FMC Corporation (FMC) Earnings Call Transcript & Summary

Thank you, everyone, for continuing to join us here at Goldman Sachs Industrials and Materials Conference. My name is Adam Samuelson. I'm the agrobusiness and packaging analyst here at Goldman. We're going to continue our session today with FMC Corporation. We're thrilled today to have Andrew Sandifer, their Chief Financial Officer, here for a fireside chat. Zack Zaki, who heads their Investor Relations efforts, also here in the front. I'm going to jump right into questions, but we're going to have questions -- microphones circulating in the room. So look forward to taking questions from the audience as we get on -- get a little bit later. But Andrew, thank you for being here. So I think what stands out with FMC when you reported last week, but relative to a lot of other cyclical end markets, the ag market is not depressed and is definitely seeing a period of strong demand. I'd love to hear you reflect on -- maybe just talk about the environment as you see it today coming out of the first quarter, how different kind of geographies are performing and kind of some of the puts and takes as you think about 2022, but on the top line and on the cost side.

Sure. Nice broad range of questions there to get started with. First, thanks, everybody, for joining us this morning. I think certainly, I'll start from this. I think we at FMC are very excited about the favorable backdrop we see for the ag input sector, broadly speaking, that's lining up not only for 2022, but potentially for several years. We've got very high crop prices historically, low inventories of materials. Due to unfortunate events in Europe with the Russian invasion in Ukraine, we have some of the world's most productive acres, at least being underutilized, if not taken out of production. At a time when food security and security of food supply is becoming much more of a front page news issue. So all of those stars aligning for what I think a very favorable backdrop for ag inputs and for crop protection chemistry, in particular, where there's a need for growth and output from agriculture and a limited amount of acreage to put into production. So it really comes down to driving down increased productivity per acre or bluntly, as we say, our business isn't selling kilos. Our business is selling yield. So the opportunity for a business like FMC and in crop protection is to help growers bring more productivity from the acres that are in production. I think a lot of reasons and certainly, we can put down Adam as is useful, to believe that, that is a multiyear trend, not just a single-quarter trend. Now I think as you teed up, Adam, we did have a good start to the year, 16% organic growth at the top line, 16% EBITDA growth and 23% EBIT EPS growth in the first quarter, certainly aided by a little bit of early ordering where we are seeing some concern about availability of supply, particularly customers in the Americas, but generally, a very strong quarter around the globe, very, very favorable conditions for our business in the Americas. U.S. have some very strong growth of new products, about 30% of our sales in the quarter in the U.S. and North America -- U.S. and Canada, were products introduced in the last 5 years. We had a very strong quarter in Latin America as well, good growth in insecticides and herbicides there. Europe, despite the beginning of hostilities actually had a fairly solid quarter, unfortunately masked by FX weakness, particularly the euro, but also the Turkish lira. And then Asia, also some very strong spots of growth with Australia, New Zealand and the ASEAN countries, in particular, a little bit of easing in India where we had coming out of the end of last year, some dryness drop in rice acreage. But overall, I think that favorable backdrop globally is a recurring theme around all other regions with the big unknown from a demand perspective just being the implications of the political situation in Russia.

Okay. Well, maybe we can dig into that a little bit. Maybe starting -- stay on the top line for now and then we'll get some of the cost questions in a little bit. But so we take -- you alluded to it just now, the idea of preordering and concerns about -- around supply chain. I mean is that really a U.S. and North America kind of phenomenon, 8% volume -- 8% global volume growth. North America was higher than that. But your full year kind of volume outlook didn't really change. And so how would you frame that in terms of signs of, hey, we think the farmer level demand is good versus the distributors are really just worried about getting sure they have the product when it's needed the spring and summer? And to that end, how would you look at channel inventories, both ahead of the season in the Northern Hemisphere, but maybe coming out of the key season in the Southern Hemisphere?

Sure. Sure. I think -- certainly, I think the most pronounced advanced ordering we saw was in the U.S. We did see some early ordering in other parts of the world as well, in parts of Europe, in Canada, but most significantly in the U.S., really driven by concerns of availability of supply. I think the industry was very concerned about disruptions that we have seen in ag chemical inputs coming out of China. But the reality is we had a very strong quarter in North America. It would -- it could have been even stronger. We had an order book -- more orders than we could fill in part because there were a bunch of orders in there that are for products we would normally produce till May or June where people were just trying to secure supply. So that does seem to be plateauing in terms of that level of anxiety. But I think people are seeing that they are going to be able to secure the inputs they need at least from the crop chemistry side. So while we don't expect it to be a major factor in the second half of the year, and as Mark did allude to in our call, there is a possibility there could be a little bit of advanced ordering between Q3 and Q2, it's less natural from a seasonal basis, but certainly out there. But certainly, as we think about the full year, it really is a tale of 2 halves. Our first half, we're looking at 11% top line growth, 8% EBITDA growth. Second half, we're looking at 4% and 4%. And it really is in part that we have expectations of a very healthy year for the full year, 7% overall growth. But we're also coming off of a second half last year, where we had very, very strong volume growth. And we had 15% volume growth in the second half of 2021. So to expect that we're going to maintain that kind of year-on-year growth after a big step-up last year, probably a bit too aggressive. So I think we feel very confident that 7% top line growth being deliverable, I don't think that there's a big change from concerns about security of supply that you're going to impact that [indiscernible] for the full year.

Okay. That's helpful. So maybe then thinking about how demand can evolve and obviously, there's an element of got to get into the growing season. You got to understand what the weather and yield potential of the crop can be, are there pest pressures or not. But beyond that, talk about, a, if crop prices are high enough, where incremental sprays can happen and where you see the most likelihood of that and how your portfolio would play to that incremental pull from farmers on existing acres and existing places that are using your products now versus an increased receptivity to the newer products that you're introducing that can gain new traction and new crops and new geographies.

Sure. Look, I think higher crop prices are supportive of a number of things beneficial for our business. It makes it a little easier for customers to swallow price increases because these are not trivial what we've been dealing with, but also just that appetite to find higher value solutions, find things or tools that are more powerful at driving additional yield. So that's where we are seeing a very strong reaction to our new products, where we are growing substantially with products that we've introduced in the last 5 years. We expect $600 million in growth from products introduced in the last 5 years and then in calendar year 2022. And I think certainly having a higher crop price market makes it more favorable because those new products tend to come at a higher price point, right? That bring a new value proposition and reset that discussion with the farmer about the split of the value that, that product creates. With that backdrop, certainly, if prices continue to stay high as we would expect and as acreage is not going to be sufficient to meet all of the demand, that drive to get that incremental bit of productivity will continue, I think, to drive sort of upgrading of the tools that are used, trying to find more impactful chemistries. And in certain cases, there can be incremental uses. Additional sprays and in fungicides, in particular, not our biggest product category, but one that we are investing heavily in to grow. That's a place where there can be general plant health and bigger benefits in addition to controlling the disease. They can have a value proposition at higher crop prices to make an incremental spray. But for insecticides, which certainly we are overweight insecticides relative to the market, a lot of it has to do with pest pressure. But there is a bit of insurance element to crop protection. If you have a high-value crop in the field and prices are solid, you may take some extra steps to protect it to make sure you don't have any loss from potential infestations.

Okay. That's helpful. So maybe now if you think about -- you alluded to it, how it's being priced into the fold. And obviously, it's been an inflationary environment. You got meaningful price in the first quarter, expecting price to continue to roll through the business in the coming quarters, maybe not necessarily quite the same rate. Can you talk about kind of how price -- kind of how you've been able to get -- managed to get that price with the market? And is there a real pushback in terms of distributors or the growers where those prices are actually going up?

Yes. Look, we've made great traction with pricing in the first quarter. We've raised prices globally at 8% with similar pricing increases around the globe. I think certainly in an environment where you're seeing such massive escalation in fertilizer price makes it easier comparable, if you will, when you go in to talk to a farmer or a distributor about an 8% price increase on crop chemistry. I think high crop prices also make that a little easier to swallow, but it's not a trivial thing. In an industry -- in crop chemistry, we don't traditionally have those kind of really large price increases for customers to accept that. We have seen a little less pushback. I think people are understanding of the inflationary environment we're in and seeing it across lots of things that impact their lives, not just fertilizers and crop chemistry. Look, our basic approach for this year continues to be we want to raise prices to an extent to offset -- more than offset our COGS increases. And we'd like to be able to cover some of the FX headwind as well, particularly in countries where we're billing in local currency. There is -- in the first quarter, we were able to price ahead of that. Now there's some timing of how some of these costs will build during the year, that narrow that gap. But for the full year, at mid-single-digit price increases and what we can see for costs right now, we will have price that more than offsets our COGS headwind. And then volumes will have to cover our increased investments in R&D and SG&A.

Okay. And so maybe kind of going into some of the cost pressures. I mean you did sound a little bit more cautious on the supply chain, both what you've experienced and what you could see coming. And especially given what's happened in China, can you just help us understand what the assumptions are on cost inflation today, the categories of spend that are seeing the biggest increases, maybe both on a year-on-year basis but also relative to where you would have been 3 to 6 months ago when you were formulating that 2022 plan?

Yes. Look, this year, we have COGS headwinds that are a multiple of what we've seen in prior years. It is unprecedented, the magnitude of cost inflation that we have. And the cost inflation is more than just base inputs. It's not just at a raw material cost more. It's all of the cost of disruption. It's having to fragment your procurement spend across multiple suppliers to we no longer have the same leverage, having to pay premiums for availability or quick turnaround, having to do business with suppliers you might not normally do business with where you don't have the same returns, the significant impacts on logistics costs, particularly within -- between steps within our supply chain for having to expedite materials because of either shortages or production delays. So relative to where we started the year in February, the couple of things that have fundamentally changed, certainly, one is the resurgence of COVID disruptions in China and thus far, at least, the unwillingness of the Chinese government to move away from the Zero COVID policy. We have thankfully been able to maintain production in all of our major manufacturing facilities, both our owned and partner facilities in China, but in part, through some pretty heavy sacrifices by our employees. In our [indiscernible] plant just out of Shanghai, we've kind of employees who have been living in the plant for 4 weeks because if they go home, they can't come back. And I can't thank them enough for their dedication and their willingness and commitment to help keep production moving. But it's a tough ask. And certainly, we're doing everything we can to support them at this time. But even with that, moving material between plants, very challenging in China now with rolling road blocks and restrictions on movement between parts of the country and then most critically, getting material out of China on ocean freight, where there's just a chokepoint in the ports around Shanghai with literally more than 500 container ships waiting an anchor to be loaded or unloaded. To put that in perspective, last year when the news media in the U.S. was covered with examples of backup -- port backups in the Port of Long Beach and out in the West Coast, there's about 100 ships. We're talking 5x that at this point. So that's a fundamental difference from where we were in February. And again, it's not just a unit cost inflation. It really is all the elements of the compounding cost of disruption, with logistics costs, with availability premiums, with fragmenting it to buy to become a challenge. Now the silver lining in that is as we get to any kind of normalization or settling down of supply chains, because I do believe that over time, China will evolve their policy for managing COVID and the supply chains will start to even out a bit, that cost of disruption eases very rapidly. And because that's not an index or a readily identified input, it's not something you can directly track to say, "Hey, wait a second, your cost went down. Why isn't my price going down? And as a part of what contributes, we think the very sticky pricing for our business coming out of this cost surge that will help rebuild margins and expand margins to get us back to a higher percentage earnings -- percentage margin where we ought to be. I would note there, though, despite all these headwinds, we continue to be the most profitable crop protection chemistry business in the industry relative to our peers. We have the highest profitability despite having to fight these costs inwards.

Okay. Well, that's -- maybe we can kind of take that and move a little bit to the longer-term outlook because you -- I mean one of the things that's notable about FMC is over the medium term, you guys have targeted and certainly the last few years have achieved growth above the market, really pick your -- pick the way you want to dimensionalize that almost any way you can cut it. Can we talk about the drivers of what you think has enabled that in terms of the portfolio, in terms of your -- the regional distribution and kind of feet on the ground that you've got around the world, the formulation capabilities and kind of how you think about the sustainability of that performance, especially as maybe some of the more low-hanging fruit related to the diamides business and the acquisition that came to you as those fade a little bit.

Sure. Look, we essentially relaunched FMC as a focused agriculture sciences company in 2018. When we started that process, we set an objective to grow the top line of the company at a 7% to 9% compounded annual growth rate. And we've been at the high end of that rate. And certainly through the midpoint of our 2022 guidance, we're at the very high end of that range. So we've been able to successfully grow in a market that historically grows 2% to 3% per year. So we've -- it's not been a single-year phenomenon. It's -- we're in the fourth year of this now, and it's a trend we expect to continue, quite honestly, for quite a long time. A lot of the drivers really have to do with product portfolio and technology. You mentioned the diamides, of course, it's a critical platform for us. I do think we took a much more commercially aggressive approach with them after acquiring that business from DuPont, but now are starting to really see the fruits of some of what FMC has historically been very good at doing, which is taking an active ingredient and developing value-added formulations from it and amplifying its growth. So with the introductions last year and this year have a number of new diamide-based formulations like Vantacor, Coragen Max, Elevest, which is a combination of a diamide with a pyrethroid insecticide, we're creating more tailored, more value-additive formulated products that both add additional growth, but also help continue resetting that conversation with the grower about the value we bring. So that's certainly a key contributor to our above-market growth. What's also been a key contributor is just that beyond the diamides, just our continued strength in formulating and taking existing active ingredients in our portfolio, things like bifenthrin and sulfentrazone that have been around for a while but which we continue to create value adding and very proprietary formulations that really do get strong response from farmers. The new thing -- the more new thing that is just really starting to have an impact on our top line is the introduction of new-to-the-world active ingredients. So one of the assets that we acquired in the DuPont transaction was a world-class discovery and development R&D operation. This builds on to some shift that FMC had made in advance of that transaction, renewing our investments into new active ingredients. And we are starting to see the first of those ingredients come to market. We launched Isoflex, which is under the Overwatch brand name in Australia. It's a herbicide used for grass weeds in cereals, and we greatly exceeded our first year expectations, and it's a molecule that we think has peak sales of $400 million to $600 million by the end of this decade. We'll be introducing Fluindapyr, a new fungicide here in 2023 and 2024, and we'll slowly build, but that one is another one that should have another $400 million in revenue by the end of the decade. And then we've got another 8 active ingredients in the pipeline that we'll be introducing between now and 2030, that collectively are about $2 billion in sales by 2030. So they become an increasingly large part of our organic growth story. So between the diamides, between our formulating prowess and our ability to continue creating value-added formulations for existing active ingredients and then the newer dimension of new active ingredients, and we really do think there's room for us to continue growing at a multiple of the market for quite a long time. Okay.

So in that kind of discussion in that intervening kind of through the end of the decade, some of the intellectual property protections that you have on the diamide portfolio do start to tail off, and it's not 1 year, everywhere. It's kind of a rolling -- it's a cascade of different rules in different jurisdictions. How -- you cited bifenthrin as an example of an off-patent active ingredient that you're still growing pretty rapidly. Talk about how you're preparing for that loss of intellectual property? What competitive advantages you used to be will have to defend that revenue and earnings base beyond intellectual property exploration and beyond?

Sure. Look, we acquired the diamides from the former Depot in November of 2017. And I think beginning in December of 2017, we started talking about this, which is how do we maximize the value of this franchise and protect it over the long haul. One of the things we acquired and great credit to the team at DuPont that did the work is a really robust patent portfolio, a combination of patents on the actual composition of matter of the molecules themselves but also on the manufacturing processes and on intermediate materials that are used to make the products and on alternate manufacturing routes and on formulations to where there really is a broad base of IP that makes it very hard to legally enter these markets for quite some time. Now the first of the earliest patent start expiring at the end of this year and into next year. But the last of the patents really go through the end of the decade, depending on the country and the particular issue. We have been very aggressive in enforcing and defending the patent. You've probably seen some press releases from it. We've actually had permanent injunctions in place against suppliers in India. We were awarded monetary damages in China, which is unheard of, but the case was so powerful, and we will continue to aggressively defend. But we've always believed that while defense is important, the best defense is a good offense. And that offense has been a strategy to continue to rapidly expand the diamides, not just through our own sales but by partnering with other companies to more rapidly penetrate the market. And to do it with partners, as we described, we have 5 global partnerships and over 50 regional partnerships, where our partners can also do similar things that we're doing, which is developing formulations that partnered the diamides with other chemistries and make more tailored value propositions to a specific use to where you're not just going out and blindly competing like-for-like, high-volume, single active ingredient product. You are out there trying to find ways to help farmers drive incremental yield and tailor that product to them. So the core of the offense with these partnerships is getting people into the business with us as their supplier well in advance of the patent expiration to where they could legally enter on their own, so they get to participate earlier. We get broader penetration in the market. We have a growing and large commercial organization, but we can't cover every square inch of every market in the world, nor would it be cost-effective to do so. So we get to piggyback on their infrastructure, and we get to have partners who are also looking for ways to continue to preserve value for the molecule by creating value-added formulations. So that partnership part of the approach can't be underappreciated. So certainly, yes, we'll defend the legal side and the patent protections, which are very, very strong. We'll continue to invest in that to protect. But from an offensive perspective, working with our partners has been a critical part of continuing to protect the value of that franchise. Now there's some other underlying structural things that are very favorable for the diamides. Most importantly, it is a much less harsh chemistry, more sustainable and a number of other competing classes of insecticides, particularly organophosphates or carbonates are being increasingly regulated out of existence, and it opens up more and more space for the diamides. So the combination of the underlying regulatory pressures and the very strong sustainability profile that the diamides have, the patent portfolio and the way we're strategically using partnerships make us very confident we can continue to grow these molecules very strongly through the rest of this decade, at least mid-single-digit level, and maintain high profitability. Now certainly, there will be new entrants, and some of them will be illegal. There are illegal product on the market right now, right? There's always been. But we are -- at this point, it's a $2 billion business that makes above company average margins and continuing to grow in the high single digits this year. It's a great franchise that we think is going to be an anchor for the company to continue growing over the next -- rest of the decade.

Okay. Great. Well, look, I only went full time. I'm happy to keep going, but if there are questions in the audience, we do have a mic that can circulate, raise your hand, I'm happy to take questions from anyone in the audience. All right, I will keep going. So maybe switching gears then. I mean you have the base business. This is a fairly concentrated industry. The avenues for deploying capital inorganically on a large scale are fairly limited given kind of your size and the size of your major peers and the industry consolidation that happened 5, 6 years ago. How do we think about opportunities, nonetheless, to find new growth avenues, biologics? You talked about fungicides is an area where you've been investing. Are there capabilities outside the company that you think you could still bring in, in a compliant way?

Yes. And look, I think we're actively out there looking for technology we can invest in. We've -- about 18 months ago, we started FMC Ventures, which is a small in-house corporate venture capital group that has invested in a number of small companies in biological areas as well as in digital and precision agriculture. A couple of drone companies, a couple of robotic application companies, looking for technologies that can be complementary to what we do and can help accelerate organic growth. And importantly, a key area of focus that can help reinforce our plant health platform. So plant health is about a $250 million business, includes our biological business along with micronutrients and seed treatments that are really, really fast growing, and it's an exciting part of how we're continuing to improve the sustainability profile of the company, natural ingredients that complement, in many ways, our synthetic chemistries. That is an area where we are actively looking for opportunities to invest and grow. Now in terms of use of cash, it's still relatively modest because these are largely start-up or early-stage companies. Not -- they're not large deals to be done in the biological space. But I would say there are opportunities out there, and I think we've been very consistent in our philosophy that relative to cash deployment that, first and foremost, we fund the growth, whether that's the organic growth baked into our free cash flow as we reported or making some inorganic investments like we did -- we bought out our joint development partner on the fungicide [indiscernible] 1.5 years ago for about $65 million. We've done, to date, about $11 million worth of venture investing. We will continue to look for opportunities where we can find them that are attractive to put some cash to work in those kinds of acquisitions.

Okay. So as we think about the generation of that cash, the company has targeted a 70% cash conversion. You got there last year. It's going to be -- it's a multiyear average. There's some noise of working capital at year-end that can flatter or unflatter the number, depending on which way you want to look at it. But maybe holistically, why 70% the right target for the business? And where are the opportunities potentially to push that further? Working capital, in particular, what comes to mind as an area that you get a lot of receivables and opportunities.

Absolutely. Look, we have agriculture chemicals, crop protection, luckily, not a particularly fixed asset intensive business, tend to be pretty light chemical synthesis that's required, but it is a working capital-intensive business. And certainly, working capital and its impacts on cash flow are something we're constantly mindful of. We have intentionally reoriented a lot of our management processes around increasing cash flow. Free cash flow was not a hallmark of FMC and its prior configuration. And it's something that we saw despite the working capital needs of this business, that there could be a meaningful cash generation opportunity here. And that's why we did set the objective of getting to a 70% plus free cash flow conversion. Now I want to be very careful because it's been made clear to me from a number of parties. We use a very pure version of -- a very strict definition of free cash flow. It literally is the cash that's left before dividends, buybacks and acquisitions. Everything else is covered, including legacy liabilities and restructuring and all those other fun things that people like to carve out our results. It is the money we have left to play with. And that money as a percentage of our net income is the free cash flow conversion metric that we use. So I do -- there's a bit of a comparability issue sometimes with how others might view it. So I don't want people to think that, well, 70% seems low. 70% on a base is actually a pretty high number to reach for, particularly when you consider that, yes, we are a working capital-intensive business. Growth requires growth in working capital. Our goal is to grow working capital more slowly, but there is no way to grow this business without growing our working capital. Second, because we do have a history of being a much more diversified company, we do have some legacy liabilities. They are relatively fixed. There's some volatility from year to year, but they're not fundamentally growing. So as we grow the earnings base of the business, we dilute them as a percentage of the cash conversion. So all those things combine to make a mid-70s kind of target the right place to be able to continue to fund the working capital growth and to acknowledge that we do have some legacy liabilities that need to be put into play. But to put that in contrast, our free cash flow conversion in 2018 as we were digesting the DuPont acquisition was 18%. So it's a tremendous change from where we were. And I think, Adam, as you phrased in the question, we are increasingly shifting to looking at cash conversion on a rolling 3-year basis. Because there is noise that happens year-to-year with working capital timing and swings that can distort it. We had free cash flow conversion in 2021 of almost 80%, right? So well above our high end of our goal. But I'd be the first one to tell you, we're not done with our journey yet. On a 3-year basis, we were still only at 62%. At the midpoint of our guidance this year on a 3-year rolling basis, we'll be about 71%. So we're getting to where we need to be. But it is the strictest of measures that we measure our performance against. And it is one where you can get big swings that are noisy and at arbitrary timing, particularly at year end that can swing your results of plus/minus 5% on conversion very, very easily. So that rolling measure is becoming increasingly important for us.

Okay. [ Sense ] of anybody in the audience give another shot here. Okay. So I guess in the vein of -- we had -- there's not a tremendous amount of inorganic things to look at. You'll try to find them -- returning cash to shareholders is what you're principally doing, 2.5x leverage. Why is the target -- why is that the right bogey for the company?

So look, I think the methodology is simple. We fully fund the organic growth and then return the excess cash. And then if there is an inorganic growth to do fund that, then return the excess cash through growing dividend and share repurchases. Our methodology is that we utilize the balance sheet at a targeted level. And why 2.5x gross? It correlates very strongly with a BBB or Baa2 investment grade, low investment grade credit rating but importantly, a Tier 2 commercial paper access. We are a working capital-intensive business. There is tremendous flexibility and cost advantage, particularly in a rising interest rate environment to being able to access the U.S. commercial paper markets to fund working capital. So we are committed to keeping financial criteria metrics in line to be able to maintain a Tier 2 commercial paper issuance stature. That said, if we look at our guidance for this year, midpoint of our free cash flow guidance. And remember, free cash flow, we define it as the cash before M&A, dividends and buybacks, so the cash essentially we have available to do those 3 things, $625 million at the midpoint, we've guided to $500 million to $600 million in buybacks and $270 million in dividends. So more than the free cash flow of the company being returned to shareholders, assuming -- presuming that there's not a cash acquisition to do at some point this year. But in the absence of the cash acquisition, we'd be returning more than 100% of the free cash flow to shareholders. And that means keeping the balance sheet at that kind of target leverage, not letting that balance sheet get lazy. So that's very much our philosophy on managing the balance sheet and on capital. We do want to stay within that strong investment grade to be able to maintain access to commercial paper as a part of the business model. But beyond that, we like having the discipline, making sure we are rewarding shareholders as we go and not letting cash pile up on the balance sheet.

Okay. Great. Well, I think we're just about out of time. So I think we will leave it there. Andrew, thank you so much for joining us. Everyone, thank you so much.

Thank you. Great to be here. Thanks.