Is it $5 to $20 or $5 to $30, that's to be determined, but we like where we sit and how we handle our gas position.

And then just in terms of your own trade flows this year, probably exports have been up just given some of this dislocation and there's the opportunity to ship ammonia to Europe. It wasn't there in prior years. And you've been doing more at the Donaldsonville with urea to South America earlier in the year? Or has that been part of the future of the year?

So our exports will be at record levels, and that was something we identified. First, we offered tons as to -- how the program works is, we offer a fill, and that's basically filling people's tanks. And we offer that to our customers in North America, and we did that in July. But the price spread from North America to export was substantial. And so once we felt like we fulfilled the opportunity for our customers in North America, we pivoted very quickly to the European market as well as South America as well as Australia. And we've exported UAN, urea, ammonia and ammonium nitrate at levels we haven't achieved in the past, and that's been very good for us.

I think just to add to that, not only the import export that Bert's team was working on, but it helps with the product mix. Those of you who have followed CF for a while understand that we can shift the product mix, whether it's ammonia, UAN, VF or urea. And I think those were really -- not only do we export or keep it here in North America, but what product mix are we doing that and chasing the highest margin that way as well.

On product mix, I mean, how are you thinking about UAN over the next year or 2, just given -- it doesn't look like the import duties are going to take effect and Russia is probably going to have trouble getting into Europe. So are we seeing -- expecting to see more flow of Russian products here? Do you make an adjustment for that? Or what's the thought process?

Chris covered it in terms of -- this is a dynamic, just as the certain segments of our business, whether it's what Chris manages on the financial side or the CapEx side what Ashraf manages or the market and gas buying, it is dynamic. And we can shift production in a day. And when you look at UAN, we've been as low as, let's say, 6 million, as high as 8 million tons when the trade case was being adjudicated, we were running at max rates to supply and kept all that in North America. And so it's margin dependent, and we are driven by that profitability and as well as demand. And so UAN for us, it's a global 20 million, 22 million ton product. We produce between 6 million and 8 million. It's a very good product, principally used in North America than Europe than South America. We're active in all those markets, and we'll continue to be.

Okay. So just from the optimization scheme.

That's it.

What are you seeing in terms of new supply, new nitrogen capacity? I mean we've seen a bunch of assets continue to get pushed out or plans slow to ramp or have trouble getting gas supply, what's the new supply outlook for this year and the next year?

I'll start and Bert can add. But I think as you look at the new supply, the benefit of our particular industry is it takes about 4 to 5 years to build a plant. So you have a very good visibility as to what's coming on. And really, as you look over these next few years, the majority of capacity in flight right now is Indian and Russian. And with Russia, I think our expectation is there's going to be some delays or deferrals. You can look at the sanctions, but even beyond that, just supply chain issues are probably going to delay that. I think India is a little more interesting because it plays almost to the rest of the globe. It's really do you import LNG or do you import urea and which one has a different energy perspective from -- or differential from it. Right now, from an energy perspective, India would be better off importing urea because it's had a discount on an energy level than importing LNG. And I think that's maybe what you saw a little bit with this most recent tender, where India made that decision. I think looking at North Africa, Middle East, the normal areas where we've seen new production come on, a lot of that is it's LNG and everything else. And so they can monetize that MMBtu as LNG. We're not seeing a lot of new announcements that are coming that way. Additionally, there's been a lot of noise about green projects coming. I think most of those projects are along the size of what we're doing in Donaldsonville. More of a pilot-sized plant, 20,000 tons of ammonia. We produce over 10 million tons a year. So it's pretty small. Anything greater than that, I would put some question marks behind it just because of the efficiency and the costs related to that. So I think all in all, we think that there's going to be a shift in what is in flight right now. New production is going to have to compete with other high-value areas such as LNG. And from the green area, that's probably going to be a little challenged going forward. Now having said all that, as we look at the back half of this decade, there is supply that needs to come on in order to meet what we believe is sort of the clean ammonia usage, whether it be in co-combustion or in marine fuel. And those are the type of projects that we're looking at with Mitsui and in discussions with others that there would be a natural offtake or demand center that those would be going to.

Yes. I mean you guys have been out in front on the green and blue with your announcements over the last year. So obviously, the IRA went through a step-up in the carbon credit. How has that changed, if at all, sort of your thought process and what you want to do?

Yes. So what Vincent is alluding to is with the inflation Reduction Act that was passed, we saw the 45Q, so the sequestration of CO2, go from 0 -- from $50 per metric ton, up to $85 per metric ton. If you think about ammonia plant, ammonia plant already removes and captures the CO2. So it just has to be dehydrated and compressed and sequestered some place down in order to get that credit. So we had hundreds of millions of dollars of capital we didn't have to put in because our sites already remove and capture that. So when we saw this increase from $50 to $85, a lot of that just moved in the Donaldsonville project to an increased return. What it did for our other sites is those that were a little bit marginal now brought those into scope, such as Yazoo City. And I would even go into Alberta with some of the discussions, the provincial and Canadian government is having about more or less the 45Q like type of item there that would help and send people to sequester. I think the other point I would just make on our sort of blue and green movement is, we've been very good, whether it's in our legacy business or what we're developing here and understanding where we play in the value chain. So if you look at we remove and capture CO2, we're not looking to be CO2 pipeline experts or sequester by land and sequestrate. We look to partner, and we value -- we look at the value chain and say, where is the most value, given our assets, given our core competencies and let's play there. And in this particular instance, partnering with ExxonMobil has really been beneficial for us where each party is now playing where their strengths are, therefore, limiting our CapEx, as we said on our most recent call, our CapEx is still going to be in around the $500 million range, even though we're doing these additional growth projects.

So it sounds like you're very focused sort of internally on the existing asset footprint and what can be done there, low risk, high return, short payback period kind of stuff. You don't seem to have a big appetite to go out and build big plants or anything like that.

Well, I think the Mitsui plant, I think something that we're looking at, which would be an ammonia-only plant, which is different from plants that we've built before, which were ammonia and urea upgrade and everything. It also be an export-oriented plant, I think. Also, we're going about it very disciplined. So we're doing a front-end engineering and design study, where we'll get a better idea of what the economics will look like on this, make certain it fits our return profile. But as we're in discussions with a lot of multinationals, there is, as I said earlier, a need for supply to develop and whether we're able to do that through offtake agreements and have type of returns that fit our profile, that's what we'll continue to look at. But I think we're being disciplined about it, as you can see with our decision not happening until next year on the Mitsui blue ammonia plant.

Plus, we're the ideal partner. The redundancies that we have in place, the capability to load at various locations to backfill and the multiple options that Chris just explained for blue that any of these companies that are looking to co-combust with ammonia we're talking to, and we should be -- and if that is the case, we need to add capacity.

When you look out probably 10 years from now and longer, and you think about your gray blue green mix, do you have a sense of what it might look like. And if it is blue or if it is green, is it going into fertilizer markets? Or has it been diverted to industrial use or transportation use? And what would that do to the fertilizer market if there's kind of more competition for the molecule?

Well, I'll start with that. So I think it's going to go to all of the above in some way. I think initially here, as we start to do blue, primarily blue because I think green is a while off of any type of commercial scale. It's going to go more initially to Asia for co-combustion. They're doing testing over there already. They're looking at ways they can import it. So there's definitely more than just an industry movement. I think there's a government movement for -- to meet their greenhouse gas goals. From our decarbonization goals that we've set out 25% by 2030 and net 0 by 2050. Part of that pathway has to go with us sequestering as much CO2 as we can. And that really goes to your earlier question, whereas we look a little more broadly across our network and where we can sequester some of that. I think the demand points, there is going to be some slight friction between that, dependent on the amount of ammonia and the supply at that particular time. But Bert, I don't know if you have anything you want to add?

Well, I just am excited about what we're doing because blue or green is good for all seasons. So your question about, well, who competes? That's exactly what we want, is that competition for the molecule. And if we're able to set up a system of return-based projects that are acceptable to the Board, we will invest. But if we're able to also have the optionality of those tons going to the commodity markets where that's driven by value and need and demand, you have a growing world population, so you need the food as well as the industrial products that we make. So that competition for the molecule will be -- will create a good position for us. But blue is good for all seasons. So we're already talking to on the ag side and what that could do to ethanol, what that could do for feed, what that can do for the global decarbonization that needs to take place, we're at the forefront of it and like that position.

Yes. And it seems like within blue versus green, I mean, there seems to be particularly post-IRA, general consent is blue is in the money now, right? Like from -- obviously, you come at it from a very different vantage point, but even people that are looking greenfield. There seems to be different points of view on green and whether the IRAs really changed the economics of green or not or made it more attractive. So I'd be curious, Chris, just to get some more color on you why you don't feel like you're there on green yet in a big way.

Well, I think there's a couple of things. One, I think the technology of electrolyzers, just with the energy efficiency and what you can get out of that, the amount of electricity that has to be used to generate that ton of ammonia. But I think what the Inflation Reduction Act has done from a green hydrogen side with the production tax credit, really has it on a sliding scale, call it from $0.60 per kilo of hydrogen to $3. But that is judged on a well to gate, okay? So from when that energy, if you're pulling that power off of a grid right now that's using natural gas, you have the carbon intensity that's with that. So most participants are not going to be able to get that full $3 per kilo. And if you were able to get that, that would be about $500 per ton of ammonia. So it would be something that would be a sizable amount. The problem why you can't necessarily get that today, there's just not enough renewable electricity or renewable power base in the U.S. and even specifically where our plants are. So that has to evolve over time. And I'm not certain that PTC that was rolled out here necessarily does that in a way that stimulates significant more. There is on the Infrastructure Act that was prior to the IRA, there are hydrogen hubs where you're looking at the full, again, almost well to gate from renewable, whether it be nuclear or windmills or solar all the way to the hydrogen consumption at the end. And there's several hubs around the U.S. in which we're participating with some other people on the value chain to see if there's anything there. So something we continue to look at. It's just where technology is today and where the renewable power grid is today. I don't know if you could make the numbers work, and that's global, and that's global. Yes.

And then just on the marketing ultimately of a blue product or ultimately a green product. How do you think the industry is going to shake out on that? Is it going to be a true merchant product where the price fluctuates based on S&D? Or is it going to evolve to be more of a contract market, whether it's a take-or-pay contract market or a monthly contract or annual contract? I mean, what do you think the architecture winds up looking like? And what would you prefer to look like?

So I'll start. But I think it looks a lot like the industrial ammonia market does today, where we have some ratable offtake that is at a return profile that's much different than the highs and lows that happened just in the general S&D market of a commodity market. So I think it's going to have elements of both those where we have a layer that may be with a partner where it is a take-or-pay or similar to like an LNG type model when those were initially being built to, as Bert mentioned, selling into the agricultural market or other industrial markets where they're bidding against it.

This is all new, and it's exciting. And so we're going to want to layer in a tranche of each. And one, we want to participate in the upside. So we would, obviously, like Chris said, have some of that capacity reserved for the additional markets. But because we're investing a substantial sum and with the partners that we're with, that will be also the tranche that make a gas plus a return profile that's attractive. But then it goes to -- I mean, this is something to think about is not everybody can do this. Not everybody has the geological understanding. The pipeline is in place, the capacity or the ability to add this capacity with the gas profile that North America provides. So we're structurally in each one of those segments of our capabilities, what infrastructure offers us as well as the output capabilities like you just asked. So each of those match up very well with our company.

And you do have some existing gray ammonia contracts with different customers on different terms, one of which I think I saw last night, you triggered an option not to extend that particular contract. So what is the thought there? You just want that ammonia back because you think you can get a higher value for it over time? Or you have another use for it or what?

Well, each contract, we look at holistically with the partners and internally and that specific instance, I think you're referring to, long-term relationship, very good partner, but the contract was structured in that exit point, but it's not an exit to leave. It's an exit just to relook at the contract, and we will be back in relation. We will continue that relationship because it has 2 more years to go, but we'll be -- we plan on at least on our side, to have that supply a portion of it still available. But it's just a chance like we look at all contracts, it's the healthy thing to do, take a step back, review and then take a step forward.

Okay. So it doesn't change the amount of volume that will be moving.

I don't think so.

Are there any questions here in the audience? Maybe a last one for me just on capital allocation. You paid a pretty healthy dividend. You've been buying back stock sort of on a 2-tiered way of sort of the commitment to what you do sort of ratably every quarter and then sort of a more opportunistic buyback and we saw the latter in the most recent quarter in the second quarter as well. So is that -- you're just going to operate in that corridor? Or is anything changing up to your buyback, you double the size of the authorization. So how should we be thinking about the buyback?

Yes. I think just the authorization itself and the size of it is really our bullishness on the next several years here and what we see. If you look really even over the last 12 months, we've repurchased $1.6 billion or almost 10% of our float that was out there. So we've been pretty aggressive in looking at our shares, and it's really because what we see from a free cash flow standpoint, not only what we've seen last year, but this year, but the next coming years here where we believe that our shares are undervalued. And the best assets to buy, I think, are the ones that we know, which are our assets here. So you'll probably see us remain relatively robust as we look into the share repurchase program going forward. As you mentioned, we have a ratable program, which is about $175 million per month. That combined with the dividend is at minimum, giving back $1 billion a year to shareholders on a pro forma basis. So that's in addition to that, then we've added on to the opportunistic. Given the fundamentals that Bert and I have talked about up here, there's a lot of volatility in our shares for reasons that we don't know, and it will go in and take out shares when we see that as long as the fundamentals remain as strong as they are. I think as you look at what we're trying to do from a growth standpoint as a company, and we've had this slide in our investor presentations all the time, but is really to grow the nitrogen and hydrogen participation per share. We do that 2 ways. One is by growing the assets like we've done over the last decade and even what we're looking at doing with the Mitsui project here. And then two is by buying down shares. So we've purchased down on a split adjusted from our high of over 350 million shares, we're down under 200 million shares now with a new authorization out. And then additionally, on that, it's really our focus on free cash flow, which I think we deserve a lot of credit for. Our conversion from our EBITDA is almost at 65% of EBITDA to free cash flow. When you look at our CapEx, our CapEx is pretty ratable every year even with some of this growth with the blue ammonia. So our focus is really not only on buying back shares, but generating as much free cash flow as we can through a disciplined approach at cost, margin expansion as we looked at here with the 45Q, as Bert's team does with DEF and how can we add more to the shareholders and what they're holding from an asset base.

And I think no more questions? From all day without a question.

Don't be offended, not more.

Thanks, guys.

All right. Thank you.

Appreciate it.