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

Good morning, everyone, and welcome for coming back. I'm Ben Theurer, Head of the LatAm Equity Research, but also in terms of the Americas agro business which include thing around agriculture here at Barclays. I'm very pleased to have with us now CF Industries, which is core businesses manufacturer of ammonia, one of the world's largest users of this compound. The company's products included Ammonia, Urea, UAN, Ammonium Nitrate as well as Diesel Exhaust Fluid. Those are CF products are sold as fertilizers with its operations, mainly North America and small facility in the U.K. We're very pleased to have with us CF's CFO, Chris Bohn, who spent more than 10 years at CF already, having held various roles, CFO back in 2019. Thank you very much for joining us. And maybe to kick it off, obviously, you reported results just last week, shared the outlook for a year or so. What do you think are the key events for 2023 investors should look for?

Yes. So as we look into 2023, I mean, we are definitely seeing a recovery in some of the demand deferral or destruction that we saw back in 2022. So we're very optimistic about the demand profile globally with application. We also are seeing the continuation of really strong agricultural fundamentals. So we've talked about over the last several calls that we've had that we see low stocks to use on all the major crops globally. And as a result of that, continuing application of nitrogen, which is a non-discretionary product that goes down in order to increase the yields and replenish those stocks, but really, where we stand today, we see that as a multiyear cycle. And as a result of that, you're seeing really strong fundamentals in the crop prices with corn over $6, and that helps provide a very good economic incentive for farmers to apply. And some of the events that occurred in 2022, we're not expecting necessarily to occur again this year. So just to maybe touch on those from more of a macro level. Last year, in 2022, we saw urea pricing, the most globally traded fertilizer hit $800, and then go to $600. And then earlier this year, it was at $300. It's now since closer to $400. But last year, when we were at the $800 level, it was still extremely profitable for like Tier 1 countries. Those are countries that have large agricultural complexes or that export a significant amount of the crop. So they were importing fertilizer and dollar-denominated, exporting crop and dollar denominated and doing very well. There's more of those Tier 2 and 3 countries where it was more regional farming, smaller farming, where at $800 to get the credit to buy urea, they were -- we saw some demand destruction there of anywhere from probably 15% to 30% in those smaller. Now it's not big on the scale of the overall nitrogen consumption annually, but it's enough to tip it a bit. That, along with part of the global recession fears last year, specifically in Europe, where you did see industrial demand pull back quite a bit. And as a result of that, you had a little bit of, I would say, demand contraction and a little bit of a deferral. And then you had also at the same time, our industry, generally, when supply comes on, it kind of comes on in larger slugs. And we saw about 5 million tonnes of additional urea production come on last year, primarily in India, Nigeria, and Bahrain. And as a result of those, what we began to see is some softness then in the market and consumers almost waiting to buy as it sort of ticked down. Well, now this year, we're about to enter the Northern Hemisphere application season. We're seeing great soil moisture given some of the storms that are going through, the rain we had out west. All the snow out West. So our expectation is that we're going to see a really robust application season. And the narrowing of that particular season is going to be probably the bigger challenge here to get the product out to the customers.

Have those Tier 2 and 3 countries customers actually come back already? Or do you expect them to come back within the next couple of weeks? Just because you said 1 was still strong last year, but the Tier 2 and Tier 3 kinds?

Yes. I think the Tier 2 and 3 events, if you're not applying nitrogen, you are going to have a yield effect, right? So at a price point of $800 or $600 a year, it was understandable why they stepped out. I think now being closer to the $400, which is more where we were prior to some of the run-up, we will see that demand come back in along with also a little bit more industrial demand coming back. I think people may not believe in a soft landing or anything, but maybe are more used to the specter of a global recession than they were last year. But I don't know if you have anything to add to that, Martin?

I mean, some of that demand that was lost last year is not coming back because the those crops have been planted, they were not fertilized. It's going to result in a low yield and that will increase the pressure on global grain stocks. But going forward, for future plantings, there's much more affordable not only in the Tier 1 countries, as Chris mentioned, but in Tier 2 and 3.

Yes. I mean there was obviously a change in like kind of the buyer psychology and like just wait because of what you've seen more recently it was like, okay, next week is going to be cheaper than this week, and then it got cheaper. And then obviously, buyers were just like holding back. Have you guys seen that now that prices have kind of stabilized holding up a little better? Are you seeing activity? And how do you think buyers are actually going to go forward into future purchases? Is there similar wait-and-see mode? Or would you expect there's going to be more activity as we settle around the prices that aren't this?

Yes. I think if you look, when prices were high in the back half of last year, a purchaser, a farmer doesn't need the product necessarily at that particular time. They need it in the springtime. So for them to have the sort of wait and see, they can do that towards the back half of the year. But when application season, which we're entering here really even in Texas and Oklahoma, you're starting to see application go down. There's only so much time they're going to get the product down. I mean we're at $6 a corn. This is extremely good financially for the farmers at this particular. So we have all expectations. Our team was just out at the TFI Conference last week in California, meeting with customers and other producers, and there was definitely more optimism about the season. I think where you start to get is the narrowing season is in order to get the product in place. Remembering North America, U.S. specifically is an import-dependent market. So you have to bring a vessel from some place out in the world, offload that product, get it up to Mississippi to get it to the Corn Belt in the Midwest. All that has to happen prior to the farmer wanting to put down application. Our site is located here in North America and our distribution system allow us that if a narrowing season, generally, we're able to get the product to our customers, but a lot of times because they don't -- the opportunities of getting additional imports in is delayed bodes well for us in the efficiency of our production network.

Okay. Sticking within like just the global trade and the necessity of imports and exports. I mean we've obviously seen some countries on the restriction side, China in and out to switch on and off. How do you think about just like the global supply in general and how it might impact trade flows given some of the restrictions that might be put in place?

Sure. Starting with China. If you look back at where their export restrictions were put in place, that was October 2020. And that was the period where natural gas outside of North America really started to take off and fertilizer prices moving up with it. So that policy was put in place for 2 reasons. One is to ensure available supply for Chinese farmers to ensure that their domestic farmers have a fertilizer to fertilize their crops, and also to avoid inflation in their food costs. The price in China since October 2020 has been roughly $400 to $450 a tonne -- for urea, even as Chris mentioned, the price outside of China was above $800 for a period of time. So Chinese farmers did not face those crisis. And so that food inflation impact was avoided in China. So from that perspective, it was a very successful program and accomplish both of those missions without negatively impacting the domestic industry. At $400 to $450, the domestic Chinese producers were profitable and they were able to sustain their businesses. So where we go going forward? Today, the price in China is actually a little bit higher than the global price. And so the incentive to export is not there. But we would see a modest increase in Chinese exports, maybe back to the 3 million to 5 million tonnes, if all the restrictions were lifted and if the profit was there for exporting.

Yes. And if not, we would see it very similar to last year, which is sub-3 million tonnes of exports.

And then obviously, the other side, just within -- on the production side, Europe has gone for a lot of volatility, ups and downs, capacity curtailments temporary. You shut down 1 of your facilities. What do you expect in terms of capacity coming back on now that the price over in Europe has more stabilized?

Well, I think our plant in Billingham is a pretty good proxy for Europe. And we have, as you mentioned, curtailed the ammonia production, and we're importing ammonia from our Donaldsonville facility. And the reason we're doing that is because it makes a higher margin doing that and starting the ammonia plant back up at $15 to $20 gas. So even where European producers are today, our expectations are those that are down are probably remaining down during this time frame. When you start up a facility after a cold start you're going to burn several million dollars worth of gas and the heat up of the overall system. So as a producer, you have to make a few decisions here. One, I'm willing to burn those couple of million dollars to bring the plant back up, because I believe gas is going to remain at the level it is right now. But more importantly, product prices are going to be higher. Well, as a producer, do you want to produce, call it, $17 per MMBtu product that may be sitting until the fall or even into next year. And so you have this working capital sort of dilemma as well is not just the start-up cost. So our expectation is right now, and it's pretty much just the best information we can get. We think about 30% is curtailed. And our expectation is that continues to be that way, just even given while there's a flattening of the European gas curve, it doesn't mean that it's necessarily low. That it's still significantly high compared to historical levels.

Okay. Got you. Now if we think about it, how CF has involved over the last couple of years, and obviously, you have different projects aligned using your asset base, seeing big opportunities on the clean energy side. So maybe if we just fast forward 3, 4, 5 years out, where do you see CF and particularly in light of some of the new businesses you're looking into on the clean energy side, blue ammonia, green ammonia, just to kind of level set? Maybe the next topic I then wanted to go into on just clean energy.

So I think what we see over the next few years is definitely a continued strong agricultural market. As we mentioned, basically where the global grain stocks are. It is going to take multiple years in order to replenish those. And in fact, with what happened last year, it sort of kicked that even further another year or so because of the yield, the yield destruction that Martin talked about. So our expectation is the base business related to agriculture is going to be strong for the next several years. The industrial side, you're also seeing a little bit of onshoring back to the U.S. with industrial. So there's a lot more activity with some of our industrial business, whether that's through nitric acid or through diesel exhaust fluid as we're seeing an expansion from that in particular. So the base business, as we look at it, we see being very strong, generating a lot of free cash flow with very modest CapEx that we see over the next several years. From moving into the clean energy, it sort of dovetails very nicely. As you mentioned earlier in your opening remarks, our asset base really can handle conventional ammonia, green ammonia or blue ammonia. And we don't have to do a lot of CapEx to get some of those incentives or to get the blue ammonia. And so the way we're looking at it is very strong base business, incremental demand in new businesses beginning to develop. That is clean energy as -- or clean ammonia as a fuel going forward. So we're very positive on our outlook and the opportunities that are coming our way because of sort of that slight pivot in our strategy as well is quite encouraging.

You've made several announcements and one was very recent with JERA, which is obviously still future out, but it's about the supply of clean ammonia. And just help us understand a little bit the demand that you're seeing out there and also what are like the tax credit implications you're getting from it, just to understand a little bit the financial.

So we announced an MoU with JERA , who's the Japanese largest utility provider. And what they're working on right now is doing testing of coal firing of ammonia, with coal to reduce the carbon emissions of their utility plants over there. So if those tests were to be successful, you would see probably incremental demand that we are talking about before the end of 2030 of upwards of 3 million tonnes in Japan. And you're seeing other Asian countries that are sort of looking at that where we would expect to see demand growth in there, whether it be Korea, Indonesia, Thailand or whatever, there's -- JERA is also active in those particular areas. So we're really excited about that. That would be blue ammonia that we'd be sending over. And to your point, with the inflation Reduction Act with the 45Q, which gives you a tax benefit to sequestrate CO2, and that was enhanced from $50 per tonne of CO2 to $85 per tonne of CO2. We announced the deal earlier this year with ExxonMobil, where we would be giving them the CO2 that we already capture and remove from our process for them to sequester it down so that we'd get that $85 benefit of the 45Q. So that particular project and others like that through our network, we're really excited about because it's pretty small CapEx. If you think of an ammonia plant, ammonia plants bringing in CH4, so the natural gas and you're splitting the carbon from the hydrogen and the hydrogen we use, but that CO2, we already removed. So it's not as if we have any incremental investments for CO2 removal, like other chemical companies would have to do. So we're sort of hundreds of millions of dollars of CapEx that we don't have to spend. And then with the 45Q, we're getting the benefit of taking that CO2 that we've already removed transferring it to Exxon and sequestering it. So really excited about those programs. And sort of the opportunity of that 45Q enhancement and what that opens up to some of our other plants that are net long CO2 as well.

Then you have -- I mean, you've talked about some of the project developments in Louisiana, but then the Donaldsonville project that's also ongoing. Where do you stand right now? What's like pending on the time line here? And how much capital do you entail to develop over there in the coming years? And how should we think about that payoff structure as well, just as we talked about this?

For the green ammonia project at Donaldsonville. So we announced 18 months now, that we're developing the first commercial scale green ammonia facility in North America. The electrolyzer is -- has been built. It will be coming over soon and installed, and we should be producing close to the end of the year. That project is $100 million, and it will yield 20,000 tonnes of green ammonia.

And on the blue side, as I said, our infrastructure is largely in place. All we have to do is put in dehydration and compression. And that's a $200 million investment that we expect to be transferring that CO2 to Exxon in 2025.

Got you. Now one of the things, and you've talked about it like U.S. being importer, product comes in Louisiana have to ship it up to Mississippi. Obviously, we're seeing more and more extreme weather events, and we had drought and the Mississippi was actually on low water. We have other countries with rivers and low water. Has that to any degree impacted your business? Or do you -- do you foresee any impact from like just a more extreme lever on your business as it comes down, particularly the logistics piece of it and the need of river shipments?

I'll start. I think it goes beyond weather. So you had COVID, where there's the risk off. You had the war going on in Ukraine. And many other geopolitical events going on that affect all global commodities, not only fertilizer. So I think there's been so many different elements that have played out that go beyond sort of the natural weather that we've seen that you mentioned there. But the 1 benefit CF has that really differentiates itself from others in our industry is our distribution network and where our sites are located. So we're shipping up. We shipped quite a bit of product from Donaldsonville up into the Midwest where we export it depending on where the margin is the highest. So we'll make those decisions pretty much on a daily basis. But at Donaldsonville, we can move product through all 5 modes, whether it'd be ammonia pipeline, barge, truck, vessel or rail. So we have so much flexibility to get the product. So if the river is flooding or at low levels, we're able to transport it through different areas and also location in the Corn Belt where our sites are. So generally, historically, what we've seen is when we have major weather events and even some of these geopolitical events, we are positioned much better than everyone else, and it actually works to our advantage to flex those investments that we've made previously in order to get the product to our customers. And as I talked about, a narrowing fertilizer window here to get product to customers. I think it's the same thing we'll flex that system again to ensure our customers have their product.

Which brings me back to just a strategic, better positioning and having a focus obviously in a lower cost feedstock cost environment here in North America. We've seen though the differential to the European and Asian feedstock price and nat gas, in particular, come down a little bit. How do you think about this price differential structurally go forward, like not for this year, but the years out. Do you think there is going to be a wider gap than what it used to be for much longer? Or do you see the price differential that gap to narrow as European and Asian countries kind of stop fighting for nat gas and LNG developments?

Well, I think as you look at Europe, you can't have that much of supply to be renewed from Russia. And not have particular energy issues going forward. Renewables just aren't there and they're not as reliable as well as we're seeing on a daily basis. What the TTF does is based on sort of the wind demand and everything. So that being said, I think that you are going to see a little bit more of an expansion versus the normal of what that delta was, which again, given that we're an import-dependent we believe Europe is going to remain the marginal producer. I think they're going to look for a lot of different energy portfolio moves, one of which will probably be clean ammonia or low-carbon ammonia being burned maybe at the coal plant, similar to what happens longer term. There's definitely more interest we're hearing on that. But my belief is that we will continue to see that spread be wider. And I think even if you look in the near term right now, Europe had a very warm winter, high wind, so their stocks are almost 70% filled right now, but that's only good until we get to fall. And then it's kind of a reset, but if you look at the TTF or even the NBP, it's kind of flat. So there's this limited risk premium that you sort of wonder why that's not built in. So I think we'll see shorter term and expansion happen later this fall, and then probably longer term more than historical.

Okay. Perfect. Before I get into the last question, can we put up the slide for the audience question, maybe. There we go. And we just go through that. As I just come to the last question before we open up. Capital allocation, you have very strong free cash flow last year, obviously. And you still have a couple of projects coming up. We're still in the pipeline to need to finance. How should we think about the priorities between CapEx, buybacks, dividends for '23 and maybe a little bit beyond that?

I'll let you start on that, if you want?

Sure so if you look back over a longer period of time over the last 10 years, we've really done all of the above. We have increased the dividend. We don't tend to focus on the dividend as a key mechanism for returning capital. And we've invested in new assets. And as Chris mentioned, we've got a slate of investments that we're working on now, and there's a potential new build that's going for FID later this year. But after paying for the growth investments, we have excess free cash flow in the last few years, and we expect to have it going forward based on the market conditions we've discussed and our primary mechanism for returning capital is through share repurchases. Last year, through dividends and share repurchases, we repurchased almost -- we returned almost $1.7 billion to shareholders. And we also paid down $500 million of debt last year. And we're at our kind of our long-term net debt position of $3 billion. So going forward, we don't see incremental debt reduction. And so that really allows all the free cash flow to be directed towards value-creating growth opportunities and for shareholder return.

And I think just to add on to that, as you look at it, the one thing we tried to do very much over the last 5 years is get more ratable fixed charges. So our CapEx isn't going up or down. And if you look over the last few years, it's generally between $400 million and $500 million. And even with adding growth projects, whether it be nitric acid or even these low-carbon ammonia projects, we're still in that band. So it really goes to the asset suite that we're starting with and sort of where we're partnering. We're trying to be disciplined. The Exxon deal, the Mitsui deal, the JERA deal is to utilize where our strengths are and the partner where we need additional strengths to provide the highest return. So with that, having sort of that ratable amount, as Martin suggested, our idea is, given the fundamentals of the business that we're going to have significant capital that we will be returning to shareholders over time.

Okay. Perfect. With that, I mean we have close to 3 minutes left. If someone has questions out of the audience. I guess just wait for the mic to come, and then we can also run the other questions, please? Just over here. Second row.

Can you talk about anything that's changing in the regulatory environment and things you're going to have to do to respond to changing regulatory issues?

Yes. So from a regulatory standpoint, I would say it's really a question of where we're participating in the world. So as you look at Europe and even Canada, they've put on carbon taxes, which are -- continue to grow and are pretty significant. When you look at the U.S., it's more the JERA. So whether it be the IRA or the Infrastructure Act, and those are really the 2 areas of difference. I think also what we saw with some of the antidumping in Europe from UAN that put tariffs on us on there, that we're hoping will go away at some point, but undecided as to if and when that will occur. But I would say the major regulatory pieces for us, we're really taking the steps by doing our decarbonization strategy. And like I said, I think how the U.S. is handling it is really getting the private sector to react more quickly with the caret rather than sort of incremental carbon taxes increases that you're seeing in Europe. One of the reasons why you're seeing some of the European production down to that we didn't talk about, not only high gas cost, but on top of that, each tonne of ammonia produces about 2 tonnes of CO2 and the carbon tax on a tonne of CO2 is almost EUR 100. So you're adding all these incremental costs to almost cause the industrial to have some issues versus what's happening here in the U.S.

So if I would have told you in '19 -- in 2019 that you would have -- when you did $920 million in free cash flow that in 2022, you do close to over $3 billion. You would have been probably surprised. But as you look forward, the Street facility isn't expected to do that level for the remainder of the decade. How do you and your team get comfort with returning to peak cash flow and peak profitability like you did in '22?

I think 2022 was an absolutely phenomenal year. So I think assessing that and saying that's where we're going to stay forever. I would agree that there's a lot of elements that played to that. But I think as we look at this year, I think there's a couple of things in our share price that aren't always understood. One, about 20% of our book is industrial, very ratable business that goes off -- and then it's really to look at the underlying agricultural fundamentals. Like I said, the global stocks to use is very low, and that's going to take years to -- in order to replenish yet our share price from time to time seems to trade based on an illiquid barge that trades between 2 traders down in the Gulf, and that's what we're being determined on. So what we're trying to do is really educate people that there's a longer wavelength here on the ag cycle than maybe what we've had historically. And then in addition to that, there's also this coming wave of incremental demand that is going to be more industrial and ratable and provide sort of, I'd call it, a skin of profitability that has a set return, but is something that our sites are just ratably producing and shipping out. And I think that's really the bridge between those 2, a strong ag cycle over the next few years, and then this incremental demand that we truly believe is coming. And the limited amount of investments we have to make in order to play in that particular part is where, I think, as a CFO, I look at and get a little frustrated that there isn't a little bit more of a growth multiple put baked into our longer-term share price. So as we've said on our call and said before, we believe we're undervalued because we see what's happening in the short term, the medium term and the long term, all is very positive.

Perfect. Thank you very much, slightly over time. But Chris, Martin, thank you very much for coming.

Thanks, Ben, for having us.

Thank you.