Corteva, Inc. (CTVA) Earnings Call Transcript & Summary

Thank you, and good afternoon, everyone. My name is Adam Samuelson. I'm the agribusiness equity research analyst here at Goldman Sachs. Very happy to continue our Industrials & Materials Conference this afternoon with Corteva, the largest seed and crop protection companies in the world. From Corteva, we've got Greg Friedman, their Chief Financial Officer, here to present. We're going to do this mostly via fireside chat. So I'm going to be moderating Q&A after Greg does some prepared remarks. But I want to remind the audience that there is -- we want to make this interactive. There is a Q&A box in your webcast windows. We're happy to take questions from the audience and include in our discussion today as we move forward a little bit later. But with that, I'm going to pass it over to Greg, who's got some opening comments with some slides, and then we'll go into the Q&A. Thanks. Greg?

Great. Thank you, Adam, and good day to everybody joining the webcast. It's a pleasure to be able to participate virtually in the Industrials and Materials Conference. Very quickly, before we start, expectations for the future given today are forward-looking statements and are not guarantees of future performance. Certain risks, including those outlined in our SEC filings, could cause our actual results to differ materially. And reconciliations of non-GAAP measures mentioned today to GAAP measures may be found on our website and in the presentation where available. So with that, just last week, we announced our first quarter 2020 results, which reflected broad-based execution by our teams across the globe, which is captured on Slide 4. Organic net sales improved 20% with double-digit growth in each segment and every region in total. This was accomplished despite a very challenging environment given the global COVID-19 health crisis and shows the quick reaction and excellent execution by our teams as conditions change daily. Operating EBITDA was $794 million in the quarter, a 53% improvement over prior year, which also translated into operating EBITDA margin improvement of more than 450 basis points led by the seed segment. This was primarily driven by the strong start in the Northern Hemisphere planting season in both Europe and North America as favorable weather drove demand. In the first quarter, our Pioneer corn seed deliveries were up approximately 60% over prior year. In fact, in the final 3 days of the first quarter, we recognized approximately $100 million in earnings from seed deliveries to customers, and this pace continued through the start of April. This is clearly a different start to the year compared to 2019, and our results show that. The latest USDA progress report indicates we have 67% of corn planted compared to about 28% a year ago. In addition, we continue to see strong demand for new Crop Protection products globally, particularly our Arylex and Enlist herbicides and Isoclast insecticide, which helped contribute to the almost 60% improvement in new product sales for the quarter compared to last year. We continue to realize cost savings from merger-related synergies and productivity actions in the quarter, delivering approximately $70 million in earnings improvement. Although SG&A spend increased primarily due to increased commissions from higher volumes, we continue to see productivity as SG&A as a percent of net sales improved by approximately 260 basis points. Currency was a headwind in the quarter resulting in a $50 million negative impact to earnings, primarily due to the European currencies and the Brazilian real. Despite a strong start, we suspended our full year guidance last week, given the global health crisis and the disruptions it is creating across all markets and industries, which is highlighted on Slide 5. Most notably is currency where we are seeing significant disruptions. Looking specifically at the Brazilian real, when we issued guidance in January, we expected to use a combination of pricing and financial hedging to mitigate any currency headwinds assuming a BRL to USD exchange rate of BRL 4.25. In April, the market observed exchange rates that were, in some cases, 30% above our assumption. Next is demand for 2021 and what planted area will look like in North America. We said last week that a reduction in corn-planted acres could be in the $5 million to $7 million range, given the expectation of a high carryover from the 2020 season. Specific to Corteva, we're monitoring the impact to the fourth quarter, given the level of deliveries we typically make for the upcoming season for both safrinha in Brazil and North America. Despite these uncertainties, we still have good visibility on the first half and the completion of the season in the Northern Hemisphere. In March, the USDA issued prospective plantings which indicated 97 million acres of corn. And with the recent softening of commodity prices, particularly corn, there is likelihood that we could see that corn number come down. It is still too early to be certain on the exact acreage. But from what we are seeing and hearing from our customers, we still expect to see a strong corn crop this year with at least 95 million acres being planted. We have good visibility on pricing at this point for the half and are confident we will deliver low single-digit price improvements in corn globally. For soybeans, we are trending favorably to prior estimates for the first half and expect that U.S. soybean prices will likely be down low single digits. New product sales in Crop Protection are trending in line with prior expectations, and we would expect first half sales from new products to be up approximately $120 million, excluding currency. Overall, organic growth in the first half is estimated to be approximately 6%. For the half, we expect an approximate $150 million earnings headwind from currency. Turning to costs. For the year, we remain committed on the execution and realization of our synergy and productivity commitments and would expect to recognize approximately $115 million in the first half. Our cost of goods headwinds are playing out as expected, with an estimated $150 million impact for the year from increased unit costs due to lower corn yields and higher soybean royalty costs with about 75% of this headwind recognized in our first half results. In addition, we are initiating targeted spending actions across the entire organization as a result of the crisis. This is to both preserve cash and create more resiliency in our results. Through these actions, we expect to achieve annualized savings of approximately $100 million, partially offsetting higher commissions, with about 1/3 recognized in the first half. And lastly, on the balance sheet, we entered this crisis with a very strong balance sheet that continues to hold true in this environment. Just this week, we completed the issuance of $1 billion in long-term debt at very attractive rates, which furthers the financial flexibility and liquidity position for Corteva. We remain committed across the organization to take the necessary actions to drive resiliency in our operations during this crisis and to ensure we are poised to lead in the recovery. So with that, Adam, we can move to Q&A.

Great. Thanks, Greg, for that overview. So maybe digging a little bit more into the first half performance and with the spring kind of planting season now more than halfway completed, just maybe start just framing how you'd evaluate the success of the seed business within your franchise? How market share kind of mix performance of some of the newer products introductions on the Qrome and the Enlist side? And how you evaluate that today?

Yes, absolutely. So yes, clearly, we're off to a better start in the U.S. compared to last year. And that's really driven by 2 things: first and foremost, weather, and recovery in planted area as a result of that; and also, very importantly, strong execution by our sales teams and our supply chain. Our first quarter results are really a testament to the strong early demand that we saw from our customers who are really looking to get out into the field as quickly as possible after a very challenging year that they had last year in 2019. For the first quarter, our corn seed deliveries were up almost 60% over last year in our U.S. Pioneer seed brand. And during the last 3 days of the quarter, as I mentioned in my comments, we delivered $100 million in earnings, and that kept pace as we went into early April. So overall, we expect to see about 13 million acres coming back into the U.S. in 2020, 40% of that going into corn. And we're also seeing our pipeline really deliver and come through in terms of pricing, but also our product mix. It's our first full year of launching Qrome, and that's contributing to the overall 4% price improvement that we saw in the quarter in North America. We also are launching or have launched Lumialza seed treatment. And for the first half, we expect global corn pricing to be up in the low single digits range. So the first quarter did start out strong and the year is starting to play out nicely, which is what really gave us the confidence to guide for the half.

Okay. That's helpful. And so maybe taking that in the understanding kind of the decision to withdraw guidance. And you previously had been framing to outlooking for a $2.2 billion or so EBITDA outlook for 2020. First half in the U.S. seems to be generally pretty healthy relative to where you had been thinking it would be. Just thinking about the uncertainties you've called on FX on 4Q corn seeds, just help us think about dimensionalizing those a little bit in terms of where the incremental uncertainty is kept at?

Yes, absolutely. It is really 2 factors: currency, and within currency, really, the Brazilian real; and then the other factor being expectations of fourth quarter demand leading into 2021. So I'll take those separately. First and foremost, with respect to the real, historically, about 30% of our sales in the second half are originating from Brazil. So Brazil has a big impact on our second half deliveries. And as we sit here today, particularly for seed, we're in the process of meeting with customers and securing commitments for seed deliveries that we're contemplating in November and December. And ahead of that timing, we're making commitments to our customers with respect to volumes and price, and we're receiving commitments from our customers for the same volume and price. So given the fluctuation that's occurred, as I mentioned, just over the last 2 weeks, we've seen the real as low as BRL 5.30 and then yesterday it was well above BRL 5.90. Historically, we would not have seen this sort of volatility in currencies in -- even over the course of an entire selling season. So just the significant fluctuation there is part of the concern. So what we're doing, as we're securing these commitments, we're also looking at hedging this exposure, not something that our heritage companies typically did from a P&L perspective. But it is something that we're looking at from a hedging strategy standpoint. We anticipated coming into the year with some hedging strategies, but the volatility has been quite significant. So we're looking at ways to expand those. And as we further develop and are able to provide an outlook, we'll be doing that as time goes on. So that's really on the currency side. From a demand perspective, we -- you heard me say that our expectations are that will be at least 95 million acres of corn this year in North America. A lot of that has been driven by the rebound. But given volatility in commodity markets, specifically oil impacting gasoline, which, in turn, has impacted ethanol prices, we've seen the demand for corn used in ethanol to decline. And as a result of that, corn prices have declined as well. So there's an expectation that we may see 5 or more fewer corn acre -- 5 million or more fewer corn acres in 2021. And that will have an impact on our seed deliveries in the fourth quarter, both to our retail customers as well as our direct-to-farmer customers. So that impact is yet to be seen. And on average, as we look at next year's forecast and in fourth quarter deliveries, the 2 really are tied to one another, so until we have a good view of where we're landing this year. And then remember, as we sit here today, there is a North America corn season that still isn't yet completely planted. There's 2 seasons in Brazil that are yet to be sold and planted, the summer season and the safrinha season. All of those variables are important as we develop our demand plan for the fourth quarter and going into '21. So that was the key driver for suspending guidance, those 2 elements. And our commitment is to get back to you with the outlook as these elements firm up.

Okay. That's helpful. And there's actually -- related to the FX point, there's actually a question from the audience and really is thinking over the last 2 years, you've had probably at least $200 million of FX headwinds in the business. And if foreign exchange actually stabilized, which admittedly is a big if, do you think that there's capability to get that earnings headwind back through pricing and other litigation actions?

Yes. We would love to see a world where these uncertainties would stabilize. And in a case where you would see a reduction in volatility in specifically the Brazilian market and the Brazilian real. If we were to see the stability in that market over the course of the next 1 year or 2, we absolutely would be able to gain that back through pricing. Pricing for value is something that we continually do and we're able to get that back in price.

Great. That's helpful. So maybe switching gears a little bit kind of longer term. And I guess maybe first on the seed side, I mean, royalty expenses has been a big focus for the company. You guys have talked about a $750 million kind of impact flowing through the P&L. Maybe just help delineate that and the road map moving forward. How much of that extends on the soy side versus other traits in corn? And how do we -- what's the pathway to actually reducing that over time? And what are the key kind of levers that you can pull, whether it's discretely on Xtend and Enlist versus anything else?

Yes. Very good. So yes, as we look at royalties that we paid last year, in total, as a company, our royalty expense was about $750 million. And then we also -- as we came into 2020, we announced our focus on launching Enlist, and that launch would drive an increase in our plan for Enlist. And as a result, we would accelerate the amortization of some of these prepaid costs that sit on our balance sheet. So we actually have about $50 million of noncash accelerated amortization that we're going to see as an expense in 2020. So if you take that $750 million and you add to it another $50 million, you're about $800 million in total cost. If you look at the global soybean portion of that number, it's roughly 1/3 of that number. And as we expand our penetration of Enlist, we'll be able to reduce our sales of other products that contain royalties. So as a result of that, we will see our royalty spend go down. And as we launch new proprietary traits over time, like we just announced or we just received regulatory approval from China for Conkesta, so as we release -- as we are able to take new traits to market, again, those are other opportunities for us to reduce our reliance on third-party traits. So that's an important element for us, reducing our royalties. It's also an important area for us to pivot to generating licensing income. And we are in the process of licensing our proprietary traits. And we anticipate that by mid-2020s, that our trait costs and our net trait costs offset by trait income will be reduced by about half. And that by the end of the 2020 decade that we'll be able to reduce our overall cost by about half and offset that cost with royalty income. So this is all underpinned by our strategy for trait neutrality for Corteva. And the launch of Enlist, the upcoming launch of Conkesta is right in line with this strategy.

That's really helpful. And maybe sticking in the seed side, just how do you think about that medium to long-term pricing algorithm in seed? Do you see changes from some of your competitors in terms of the model give you any cause for concern? And similarly, there's some older traits that are going off patents that people seem to be pushing to push back into the market over the next couple of years? And how do you assess any risk from those moving forward?

Yes. I see here with the market, there's many changes that happened over time. But one constant over time has been competitiveness of products in the market. And our products tend to be the most competitive from a performance perspective. We tend to price at the top of the market, giving the level of technology that we deliver as well as the level of service that we provide. The yield advantage in our portfolio of products that we've quantified specifically in corn, average 6-plus bushel per acre yield advantage and -- versus competition and in soybeans more than 3 bushels per acre advantage. Our top yielding products tend to command the top position in the market and also the top prices. Along with our product sales, we also deliver a very important service that our customers utilize as well as some digital tools and, of course, things like replant and credit that are highly valued by our customers. But our product portfolio is constantly evolving. We turn over about 20% of our seed lineup each year with new genetics, the newest and best genetics that provide even better yield than the previous products. So on average, over 5 years, we're turning over about 100% of our product line. And this is all based on our Corteva germplasm, which is noted as best in the world. It's got a history of more than 90 years. And you see the advantage this year in new products like Qrome and PowerCore Ultra, which have some nice yield advantage and have been a key choice for our customers. So we see our ability to retain our pricing position and share our yield advantage with our customers in the form of price that we get, but our customers get the benefit of yield. And we typically set our price cards in the August-September time frame for North America. And there's a lot of the season to go between now and then before we can really comment on what pricing is going to look like next year. But what we do is, we dial in our performance this year, what we have coming to market next year, and all of that goes into how we eventually set the prices for next year.

Okay. I appreciate that color. So maybe switching gears and thinking about balance sheet and cash flow a little bit. There is a question here from the audience about how to think about your EBITDA to free cash flow conversion, both this year and in the future? And if you maybe just start there and some couple of others on the balance sheet.

Okay. Great. Yes, from a free cash flow conversion standpoint, we didn't provide guidance on 2020 earnings. And so we're not providing guidance on free cash flow as well. But there are some key elements that we are working on very aggressively that I think are important. First is spending. The first line of the cash flow statement is earnings and spending actions are -- that we're taking in light of the crisis is something that is going to serve us well. But we're also very focused on improving our working capital. And we have focused teams across the company focused on improving our receivables position. Our commercial team's working very closely with our credit teams to make sure that we collect our receivables and minimize our past dues. And we've seen really good improvement there year-to-date. On inventory, we have a number of inventory actions that are being driven across the globe. Our production and supply chain teams are really synced up with our commercial teams to make sure that we only produce what we are going to sell, the product's available where it needs to be available to customers and that we're getting it there at the lowest possible price. And then -- and of course, just focusing on lowering our overall inventory balances. And then on payables, we also have some very focused efforts around not paying early, but also extending terms with vendors so that their payments are on time. In addition to all that, we did announce at earnings that we were reducing our planned CapEx spend. Our forecasted CapEx spend was $500 million to $600 million. And last year, we delivered or we had CapEx of about $660 million. So we had already forecasted a reduction we just -- at earning. Plus we committed to spend approximately $500 million. So again, building some more resiliency in cash flow. That's about $160 million, $170 million reduction in CapEx for the year. So while we don't necessarily have a planned free cash flow conversion target for 2020, we are taking actions to really improve our cash flows aside from improving our EBITDA.

Okay. Great. And then I want to be sensitive to time. So I think this is probably going to be the last one. But just help us think on the balance sheet. Now that you stood up quick as a stand-alone company, what you think the right gross and net debt positions are for the business? And maybe in conjunction, how you finance the work -- the seasonal working capital needs? There's cash actually you need to keep on the balance sheet. And did the bond offering earlier this week, there was an illusion in the documents there to a potential voluntary pension contribution. Just any way to size what that could be.

Yes. Yes. Very good. Yes. So you mentioned seasonality, and seasonality is an important element of our balance sheet and is rather unique from a cash flow perspective. It's really driven by our customer-focused strategy and specifically in North America and -- which, as you know, is about 60% of -- or 50%, I should say, of our global revenue. But from a seasonality perspective, we typically sell in North America in the first half of the year and book receivables, while at the same time we're putting feet in the ground to grow to be delivered for next year. So as we progress throughout the year, the first 3 quarters tend to be uses of cash. And as we use the cash that's on the balance sheet at year-end, and we typically then go to the commercial paper market to borrow cash to supplement our needs for the first 3 quarters. And then typically, in the fourth quarter, it's a strong collection of cash period and we wind up having cash on the balance sheet. And net debt for us will tend to be positive because the cash on the balance sheet will offset any debt that's there. So right now, about $2 billion of cash is about the right balance that we typically will have at the end of the year as part of that program, and we'll continue to look at cost-effective ways to fund our working capital. One of those cost-effective ways was exactly what you were talking about here with our issuance of bonds just this week. And what we saw in the commercial paper markets was a slight dislocation where we weren't able to get the tenors that we needed and we also weren't able to get rates. Rates were much higher. Spreads were much higher than normal. So what we're able to do with this bond issuance was really swap long-term borrowing for short term borrowing. We were able to get a 5-year rate at 170 coupon and a 10-year rate of 230 coupon. So some very good rates that we were able to get for terming out a little bit of our short term needs. You mentioned that we said we would look at opportunities of making a voluntary contribution to the pension plan. That is certainly something that we're evaluating, and it's something that we'll continue to evaluate, the pluses and the minuses of. On the plus side, of course, you have tax benefits, and you also have the deferral of potential future cash payments. We don't see any need for cash payments now for at least a couple of years. So those are 2 benefits. But the downside is a use of cash. And right now, having cash on the balance sheet makes a lot of sense given the current economic situation. So that's how we're looking at it.

Okay. Great. Well, I think we're just about at our scheduled end time. So I think we'll stop it there. Greg, I really want to thank you and Corteva for participating. I want to thank everybody on the webcast for listening and sending in your questions. And I want to thank everybody for participating in our Industrials and Materials Conference. Hope everybody has a good afternoon and a great weekend. Thank you, everybody, and goodbye. Thanks, Greg.

Thanks, Adam.