CF Industries Holdings Inc (CF) — Q1 2019 Earnings Call Transcript

Good morning. And thanks for joining the CF Industries’ First Quarter Earnings conference call. I'm Martin Jarosick, Vice President, Investor Relations for CF. With me today are Tony Will CEO; Dennis Kelleher, CFO; Bert Frost, Senior Vice President of Sales, Market Development and Supply Chain; and Chris Bohn, Senior Vice President of Manufacturing and Distribution. CF Industries reported its first quarter 2019 results yesterday afternoon. On this call, we'll review the CF Industries’ results in detail, discuss our outlook and then host a question-and-answer session. Statements made on this call and in the presentation on our website that are not historical facts are forward-looking statements. These statements are not guarantees of future performance and involve risks, uncertainties, and assumptions that are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or implied in these statements. More detailed information about the factors that may affect our performance may be found in our filings with the SEC that are available on our website. Also, you will find reconciliations between GAAP and non-GAAP measures in the press release and presentation posted on our website. Now let me introduce Tony Will, our President and CEO.

Thanks, Martin. And good morning everyone. Last night, we posted our financial results for the first quarter of 2019 in which we generated adjusted EBITDA of $305 million after taking into account the items detailed in our earnings release. We're really pleased with this performance, especially against the backdrop of another first quarter with cold and wet weather that delayed the application season even more so than last year. Despite lower sales volumes we exceeded our first quarter adjusted EBITDA from last year as selling prices were significantly higher for urea, UAN, and NAN. We also operated extremely well. We set a quarterly production record for urea and ammonia production was our third highest ever. Most importantly, we continue to work safely as our rolling 12-month recordable incident rate remained at 0.6 incidents per 200,000 work hours. As we have said many times in the past, we plan our business on a six-month increment. Weather patterns may move product shipments out of one quarter and into another, but we run our plants 24/7, 365 and over the course of the year, we're going to ship everything we make. We believe this year will be no different. April saw much improved shipments and we are now ahead of where we were a year ago on volume. As Bert will outline shortly, we expect high demand for nitrogen due to increased corn acres in the United States amplified by low ammonia applications last fall. At the same time, we expect continued disruptions to barge and rail transportation due to the lingering effects of weather. This is testing the industry's logistics capabilities to move upgraded products to farmers, when and where they needed. We believe these challenges play right into our strengths. We have significant in-region production, unparalleled logistics capabilities, and an expansive distribution network, these position us well as the spring application season progresses. Longer term, these same operational advantages, along with our structural advantage of operating in an import-dependent region and our access to low-cost North American natural gas, will continue to drive our cash generation capability. Before I turn it over to Bert, I want to comment on the expected impacts of the European Commission's announcement of provisional duties on imports of UAN. We strongly disagree with the Commission's conclusions, which we believe ignore the market fundamentals of the globally traded commodities like UAN. We purchase natural gas as our primary input at prevailing market prices. We use that in our highly efficient plants to produce UAN and then sell it at prevailing market prices. The key difference between us and Eastern European producers is that we have newer, more efficient, reliable, climate-friendly, and lower GHG plants than they do. We also have access to low-cost North American natural gas. That said, we fully expect that these duties will impact global UAN trade flows, and that will take some time for the industry to adjust. Fortunately, CF has more options than many others. We have been taking appropriate steps to mitigate the financial impact to our company. We exported roughly 850,000 tons of UAN to Europe last year, and this is how we think about realigning those tons going forward. We'll make more granular urea unless UAN, which will absorb between 300,000 to 700,000 tons of that depending upon the specific production mix decisions we make. We continued to build demand in South America and leverage our relationships there, so we expect to increase our exports into that region. In the last six months, we have leased additional access to UAN space within North America. Based on these actions that Burt and Chris and their teams have taken, we can easily realign those tons that we previously sent to Europe without a significant financial impact. In the short term, we also benefit from an increase in corn acres in North America, which coupled with poor fallout, ammonia applications will significantly increase UAN demand here this year. So net-net we're well prepared to deal with the loss of access to the European market. With that let me turn it over to Bert, who will talk more about the spring application season. Then Dennis will cover a few financial items before I offer some closing remarks.

Thanks, Tony. As has been well documented, wet and cold weather delayed fertilizer applications in North America. However, in April, the weather was favorable for field work and fertilizer applications currently as well in the Midwest and field work has slowed. Over the past several weeks, we saw significant activity at many terminals from Eastern Nebraska to Western Illinois and Northern Missouri. To give you a sense of the movement, on one day in April our Albany Illinois terminal loaded 263 trucks. To do this, we loaded trucks for 24 hours straight for more than 5,000 tons of ammonia at just one terminal. This week, urea truck shipments at Port Neal reached nearly 10,000 tons in one day, a record for the facility. Applications have begun to shift north and east more recently as would be expected. In fact, CF ammonia shipments are now ahead of last year's pace. We continue to expect nitrogen demand in North America to be strong during the first half of the year, driven by an increase in planted corn acres in the United States. And though, we have had a late spring it is not too late for farmers to catch up on applications and plantings given the technology they use. If farmers switch to other end products, we have all three ready in position. As of this week, corn plantings run on pace with 2018. We also anticipate strong demand for upgraded products this spring in order to make up for the lighter than normal fall 2018 ammonia applications. We believe the industry's ability to supply all this volume in a timely manner will be challenged. Most significantly, barge transportation has been disrupted by the after effects of the winter and spring rain. Barges are moving slowly and we don't expect regular access to Minneapolis for a couple of weeks. This is the latest opening in at least 30 years. This has two effects. First, prompt urea barges in Orleans so far into the second quarter have been in high demand. Barges need to be moving north for spring applications. Pricing is reflected this, as urea barges pricing approached $300 last week before retreating to $270 this week. Second, product already in region is trading at a significant premium to Norway barge prices. We benefit from this due to our strong production at our Port Neal facility and our inventory position. We have also leveraged Donaldsonville logistics flexibility by railing urea into the upper Midwest in anticipation of the high demand. All these factors should enable us to capture higher prices across most segments compared to the second quarter of last year. The first quarter was challenging because of the weather, but these challenges play into our company's strengths. We're well prepared for the next two months and as a team, we have the assets and flexibility to meet our customers' needs. With that, I'll turn the call over to Dennis.

Thanks, Bert. In the first quarter of 2019, the company reported net earnings attributable to common stockholders of $90 million, or $0.40 per diluted share. EBITDA was $301 million and adjusted EBITDA was $305 million. Our first quarter 2019 net earnings of $0.40 per diluted share included a $0.13 per share net income tax benefit. This was the result of the net income tax credit of $30 million recognized during the quarter. As Tony and Bert have described, our results in the quarter were higher than a year ago as higher product prices overcame lower sales volume, supporting strong cash generation. During the first quarter, net cash provided by operating activities was $306 million. We returned $127 million to shareholders during the quarter, including $60 million to repurchase approximately 1.5 million shares and $67 million in dividend payments. Due to the seasonality of the fertilizer business, we evaluate our company's performance against our peers on a rolling 12-month basis. Looking at the most recent period with our reported financials, you can see CF generated $1.5 billion in operating cash flow in 2018. After deducting capital expenditures and distributions to non-controlling interest, we generated $936 million, significantly higher than our peers in both an absolute sense and as a percentage of our April 30, 2019, equity market capitalization. This demonstrates CF’s free cash flow power, which we believe provides ample flexibility to repay $500 million in debt on or before its maturity date in May 2020 and deploy excess cash in line with our longstanding capital allocation philosophy that is to pursue growth within our strategic fairway. In the absence of these opportunities, return excess cash to shareholders through dividends and share repurchase. Capital expenditures for the first quarter of 2019 were $80 million. For the year, we continue to expect this trend before the total of $450 million. We ended the quarter with $671 million of cash on the balance sheet. This does not include $55 million in proceeds received in April from the sale of our Pine Bend dry bulk storage and logistics facility in Minnesota. With that, Tony will provide closing remarks before we open the call to Q&A.

Thanks, Dennis. Before I move on to your questions, I want to thank everyone at CF for their great work in the first quarter. They operated safely, made the most of the opportunities, and helped us to be well positioned for the remainder of the first half of 2019. When we spoke to you on this call one year ago, our prices at New Orleans were about to hit the low point of the year at roughly $200 per ton. Today, New Orleans barge prices are about $270 per ton and our price for urea in the Midwest is over $370, more than $100 per ton premium, reflecting the logistical challenges the industry sees currently. We are also benefiting from lower natural gas prices. The cost of natural gas at Henry Hub in the first quarter was lower than a year ago, and through the end of 2019, Henry Hub natural gas futures remained well below $3 and below 2018 prices. Added to that is the benefit we received from basis differentials in Alberta and Oklahoma. These factors highlight the operational and structural advantages that we enjoy and that will drive our long-term cash generation capability. With that operator, we will now open the call to your questions.

Thanks, good morning everyone.

Good morning.

So I guess I wanted to dig a bit more into the European Union tariffs on UAN, and just the impact both on the company, and your adjusting and just more high level market impact. In the quarter you've shifted the capacity utilization in the production more heavily to urea versus UAN. I know there is more room to go based on the flexibility you have at Donaldsonville, but is this a decent representation of what the forward product mix looks like or is it even more skewed urea versus UAN?

I mean, it's really a question of where prices are for the various products or trading. If we make more UAN, it uses both ammonia that would otherwise go into the nitric acid to AN piece in urea. If we dial back UAN, it will make more urea, and we’re getting urea and some excess ammonia out of it. So what Bert and Chris are doing is they’re looking at the relative values of the various product prices, where we sit in inventory, and what the demand profile looks like, and then are trying to optimize what the production mix looks like. As we talked about in the comments in the script, we've got pretty ample room to move, probably between something like 300,000 to 700,000 tons of what we historically shipped to the EU into granular instead and make that just disappear. We've also got exports and more tank space, and it doesn't necessarily have to show up as granular, it can also go out the door as either urea liquor or DEF, which the demand for that continues to grow. So when we built the projects, we built a lot of flexibility into the product mix side. Bert and his team have done a great job of continuing to open up additional markets for us. That effort has been underway for the last four, five years. Even though it's disruptive and it removes a little bit of our flexibility, it's something that we're in a position to manage going forward.

And along those lines and the part, I mean your flexibility will impact certainly, but I mean historically UAN has commanded a premium on a nutrient basis to urea given kind of the value it adds to the farmers from a flexibility perspective and the added transportation logistics costs, is that a liquid product, does that change at all, as the market reorients itself and trade flows readjust?

I mean, I think they're going to kind of bounce back and forth for a while, as the market sort of adjusts to the new trade flows and people figure out what sort of product mix. Other people have flexibility, particularly the Russians have some flexibility between NPKs, AN, and other options as well. What you'll see is those relationships kind of bounce around a little bit. Long term, I think there needs to be a premium in UAN in order for people to justify putting the incremental capital into acid plants and UAN plants because otherwise, if it doesn't command a premium, you'll see people stop putting maintenance into acid AN plants and just produce granular going forward. Long-term eventually, you've got to see that return. But I don't know whether long-term in this context means three months, six months, or a year and a half. But we feel pretty comfortable that we'll get back there. In the near term, we've got a lot of options in terms of how we deal with it.

Hi, good morning everyone. A couple of questions. Last year during the Q1 release you did talk about that you should expect similar volumes in the first half of the year, as the year before you didn't have that commentary in this release. You did speak you can maybe it’s not too late to catch up. Could you give a little more color? Do you think you can get the same volume as last year – first half of the year, sorry?

Yes Joe, I'll turn it over to Bert to give you some specific commentary here in a minute. But through April, we're ahead of where we were on volume shipments last year. So May or the first quarter was a little bit behind, but we've more than cut that up through April. So we're very comfortable with where we sit from a demand profile. Bert?

Yes, just looking at it from an agronomic swing. If you're planting corn or nitrogen-consuming crops, which we still are estimating 92 million to 93 million acres to be planted, then out of the short-cycle or long cycle. We still have a month left of field work in time to get the crop in which is plenty of time. We've proven that the market can move or the farm community can move in a matter of days to weeks with new equipment that's available. If you plant, you're going to apply nitrogen P&K, it will take a little more at risk depending on what was put down in the fall. But we have a lot of fall to make up that was lost in terms of ammonia that will be made up as well as if we do have to transition from ammonia to UAN or urea. We think that there is sufficient lease from CF and we would plan to train our inventory to pick up all that volume in Q2. And so I think it's just an understood that we would move that volume in the first half. And so that's probably why it wasn't stated.

That's great. And my second question on pricing. So we see where the Midwest Premium is trading now. We see that you realize for urea and UAN, some of your largest premiums to NOLA benchmarks for realized prices for years. Should we expect in the second quarter elevated realized pricing versus benchmark in NOLA? Thanks.

Well, as we went through the first part of the year, we positioned product in the interior. We have the tanks for UAN, as well as the ammonia. We have the dry storage for urea, the barge capacity to move it, the rail capacity to move it, and the relationships in place to receive it even if it's not under our own control. So with that being said, yes, there is a premium to NOLA today and has been, and it has been expanding. I think it's also expanding for P&K. And that's a reflection of proper planning and distribution. I do think you'll see that carry through in the Q2 realizations a nice spread.

It's a nice conversation to have as opposed to us trying to defend the notion of an in-market premium being sustainable when people a few years ago were talking about, that's getting wiped out. The fact of the matter is the evidence doesn't support that thesis. We're trading in a $100 in-market premium right now because of supply disruptions and other issues and that's kind of what we've said all along. We really enjoy the benefit of our network as a result of that.

Thank you and good morning. On the logistic challenges and you talk about your in-region production and transportation distribution network, how are their advantages? Can you talk about that $100 premium and how much of that you benefit from and how much of that is the cost?

Well, the costs haven't really changed. I think there were some disruptions in Q1, which have been communicated to the market relative to flooding that took place, that limited some rail service from the BN and UP as well as just poor service from the CP coming out of Canada. That has been corrected. The barge logistics has been a lot of accumulation of barges in the northern end of river opening. Part of it is just a dislocation. Some tons were sold short not supplied and a bit of a squeeze got put on. With the additional acres and the timing, that moves to our advantage with our assets in place and our short moves from where our assets are in the heart of the Corn Belt, so that spread has expanded and we've followed that and taken advantage of it. But I think also Ben on that point, the big issue is we've got a lot of rolling stock, we've got access to multiple rail lines. We've got our own barge network in our contract in place and traders and people that are bringing tons over who don't have access to that. What the in-market premium is really kind of reflecting is that there are instantaneous challenges of moving products from the Gulf or other ports into the interior. We've got an ability to move diesel tons into the interior, and we also have Port Neal and Verdigris and other end market plants that are already there. From the coast, it's probably or from diesel, it's $30 to $40 to move most of those tons into the Corn Belt. So the spread between that price and what we're realizing today is just the arbitrage that Bert was talking about earlier of either short squeezes or inability for traders to move tons because they don't have access to logistics.

Great. And just quickly, my second question is, maybe just to expand on Joe's question you talked about how you are through April, you're ahead of where you were a year ago. I think you mentioned for ammonia specifically, but what about urea, UAN, and ammonium nitrate?

Yes, I mean shipments in aggregate are off at this point year-on-year. We feel very comfortable both with how demand is shaping up for this year, what our inventory position is, what our book looks like and kind of again where prices are and where gas is. We're well ahead of what last year looked like. So all of that shaping up to be a really solid first half for us.

Yes, hi, good morning. Wanted to touch base a little bit more in terms of the outlook for Chinese exports. You said that you're looking for relatively flat levels of Chinese exports, year-on-year. Where do you see them on the cost curve and where do you see the Europeans right now?

Yes, relative to China they're producing due to some of the shutdowns and lower operating rates. We estimate the 53 million to 54 million metric tons per year run rate. They did export more in Q1. We believe that was a reflection of a couple of issues, one being the higher prices in Q4 that were realized and then product moved into position and exported in January and February as well as possibly some of the Iranian tons that have come in and have been re-exported. For that reason, we're fairly confident with where pricing is worldwide and where it's whether you're looking at the Arab Gulf, Asia price, NOLA price and the cost curve with their cost generally driven by coal. Gas today is around $5 in China, the forward strip, especially for Q4 late Q3 and Q4 is back in the $7 to $9 range. And that would curtail expect if we stay at this current pricing level. That's why we feel fairly comfortable estimating in the two million ton range for China to export.

Okay, great. And then if you could talk a little bit about your expectation for the Iranian urea in terms of how much product is theoretically available at this point. If you think India, who has been aggressive in tenders, or is it China, or where could the product theoretically go and what's your expectation?

I mean, our expectation is that all of that production finds its way out in the public marketplace. There are enough people and the world demands that product, and there are enough people kind of willing to chase the dollars that we're just planning on all that production coming out. We don't believe all of a sudden that there's going to be some huge disruption to the supply side. That said, if the U.S. actually does get on sanctions and makes it more difficult for bidders, there's possible upside there for us, but we're certainly not planning on that.

No, I agree. I think the surprise was the tonnage has gone to Brazil that was partnered for soybeans or corn, that was a new development. I think you're seeing further restrictions, especially the sanctions that were announced recently, that tighter full sanctions will transition to urea. We believe it does make it difficult for those extraneous markets and then I think there is an issue to the sustainability of their production with an inability to work with the providers of services and products and materials at longer-term which would make that probably a question mark on production.

Thank you. So a big seed company surprised us recently by saying that it sees corn acres moving back to soy or maybe moving back to soy. I'm curious what your market intelligence says about the extent of that risk.

At this point, I think it's too early to tell. It's really an economic decision on the corn-to-bean spread and that's still attractive to corn. If I were to look at it and being able to yield it on trend with corn and/or soybeans, looking at what the difficulties could be out there with soybeans and the production that's expected to come out of South America and already has as well as the consumption in China with the possible impact of African swine fever, what that could be or communicated demand. I think the safer choice would be to stay with corn. I don't think we've gone through wet years, we've gone through dry years, and as Tony articulated and as Dennis and I did also, there is still plenty of time to plant and we believe that people will make an economic choice.

I mean, the other thing I'd add, Bert, if I can, Mark, is if you look at stocks to use, soy is really high and corn is actually down to 2012 or below levels. As we just look at our own, we don't have Intel that the seed guys do. But as we look at our order book and where product prices are for nitrogen, and as we look at what the in-market premium is and the urgent demand for our products and just kind of what the overall shipment pattern has been despite it being a pretty tough first quarter. We are very comfortable with what the acreage numbers look like and what we see developing for the first half of the year.

Thank you. Just reiterating what Dennis and Bert said, the market remains strong and we have solid planning in place to meet the demand for our products. We have a resilient production and logistics network, and we are confident in our ability to navigate current challenges while capitalizing on opportunities ahead. Thank you all for your questions. We look forward to speaking with you again next quarter.

Thanks everyone, and we look forward to speaking with you in the next few weeks and then we'll see many of you at several conferences over the next month.