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

Welcome. Welcome. Thank you very much for being here. Again, I'm Edlain Rodriguez from the Chemicals team. And it's my pleasure to welcome CF Industries to the conference. With us today is Brett -- I mean, Bert Frost, who is the SVP of Sales, Market Development and Supply Chain; as well as Martin Jarosick, who is the Head of IR. I mean I think Chris was supposed to be here, but he wasn't able to come. So...

That's right.

Thank you. All right. We'll kick it right here.

I mean, Bert, let's start with the current state of the global ag market. Again, it's quite strong. Farmers are doing extremely well. They're flushed with cash. Like what's driving that strength? And how long do you think that strength will continue?

So I think you're referring to the strength of the fertilizer markets. But it starts with the strength in the grain and oil seed markets. And what we're seeing globally is the classic supply and demand imbalance. And due to some restrictions on, I think, some lower applications of fertilizer in 2022 for yields in 2022 as well as droughts, we had droughts in South America, a little bit in North America as well as China. So limited on production, so yields were lower. And demand has been fairly consistent. And so we're seeing a stocks-to-use ratio that is very low by historical standards. And that is going to be exacerbated, we believe, going into '23 and probably 2024, maybe even longer. And so what has happened to that? You've seen a price escalation of those goods: corn, wheat, soybeans, cotton, canola, sugar, that are very positive based on historical standards. So to your point, farmers today have the resources to invest in their land and their equipment and other expenses. And so fertilizer demand, we believe, will be very strong as we try to replace and rebuild those grain stocks. There are some complications globally with the movement of products, and that is further exacerbating and creating a demand -- or a supply shortage on the fertilizer side. So we see some very positive steps going forward that will be a multiyear program for us.

Perfect. So let's talk about the nitrogen for the market. We know prices went through the roof late last year, earlier this year. Like high natural gas prices in Europe was a key driver of that surge. Like what has been the impact of natural gas prices in Europe? What has that done to fertilizer prices? And is the EU the marginal cost producer of nitrogen right now?

So when you look at the cost curve today, based on gas costs, which is 70%, 80% of the cost of nitrogen production, yes, the EU is the high-cost producer. Daily gas, just a few weeks ago, is fairly reasonable in the $10 to $20 range, depending on the day. That is since this week, and we believe for the forward, gone up to $30 to $40. So further distancing on a cost basis, the European producer. And so cost or production rates have been as low as cuts of 50% to 60% of the capacity that has attracted tons to be imported into Europe. And so you -- when you look at the European overall going into winter, again, with these high cost, we don't see how they can operate, that keeps the global situation for upgraded products, urea, UA and ammonium nitrate, very tight.

Yes, clearly. And one question we've been getting is like who is setting the price? Because it seems like ammonia and urea price, they're lower than the cost of production in Europe. I mean if you look at where gas is in Europe, likewise, it should be much higher, but they're not. Like what's driving that discrepancy between that cost of production in new overseas like the global prices we're seeing out there?

This is one of the anomalies, I think, in our industry. Because we're not a board-traded product, every day, every minute, you can look at the price of WTI, the price of Brent, the price of gas, the price of copper on a board. With fertilizer, that's not the case. And so there are anomalies as supply changes that's happened because of Russia-Ukraine or because of the lack of Chinese exports. There have been movements, supply movements of -- we're one of those, North American tons going to Europe. And so the absolute cost of production in Europe today, let's say, it's $1,500 for ammonia, well, we're trading under that. You're correct. And why is that? There are anomalies, like you may choose to lower your upgrade of urea and produce more ammonia. We've seen Chinese ammonia come out. And so there are different supply -- ways of supplying that shortage that we've seen at different prices. And so it won't trade at the -- and it hasn't traded at that absolute price. It's traded in a band slightly low to further below, but at an acceptable demand or band to make sure those tons are supplied to Europe and other places in the world.

Okay. Okay. And natural gas prices, of course, in Europe spiked especially during the summer. They have -- they came down for a while. But are we seeing more restarts of production as a result of those lower gas costs in Europe?

Yes and no. So again, this is a European phenomenon, where 40% to 60% of that capacity came offline, as I said earlier. But when you had the expansion of price for -- to attract LNG to Europe, we saw contracted tons that were maybe contracted to China or to India to other places diverted to Europe. And so the reservoirs were filled to a very healthy level, 90%, 95% of capacity, which hasn't happened in recent history. And you had very few points of importability, the U.K., Spain, had excess capacity to bring in and maybe piped to Europe. And so the daily price fell to a fairly low level for a period of time. Some of those plants were restarted, but today, that's not the case. Europe has about 2 months of capacity of storage of natural gas, and then with additional LNG coming in, can probably extend that period of time. But again, we're entering now the depths of winter, so we'll have to see how that goes. But I don't think those plants that have restarted are going to be able to continue to run during this period where gas is now $30 to $40, not $10 to $20.

Okay. And you don't think that's going to put pressure on global prices? Because I think this morning, we had -- we learned that ammonia prices settled down, I think, $100 or so. So do you expect to see more pressure on near-term prices or as a result of...

So we're in the shoulder season of South America demand being completed and moving to the Northern Hemisphere for spring demand. And that generally happens in June, July, same occurrence in November, December. So we're in a pricing low, but where the cost curve would dictate and where the price of natural gas is globally for again, that traded LNG ton and where demand is for the nitrogen product, we expect prices to increase going into Q1.

Okay. Perfect. And another driver of prices has been China. I mean China is the largest global urea producer. They have put a lot of restrictions on exports. Do you think that's going to continue into next year? Like what's that been doing to prices kind of? I mean, is that going to continue to tighten the market?

So we have seen, it's been an interesting for those who've been watching this space, we've seen a different China almost every year from the largest importer, maybe 2 decades ago, to the largest exporter a decade ago to these new policies of export restrictions. I think it's been a brilliant policy for the Chinese consumer of urea to have an internal price of Chinese urea internal to the country of $350 to $450, where the export price or the international price is, let's say, $550 to $800. So a very good way to control internal inflation and cost control. But also when you're consuming an energy importing an energy to produce an energy in the form of urea and exporting it at 0 value, it makes geopolitical and economic sense for the country to do what they've been doing. So our expectation is that the amount of tons that are coming out of China from a peak of 14 million tons of exports to today, 2 million to 3 million tons of exports to probably be the sustainable future for China.

Okay. And I'm assuming that should continue to tighten the market and support prices on a global basis, right? Okay.

There are many things. In terms of on the supply side, China, Russia, Ukraine, Europe that we've just articulated and other gas constraints regions that have been exporters in the past, we are in a tight supply market on a continued basis.

Yes. Exactly. And let's talk about nitrogen applications this year, I mean, in the U.S., especially. Clearly, there was a compressed season. Like is that all there was to it in terms of the volume decline we saw a little bit? Was there any demand destruction at all because of the higher prices we saw?

So a couple of things happen with demand. I would call it demand deferral, not demand destruction. Because this product that we produce, nitrogen, is consumed throughout the year, it's a ubiquitous product, urea, let's use that as an example, you cannot grow crops without that product or without nitrogen, at least nitrogen-consuming crops, not soybeans or beans. And so yes, there were probably some -- we saw movements between products. Urea was cheaper than UAN, so migration to that direction. And I would say in the single digits, we saw some economizing of product but that came at a cost, which is yield. And we -- as we started with, the global yields have been lower. And what we saw in Sri Lanka was a 50% cut when they decided to go organic and then riots ensued. So you have to properly manage your inputs to get your outputs in agriculture. And I think with the stocks-to-use ratios that we have in place globally for corn, wheat and consumable crop, human consumption crops or as a feed component are tight and price is up. And you're going to see a migration back to application, especially for those countries that are exporting a dollar-denominated good, like Brazil exporting corn or protein in the form of pork, poultry or beef.

Okay. And so did we see any yield degradation at all in the U.S.? Because, again, I think even in the U.S., volume was down a little bit. I mean, I think in the past, farmers are used to -- they can skip on potash or phosphate for a year or 2. Did they do that in the -- for nitrogen? And if they don't see any yield degradation, will that condition them to maybe, going forward, if we have to, we could take a pass for a year?

Yes, there's no agronomic way you can take potash for a year. So trend yield was projected to be close to 180 bushels per acre. We're trending -- we're coming in actual 171 to 172. How much of that was drought? We did have a drought in certain parts of the United States. And how much of that is nitrogen-related is debatable. I think majority of it was drought related. But we didn't see that big of a cut. We saw -- as again, we had probably a 10-year high of ammonia consumption fall/spring combined. So nitrogen was very positive for ammonia. We produced and sold everything we made. So we didn't see whether it was export or consumed. We didn't see a drop in our tonnage. And I don't think -- if it was a cut, it was single digits. And I think we'll make that up in 2023. And acres are projected to be up in 2023, so higher consumption.

And if there was a -- even if it's like a small cut this year, would that bode well for next year in terms of they probably have to increase application a little bit?

Well, again, stocks use ratio bode well for 2023 and 2024 for consumption and applications.

Okay. That makes sense. And so when you look at the state of nitrogen right now, what's the outlook for the next 12 to 24 months in terms of supply? Like are there many projects coming to the market? I mean like what does the supply look like over the next 12 to 24 months?

So there are 2 sides of that coin. Yes, there's going to be additional supply. Nigeria, India and China have plants coming on stream or have come on stream or are coming. But India is 60% supplied by imported natural gas. Today, that's again, $30 to $40. Do you import gas to make urea that cost $800 to $900? Or do you import it at $570 like they just did last week? It would say, economically, they should be importing that urea and forgoing the LNG. Then there are also plants that are slated to come online in Iran and Russia. And the question is will they get the technology and the licensing, because a lot of that fabrication takes place in Europe. So will those projects -- our expectation is they will be delayed because of the current situation geopolitically with both those countries against Europe and the other countries that are standing firm.

Okay. And I mean, one question we've been getting is like in terms of the Indian tender, it seems like the price was lower than some were expecting because it's lower than the cost of production in India. Like why would the tender be significantly lower than what they would cause the Indians to produce [indiscernible].

Well, I think India's done a very good job of buying, one. Two, they timed it appropriately in a week time in the market, two. And the functioning -- the way that tender functions with all these companies submitting prices and then they take the lowest price and then they offer that out to the other participants. And I think the participants looked at that and said, I have inventory like NOLA's weak right now by other market options, so it's a clearing mechanism. 1.4 million tons are cleared out of the market in a 3- to 4-week period, play for another day.

Okay. Okay. And before I continue like any -- if there is any question from the audience, we'll take some now. Okay. Not good. All right. So let's talk about -- let's shift a little bit about the new projects you're working on in terms of green and blue ammonia projects you're working on and talk about what's going on there. Where are we? And why they're so attractive?

Yes. So we have 2 projects underway, 1 small green project, and that's where we're investing about $100 million to add electrolyzer to our Donaldsonville facility. That will allow us to make about 20,000 tons of green ammonia. And that's an important project for us to gain access to the technology, operate it, learn how to integrate it into our production, how to maintain it and really sets the stage for the longer-term opportunity in green ammonia because today, the cost structure of the availability and cost of renewable power, the cost and availability of the electrolysis units, all those things are relatively high over time. General expectation is they will improve. But today, that's a -- that's not something that you'll see lots of incremental investment following that green project. Our bigger project and more of our focus is on the blue ammonia side. And what we have announced, a $200 million investment in our Donaldsonville project again to capture -- or we already capture the CO2, but we need to process that CO2 for transportation and sequestration. And so we're putting in the dehydration and compression to get that CO2 ready to go off-site. And then we recently announced a deal with Exxon, where they will take the CO2. They'll transport it to their property in Vermilion Parish in Louisiana, and they will inject it into a Class 6 well. And that will allow us to claim the 45Q tax credit off of that project.

Yes, that was the question I was -- next question, has the inflation reduction at make that project more attractive for you? Like has that changed the economics there?

It definitely has improved the economics of that project. I mean the old 45Q was roughly $50 a metric-ton of CO2 credit value. Under that scheme, the project was a favorable project for us given the cost that we incur to condition the CO2 and then the cost that we would pay our partner to transport and sequester. And so it made sense under $50. It makes even more sense at $85 a ton. And so that's a -- so you can look at $85 a ton, times 2 million tons, times 12 years, that's the life of the -- how much you can claim off of a project. And so it's an attractive return project, and it also is a big step forward in our own decarbonization efforts of our network. So that will take 2 million -- that's a real 2 million tons of CO2 that won't be going in the atmosphere, be going into sequestration. And that allows us to then market about 1.7 million tons of blue ammonia and work to develop the demand side for blue ammonia.

And how much of that $85 per ton credit you capture? I mean, do you capture all of it? Or do you have to -- are your partners going to get some? Like how does it work?

So the way it works is we're the party that will qualify for the credit. We're the -- because we're the capturing -- we're capturing the CO2 in our process. And that's something that's already built into making ammonia. And that's what makes ammonia a little bit different or, I guess, a lot different from other processes, in that we're creating this CO2 in a controlled chemical process. So we already have hundreds of millions of dollars invested in all of our plants to separate the CO2 from the hydrogen in the first step of the production process. It end up with a highly concentrated large amount of CO2. So we don't have that much further to go to get it ready for sequestration. And the other industries where you're starting with a combustion CO2, much lower concentration much more expensive to capture that CO2. So the credit stays with us. And this, what you'll see in our -- it will be a deduction in our federal tax cash taxes. And then we'll pay our partners, and that will show up as an operating expense.

Okay. Okay. And so that blue ammonia and all those projects being worked on, that's going to go for fuel, right? So if the fuel market becomes like such an attractive market for ammonia, is there going to be like a battle between fertilizers and fuel in terms of who gets what and who gets that ammonia? Like how does that work?

I think we look at it -- you do see new use cases for low carbon ammonia in co-combustion of ammonia in coal-fired power plants. So you can displace 20% or more of the coal and a coal-fired power plant and replace it with blue ammonia. That is -- that's a use case. The marine industry is evaluating ammonia as a fuel to displace bunker fuel and decarbonize global shipping. Those -- so that, in effect, will be new sources of demand. And so the demand growth rate for ammonia of any color would increase as those demand sources develop. And does that tighten up the ammonia market? It probably, in the immediate term, you would see a tightening of the ammonia market.

The whole blue growth and the investment is good for so many categories. One, it's the right thing to do, and we're excited about that. But it's -- there will be, as other products, economies and end users decarbonize their portfolio, whether that be ag, industrial and all the different segments of industrial or finished products, it's going to be good for all seasons. And so we're investing accordingly, not only for the 45Q, not only for the co-combustion but for the areas that Martin articulated and that we're already working with other customers for future demand. And then yes, it does. It does compete. That molecule has to compete for amongst the upgraded products or just for ammonia.

And as more of that demand continue to grow, like is there enough supply to meet that demand growth? Or somehow are we just going to have to, I don't know, accelerate the supply equation?

Well, I think you're seeing, as the demand side, I mean, it's a little bit of a chicken and egg problem, right? Producers don't want to build spec supply, not having any demand to show for it. And the demand side doesn't want to make their investments to not have a supply because it's particularly for power applications in marine, it can only be a low-carbon ammonia. It can't just be regular ammonia. So they need to kind of match up with -- and that's what -- I think that's what you're seeing as the market is developing. You have -- we have announced a joint venture project with Mitsui. It's effectively 52-48. And we're evaluating building a purpose-built export-oriented blue ammonia facility, which would just be an ammonia facility and a dock, and it would direct that blue ammonia to those markets. And there are others who are working on similar projects. And I think what you're seeing, you're seeing the partnerships of entities that kind of represent the demand side of the equation and then producers like us as the other side of the partnership evaluating projects. But ultimately, I think the product -- they kind of have to -- you have to link it and then they'll come on together because you don't want one side getting way ahead of the other. Otherwise, it stalls out.

Yes. That makes sense. So clearly, the nitrogen market is very strong. You have a favorable outlook for the next couple of years. Cash flow generation has been significant. And if the market stays like this, should continue to grow going forward. What are the key -- I mean, I know Chris is not here, but what are the key priorities for cash? Like what are you thinking of in terms of capital allocation over the next 2, 3 years?

I think the last year kind of illustrates where our capital allocation priorities are pretty well. So over the last year, we paid down $500 million of debt. And that finishes a debt reduction program and a fixed charge reduction program that started in 2017, where we had about almost $6 billion in debt and a high level of fixed charges based on the interest expense of that debt. We've paid that down now to $3 billion of gross debt, and that's a comfortable level for us. We're back to solid investment-grade ratings. So that $500 million pretty much completed that debt reduction program. We also increased the dividend by $0.10 a quarter. So that's a 33% increase. But it's still -- our dividend yield is not -- we're not setting records. We don't want it to be so small that it's de minimis, but we're always mindful. The dividend is, in our view, a fixed charge that we don't want to be in a position somewhere in the future where we need to look at changing that or lowering that level. And then over the last year, we've repurchased $1.6 billion worth of stock and taking out about 20% of the share count. And we now have our share count down to its lowest level in our history. So from its peak of 2010 or '11, I think we're off 45%. So we have a long history of using the share repurchase program as our main vehicle for returning capital to shareholders.

So is that still going to be like a priority going forward? Like, I mean, again, the stock wise has done extremely well. You still take share buyback is going to be a tough priority.

We always look for opportunities to grow the business. The organic opportunity that we talked about with Mitsui is a good example. We look at inorganic opportunities that just usually aren't a large set of actionable inorganic opportunities. And so over time, the share repurchase program is -- it's a variable return of cash, so it fits our profile as a cyclical business and that we can turn it up and turn it down as our cash flows change throughout the cycle. And we have a program in place that is both a ratable return and an opportunistic program. So you will see differences from quarter-to-quarter in the amount of share repurchases because we would like to get as many shares as we can for the same dollar authorization that we have from the Board. And so we started a new $1.5 billion program. This year, we've -- we're about 75% of the way through it on our last earnings call, and we also got a fresh $3 billion authorization from our Board that will start once we finish up the current authorization.

Martin, you talked about inorganic opportunities. Like are there any -- like in terms of M&A, anything probably not in the U.S. but outside the U.S. that would get you excited? Yes. And will CF ever be, I guess, like a not pure natural in a company in the future?

When we look outside the U.S., there's a number of criteria that we would need to meet in order to find something attractive. It needs to be in an area where we can operate and we can operate freely the way we operate as a U.S.-based company and all of the requirements of being a U.S.-based company, being able to move cash in and out of that entity and not have it trapped. You would want to see some connection to the network so we could extract synergies. So it's -- right now, I mean the U.S. assets are some of the best in the world. By comparison, it is a -- it's harder to look at outside assets and you can get extremely excited. But there's always a value calculation that we would do in that case.

That makes sense. And I mean, one in terms of -- maybe actually before I go in, like anyone has any questions...

[ Fernando ] , please. So obviously, as you just mentioned, U.S. assets, natural gas, you have an incredibly favorable position. And so I understand that, obviously, the U.S. is sort of supplying a lot of what couldn't get to Europe otherwise. And maybe there's some additional capacity coming on, it will be years out, 25, 26 to maybe to sort of export more maybe in the future, there's less of a differential between like U.S. and Europe gas prices, but some time out. I'm just wondering how you guys are thinking about that from sort of a medium- to long-term strategic standpoint. I mean you're in an excellent place now. The runway for years looks excellent. Is there going to be a more global price for natural gas that you see? Or do you have any visibility on that just in your channels and connections?

For the first time, really, in the last few years, there has been a global price or a global communicated value. Yes, it's traded on the JKM or TTF or NVP or Henry Hub. But a lot of contracts have been put in place to take the molecules that are available, whether that be Qatar, Australia or the United States, the major exporting regions. But regarding LNG, there is today a limited number of facilities to put that product on a vessel and a limited number of vessels to move that product globally. So you're at 50 Bcf roughly of product available to move again, under contract. And so now this is speculating the forward demand, but with the desire to decarbonize and improve global climate issues, and so you think that then coal consumption continues its decline. The one product that's available today to replace that is LNG. And so demand is accelerating at a greater rate than supply is available. And the timing to put those facilities in place, whether that be in the Gulf Coast or again, other places, is 4 to 5 years. So the question is what will the gas molecule from some of these originating sources be used for ammonia or LNG. And today, LNG is a better return than building additional fertilizer capacity. So our expectation is that it grows, but it grows at a slower rate than demand and that energy differential, whether that be Europe or Asia is at a higher rate than has historically been the case, and that sets up a very positive operating environment for CF as a North American producer.

So coming off of the highs where we are now. But the question is where does this set allow? And you see some of the constraints on LNG to get release and with all the capital that's required to go into the LNG from development of the deals, [indiscernible] shifts, regas, storage on the customer side is some of capital that all has overturn. Otherwise, it stops, it doesn't grow. And so that provides that differential that's fairly between producing region and the [indiscernible] importing region. And so that -- what that gap is going to be presumably in our view is going to be wider than it has been over the last decade different between [indiscernible] versus [indiscernible]. It is very wide right now is probably a little bit impressed the investment structure show up go to Europe all those LNG projects or are out of money in questions.

And you've got to move this stuff, right? And there's a cost of that.

Yes.

Any last question? I mean it looks like we're right on time. Again, really appreciate you guys for doing this. Again, Bert and Martin. Thank you very much.

Thank you.