FMC Corporation (FMC) Earnings Call Transcript & Summary

It's a pleasure for me to host FMC for this next session. And I have CEO and CFO of the team up here. So Mark Douglas, he's been with FMC since 2010. And as far as I know, he's always run the ag business for FMC. It's what FMC is now. But prior to that, he had a 2-decade career at Rohm and Haas. Also up here is Andrew Sandifer, also joined FMC in 2010 and he joined to lead M&A for the company. And also prior to 2010, he was with Rohm and Haas, quality company. I worked too in one of their manufacturing plants 20 -- 30 years ago. So I had a very high regard for Rohm and Haas, and these 2 guys certainly came out of that. So good to have you here. A lot going on in ag these days.

But maybe, Mark, why don't you give us some high-level view on your outlook for 2023 positive concerns. Anything that you would like to highlight just upfront, and we'll drill in from there?

Sure. Look, I think, basically, we are bullish on the ag market as we look at '23 and probably as we stretch out into '24 as well. The fundamentals are all good for agriculture, whether it's food security, whether it's the use of alternate fuels, everything is moving in a direction of greater demand for agriculture. Greater demand means greater yield, greater productivity. And that's where a company like FMC brings the technology to improve that yield. So for us, we see that backdrop as being positive. Weather plays an important part in agriculture. We always say that the weather is never good in agriculture. It's always bad somewhere in the world. But the reality is it's becoming more frequent. And those dislocations of weather are having an impact on soft commodity prices, on yields, so we have to now factor that into our thinking as we think about the markets going forward. But overall, fundamentally, bullish for the markets in agriculture.

And since you brought up bad weather, certainly, Argentina and Southern Brazil are in the grips of yet another drought and this one is really bad. What's your level of concern about your own business in that area? Does it meaningfully affect demand for your products?

Yes. I mean, we talked about this in the February earnings call. We saw it in Q4. We said we would probably see it going forward into Q1, and we are. I mean, Argentina is very dry, Southern Brazil is dry. So that's going to have an impact on yields. Obviously, it's going to have an impact on commodity prices. So it's something we're watching. Now you contrast that to other parts of the world. Here we are getting ready in the Northern Hemisphere for the U.S. and European seasons, everything is looking very good in those markets. So from a U.S. perspective, we're expecting a good run into the spring weather-wise, especially in the Midwest. California has water for the first time in a few years. So that bodes well for the niche and specialty crops, almonds been a good example of that. Europe is gearing up for a good season. We expect cereals to be strong. It's a little warm still in the South of Southern Spain, Italy, Greece, but the rest of Europe is looking good. So you always have these contrasts between areas that have an issue such as the south of Latin America, but the U.S. and Europe gearing up for a good start to the season, I think.

And in the area that like Argentina, where there could be weak demand, is it so much of a risk that you might have to reverse some sales in that channel or that you need to lower that? I remember that happening a few years back.

Yes. What normally happens in those situations, and we're facing that in India right now where we've had -- we and the rest of the industry have channel inventory in India because of bad weather, rice crops being lower. What you do is you reduce your sales into the channel going forward. And you consume the inventory as fast as possible. That is what is probably likely to happen in Argentina.

Okay. And while we're talking about demand, I'd sure like to get your views on the cost structure and perhaps price cost balance and thus margins. How would you view the outlook for 2023 with respect of potential moderating or even deflation in costs?

Certainly, I think you've touched on this a little bit in the earnings call as well. But look, I think we're beginning to see the turn, right? In Q2 -- at the end of Q2 of '21, we saw a real wave of cost inflation coming on us. We didn't know how big it was, but we could see it coming across the horizon. We've really lived through that over the past 6 quarters with pretty massive cost inflation over $460 million versus cost headwinds of EBITDA last year and a year we generated $1.4 billion in EBITDA. It's a heck of a headwind. As we look to 2023, we still see input cost inflation in the first half. The material that we have in inventory, the materials we buy, we tend to turn inventory a little less than twice a year. So the things that we're buying and then going through our manufacturing process and actually being packaged -- formulated and packaged out and sold to customers takes about a 6-month lag. So in that time period, what we have right now, what we're selling right now has it, there is year-on-year cost inflation and cost in the products we're selling right now are higher than the year before. What we are seeing though purchase orders we're placing now as we're negotiating with suppliers for material that will flow through and through production and inventory and be sold in Q3 and Q4, we are starting to see lower prices. So we are starting to see a shift and a swing in that input cost line such that we are anticipating input costs to be a tailwind in the second half of '23. Now for the full year, it's net-net, still a small headwind but with continued price increases, that price cost relationship is favorable throughout the year, and we see, importantly, a return to margin expansion in the second half of the year.

And we can model that reversal of that 400 in COGs in 2024?

Maybe. I mean, we didn't get here overnight, and we're not going to get out of it overnight. I think '23 in the second half will make good progress, as Andrew said, I think we'll make even more progress in '24. So time out on that, whether it's by the end of '24 that we recover it all or whether it's into '25, we've got to go through a couple of seasons to work that through. The intent is to get absolutely back what we had. Our peak EBITDA margins were 27% in Q2 2020.

Trailing 12-month basis.

On a 12 -- yes. We intend to get that back. So right now, we're at the 24.5% range, give or take. The intent is to get FMC back to 27% EBITDA margin as we come out at the back end of this cycle.

But if you recover that cost and that cost would deflates, wouldn't your margin be higher than that?

So that cost headwind as we talk about is total cost. It's a $460 million included growth in SG&A and R&D spending not just COGS. So the headwind in 2022, about 70% of that was at COGS line. But certainly, I think to your point, Steve, there is a great opportunity for margin expansion as we continue raising price and holding price and raw material and input costs start to ease. Again, it won't -- that swing doesn't happen until the second half, so we only had a small benefit in this year. In 2024, there should be significant margin expansion. Whether or not you can recoup all of that in one season. I think to Mark's point, it took several seasons to get here. I think it will take several seasons to get back out.

And how about price, do you see risk that you will have to give back any of the pricing that you're getting? And I raise it because of some dialogue that we had with ADAMA and Nufarm a month or so ago. And clearly, they have a different platform than you do, but they were expecting lower pricing in the second half of this year.

Yes. We're not expecting lower pricing in the second half of the year. I think there is a big difference in how some companies sell generic products that are very commoditized versus the more specialty value-add products that a company like FMC develops themselves. Pricing for us is always based upon value to grower, that value is still there. We intend to maintain price as we go through the year. It doesn't mean to say there won't be pockets of movement. Obviously, there will be in a market of this size. But generally speaking, we intend to continue to raise price as we go through the year. And then the intent is to hold that price, obviously, to get back to the margins we want to be at.

Okay. I'd like to drill in the diamides a little bit. Where are we at in the patent expiry outlook over the next couple of years and your preparedness for that given your existing contracts with some of the really big crop chemical peers?

Yes. Listen, we've talked about the diamides a lot, obviously. We get a lot of questions about the patent estate. The patent estate is a matrix of just over 1,000 patents for the 2 molecules. The base composition of matter patents for Rynaxypyr started to come off last August. In some countries, we have runway in others. Same thing for Cyazypyr, which is the smaller molecule, the initial ones start to come off in August 2023 this year and again, spread out after that. There are also significant patents related to the whole process of manufacturing. These molecules are 15 or 16 synthetic steps, and we have many of those steps patented. I think it's worth noting today that the only legal material that's available is from FMC, even though the original patent has come off. Why is that? Because of the strength of the rest of the patent portfolio. We have great contracts with 5 of the other major players in the industry and about 50 contracts with other smaller players in different regions of the world. They are very successful. About 40% of our total diamide sales go through those contracts. So we already have a strong network out there of people who are selling diamides, so in some cases, competing with us in different markets, in many cases, expanding the market by having routes to market or formulations that we don't have. That was the intent of the plan. That's what we're seeing today. So we expect the diamide growth to continue. Last year, diamides grew about 7%. I think in the mid- to long term, you're going to see them continue to grow in the mid-single digit. I think that's an important part of the algorithm of growth. They have been around for almost 20 years now. So that we talk about them as being new molecules, new technology, and they are, but they're coming off the end of their patent. And you should expect at some point towards the end of this decade, you will see generic manufacturing. That is what happens. So we're ready for that. We anticipated and we'll continue to invest in the diamides. I think the other important asset that we have is our whole formulation strategy around bringing new products to market. We have replaced some of the older ones that were probably more simple in nature with very sophisticated formulations. Some of them have extremely high concentration, so you can use smaller amounts. Those are completely new patented in some cases. So they won't be able to be repeated by generics. So there's a whole different mismatch of how patents work, how you go to market, who you partner with. It's pretty sophisticated and so far bearing very, very good results.

And then recall you have a couple of legal battles in India for some generic product. What's the status of those patent infringement cases?

Yes. There's a couple of cases in India that we recently won, a couple of cases in China as well. It's interesting when we bought the assets in 2018, there was already illegal material being sold in China, way back in 2018. That continues today. It's unfortunately a facet of the Chinese industry that many companies will not respect patents, and they go and make legal materials. So it's not as if we're not used to competing with products out there that are of inferior quality but they are illegal, and we will enforce our patents all over the world.

And having contracts with 5 big peers, does that effectively preclude them from sourcing generic material from the Chinese in those out years?

Yes, it does. The way the contracts are structured, a number of the contracts run through the end of the decade, at which point, we'll either renegotiate contracts or they will go and source from somebody else, assuming that there is legal material available. But we anticipated that. I mean, at the end of the day, it is a competitive market, and we all compete. So the contracts will run their costs, and we'll see where we get to.

And mid-single-digit growth at the end of the decade, does that take into consideration intense regulatory pressure on other insecticides out there, like the neonics and organophosphates?

Yes, it's a good point, Steve. You think of the diamides today, there are just north of $2 billion in size, 2 molecules. The insecticide market today is about $16 billion. Now the diamides cannot deal with all the pests that are out there. So you're always going to need a mixture of insecticides and we have them ourselves. But we do believe that in certain cases, neonics being one of them, organophosphates being another one, carbonates, that the diamides can continue to take share. And I think one facet of our strategy is to go and get registrations on new crops and geographies where we don't currently sell the diamides. That's part of that growth algorithm that keeps the molecule moving. I do also think you've just got to look at the law of sheer scale. There are very few molecules of this size. They really are some of the largest molecules out there. And eventually, growth is going to slow down. It's still very healthy. And I don't mind having a mid-single-digit growth on $2 billion of revenue. It's a healthy business to have.

So let's talk a little bit about what's coming. Your pipeline. You are moving more and more into biologics. So maybe a couple of questions on that. What's coming that you're really particularly excited about as a new active ingredient. And is that best developed in-house? Or is that more efficiently developed outside and partnered?

Yes. The pipeline that we have has about 35 molecules in it today. That's a combination of the classical synthetic molecules as well as the brand-new biologicals. When I look at that pipeline, the next generation of products to come, we've just launched last year or the year before, a new cereal herbicide that was in Australia that now moves to Argentina in the coming year. And then by 2024, we are going to launch in Europe. That's a big move for us in Europe because cereals is the biggest market for a brand-new herbicide in that space, it's a brand-new space for us. So that's real growth in Europe.

And no herbicide-tolerant genetics.

Correct. Yes. The next one is a fungicide that we just launched called fluindapyr. That product is going into Argentina and to Paraguay as its first launch, we'll then move through the Americas and parts of Asia. The next one after that is at the end of '24, early '25, it's called [indiscernible] and that is a brand-new grass herbicide for rice. So for the nontechnical people among you, of which I count myself, rice is a grass. We're going to kill grass in a crop that is a grass without harming the rice. That is brand-new technology. And you can imagine in Asia, that is going to be a big market for us. So that comes at the end of '24, beginning of '25 assuming registrations go as planned. And then following that, we have 2 more herbicides that come in '26 and '27 and a new insecticide that comes at the end of the decade. Now you take all that into consideration. If you think of last year, we had $600 million of brand-new revenue that came from products launched in the last 5 years. In 2021, that was about $340 million. Jumping to this year, we expect that $600 million to grow to about $720 million, $730 million. What does it mean? It means the pipeline of products that are coming out of discovery and development as well as new formulations in the regions are becoming a much more important part of the overall portfolio. That's very healthy for the growth of the company. And I would say the other piece of that that you can't see yet, yet we know is there, we're getting a very interesting mix uplift in terms of margin. It's just been swamped by the sheer scale of the inflation that we've had coming at us. Once that starts to abate, we will have margin uplift because of the way the mix is moving with the new products, which are more profitable than older products in the portfolio.

What about this BioPhero that you acquired, what's the potential for this?

Yes. Listen, it's a very exciting technology, which is producing pheromones from essentially fermentation of modified yeast. What does that mean? It means you have a cost base that is substantially lower than the synthetic group for producing pheromones. Why is that important? Pheromones today are used as mating disruption in a lot of specialty crops because they're expensive. We're going to produce it at a much lower cost point. We want to introduce those pheromones into the row crop area. So soybeans, corn, cereals, around the world. That will allow us to use less synthetic products in combination with pheromones. So not only do you have a completely new disruptive technology in row crops, but the sustainable benefits are obviously there from reducing the synthetic loading on row crops. . We have said that we believe this could be a $1 billion business by the end of the decade. Those are the numbers that we're sticking with right now. We -- when we bought the business, we had 5 new pheromones in development. Today, that number is 9. So the accelerated pace of R&D in that new business is really something to see. So we're very excited about where the pheromones can go.

And does that potentially put some of your existing insecticides at risk? Or could they work synergistically?

They do work synergistically. That's the idea of what you would -- what you -- the way to think of this is you would spray an insecticide, then you would spray or use the pheromones to mating disrupt, the next population is lower, you can use another insecticide at a lower amount, spray pheromones again, the population gets reduced. So you're going through a curve of reducing populations, therefore, reducing amounts of product.

Do these pheromones have to be put like in a box to catch or to attract the males? Is that how it works?

So what happens is, in today's world in specialty crops, they're used as a dispenser. So you will get a puff of pheromones and just to put this in perspective for you. For an acre on a row crop, we probably need 1 gram. It's a tiny, tiny amount of chemical that basically means that the males and females can't get together, no mating, lower amount of insects. We intend to use drones on large-scale acres. So we're not going to use dispensers. We're going to use drones in special formulations to put the pheromone out in the field.

Interesting. Okay. How about biologics? What do you see as the opportunity for that? Is that still early days? Or are you thinking that there's some applications where it could really be efficacious by itself?

10 years ago, we invested in biologicals. That was our first start. We created a plant health business. So I would have said 10 years ago, I thought it was early days. Today, we have a plant health business that's about $300 million in size, growing north of 20% at above average EBITDA margins. About $150 million of the $300 million is real biologicals. That business is growing much faster than 20%. So we have a view of getting to the biological and the plant health business to be $500 million to $600 million by 2025 and then continue the acceleration. I think overall, for the industry, you could say we're still in the very early days. As real research gets applied to these segments, much more is known about how biologicals work, the different types of biologicals. We're investing through FMC Ventures into the use of peptides as pesticides, which has never been done before. We invested in a company called Micropep in France, who have some very, very interesting technology. We have a relationship with Novozymes on enzymes for use as pesticides. So there's a long way to go in understanding microbiological activity in different areas. So I would say early stages of the real research here.

Okay. Andrew, maybe jumping over to you. How does the higher interest rate environment been affecting you guys?

Yes. Look, I think it's a pretty substantial step-up in interest expense from '22 to '23 that we're managing through. Look, we have a working capital-intensive business. We use a lot of short-term financing commercial paper, in particular, to finance working capital, very seasonal financing need. So it makes sense to use that kind of financing. It exposes you, unfortunately though when you have this kind of structural shift in interest rates, to a pretty big headwind. So we have a $50 million plus year-on-year headwind in interest expense this year. So it's a bit of a drag on earnings growth. First time in 5 years that our earnings are growing more slowly than our EBITDA. That is not the long-term expectation I think as without making profound prognostications of what the Fed isn't going to do -- is or isn't going to do. At some point, this tightening cycle will top off and will start easing. And certainly, the step from '23 to '24, I would expect to be much more modest. So I think we'll manage that. I think we're being very cautious to manage across a number of different metrics, not just interest expense, but looking at the impact on cash flow, thinking about how we manage the balance sheet through that cycle as well.

And then how about free cash flow? Was this inflationary challenge you guys dealt with last year that clearly, that was meaningful for you. Do you expect that free cash flow to conversion to improve?

Yes. I think we're seeing a nice step up from '22 to '23. We certainly were disappointed with our free cash flow results in 2022, but it really was the flow-through of inflation through working capital. And unfortunately, the last thing to see easing is your receivables because as we continue to raise price and grow revenue, the receivables continue to grow. Certainly, in 2023, we are seeing still healthy growth, guiding to a midpoint of 6% revenue growth, but a deceleration from 15% revenue growth in 2022. So growth in working capital and particularly receivables becomes less of a use of cash in '23 than it was in '22. We'll see cash conversion creep back up to 65%. And on a rolling basis, which is, I think, the way we prefer to think about it, at 67% over a 3-year rolling horizon. We'd like to get it into the 70s. We've done it before. We think the right place for this business is in the 70-percentage range. . It's not 100% because we do have working capital. If we grow, we grow working capital. Now we are not a particularly capital -- fixed capital intensive business. We have less than $1 billion in PPE and about $2 billion in working capital. But that 70% -- 70% to 80% free cash flow really is a function of if we grow, we have to use some cash to fund the growth in working capital. We have reasonably modest fixed capital investment. And we do pay some ongoing legacy liabilities from our history as prior to becoming a focused ag company being a bit more diversified and having some old liabilities. Relatively stable, but it's about a $75 million drain on cash flow every year.

Anybody want to jump in here with a question. Up here, please.

So a couple of questions. The first, just because you mentioned these liabilities, think are $50 million, $75 million a year. What is the kind of -- for how many more years will you have to take this charge firstly? And the second, just a little bit on your guidance. You gave a nice range in line, I guess, with the historical targets you have. But when we think kind of about some of the moving parts of your assumptions, including high single-digit price, it looks to me that the best case EBITDA should be much higher when you put the numbers in the model. So...

So why not take the easy part, then I'll hand the hard part off to you, Mark, how about that? On the legacy liabilities, I think you should assume that they stay in the $60 million to $90 million range for the foreseeable future. Many of them have -- we are doing lots of things to try to fix them in terms of the expense and reduce variability, but they're not fundamentally going away. They become less of a drag on free cash conversion as we grow the earnings of the company. Regarding the guidance, I'll make a quick comment and then hand it to Mark. Our guidance for the year for pricing is mid-single digits for the full year. In the first quarter, we expect to be in high single digits. And I think certainly, the dynamic of where we guided in that range reflects what we can see today, the visibility we have at this time of year and it is still very strong growth at 6% top line, 8% EBITDA. But I'll hand it over to Mark on the rest of the guidance.

He just said exactly what I would have said.

Maybe one last one, and that is I've spent a lot of time crossing the Corn Belt area and met with a lot of retailers. And when I have asked them about who they get their crop chemicals from, almost always FMC is mentioned. And you compete with some big competitors that also sell seed, and you don't. My question for you, just really conceptually is how do you stay so relevant in a market that is where you have seed and crop chemical bundling, our dialogue with ADAMA made that very clear, it's very tough to get into the U.S. market.

I would say technology is key because of a simple reason. The people that are selling seeds and chemicals don't necessarily sell the chemicals to the same people they sell seeds to. They compete in an open market. They're very different markets. So for us, we're bringing technology that enhances yield and productivity. We're agnostic to whose seeds somebody buys, whether it's row crops, whether it's specialty crops, no matter where it is in the world. So we offer flexibility. And I think that is incredibly important. Not everybody wants to buy a bundled package. They want optionality of technology. So if we're bringing something new, whether it's a new herbicide and new insecticide or a biofungicide, people want access to that. We've been told by our customers that they do not see the fact that we have -- don't have seeds as a liability. They see it as something that is positive for them because we are truly independent. We don't care. And I think that's something that really adds value plus the fact that we're a pretty agile company. We can move quickly with technology, and we can move quickly into new spaces. That's what we do. So that's -- I think that's highly valued by our customers, not just in North America, but you can go around the world. We're north of $6 billion in revenue, truly global. That has to tell you something that there is a model that works.

Very good. We're out of time, guys. So join me in thanking Andrew and Mark for the presentation.

Thank you.

Thank you.