CF Industries Holdings Inc (CF) — Q2 2021 Earnings Call Transcript

Good morning, and thanks for joining the CF Industries' first half 2021 earnings conference call. I'm Martin Jarosick, Vice-President of Investor Relations. With me today are Tony Will, CEO, Chris Bohn, CFO, and Bert Frost, Senior Vice President of Sales, Market Development, and Supply Chain. CF Industries reported its first-half 2021 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 any statements. More detailed information about factors that may affect our performance may be found in our filings with the SEC, which 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. Yesterday afternoon, we posted our financial results for the first half of 2021, in which we generated adjusted EBITDA of approximately $1 billion. Strong nitrogen demand and lower overall production have tightened the global supply-demand balance, supporting much higher prices than in recent years. At the same time, energy spreads between North America and high-cost regions have expanded considerably, increasing margin opportunities for our cost-advantage network. These factors helped drive an increase in adjusted EBITDA of nearly 25% compared to last year, and we produced our strongest first-half financial results in six years. Additionally, the business continues to generate strong free cash flow, giving us tremendous flexibility as we focus on achieving investment-grade metrics and executing our clean energy initiatives. The first half was not without its challenges, including the natural gas-driven production interruptions we described on the first-quarter call. The first half also saw a continued demonstration of the harm the UAN industry in the U.S. faces from subsidized and dumped imports from Russia and Trinidad. Until the last few years, UAN earned a substantial premium over other upgraded nitrogen products due to the higher capital investment required to produce it and the meaningful agronomic and operational benefit it offers to farmers. As you can see from our recent results, UAN now trades at a significant discount to all upgraded nitrogen products due to unfair trade practices. We have taken the necessary steps to address the situation by petitioning the Department of Commerce and the International Trade Commission to initiate anti-dumping and countervailing duty investigations. We look forward to the result of the ITC's preliminary vote later this week. Looking forward, we are very bullish about the next two years. As Bert will describe in a moment, the need to replenish global coarse grain stocks driving agricultural demand, along with the impact of increased economic activity driving industrial demand, should support all-time record global nitrogen demand over the next two years. Forward energy curves are also very favorable over this timeframe. We expect these factors to help keep the global nitrogen supply and demand balance much tighter than we've seen in recent years, supporting an extended period of higher nitrogen pricing and higher margins for our cost-advantage network. Longer-term, we believe increased demand for ammonia and its clean energy attributes will become a significant factor in the tighter supply and demand balance, driving further value for our network. We continue to see broad interest in clean hydrogen and ammonia to help meet the world's clean energy needs. As we continue our discussions with market participants, our focus remains on being at the forefront of this significant opportunity from positioning our network to be the world's leader for blue and green ammonia production to collaborating with other global leaders where our unique capabilities can provide value. We are pleased with the progress we've made and look forward to additional developments in the coming months. With that, let me turn it over to Bert, who will discuss the global nitrogen outlook in more detail. Then, Chris will follow to talk about our financial position before I return for some closing comments.

Thanks, Tony. The global nitrogen supply and demand balance remains far tighter than we have seen in recent years, underpinned by strong agricultural and industrial demand, plus higher energy prices in Europe and Asia. This has created a highly favorable pricing environment that has persisted into the second half of this year. Based on the agricultural and energy outlook we see today, we believe a positive pricing environment for fertilizer will remain in place, at least into 2023. Strong global nitrogen demand is being led by the world's need to replenish coarse grain stocks. The global coarse grain stocks-to-use ratio was the lowest since 2012, entering this year's spring planting season; commodity prices have risen significantly in response, and farmers are incentivized to maximize yield with fertilizer applications. Given this, we expect to see sustained demand in the second half led by India and Brazil. We expect similar strength from North America and Europe leading into the 2022 application season. We had a positive start to meeting this demand a few weeks ago when we launched our UAN Fill Program. We have built a solid order book for the third quarter at a no-load equivalent price of $285 per ton, though prices remain at a significant discount to urea for the reasons Tony mentioned. Further out, we expect that high demand for coarse grains, especially from China, will contribute to persistent low global stocks into next year. As a result, we believe that stocks will still need to be replenished at least into 2023, supporting continued strong nitrogen demand. Increased economic activity is also driving higher global industrial demand for nitrogen. In North America, we've seen diesel exhaust fluid sales rise above pre-pandemic levels. Our first-half DES sales were a company record, and we expect overall demand will continue to grow. We've also seen higher demand for ammonia and nitric acid from our industrial customers. Globally, industrial-related demand in China and from phosphate producers has also increased. While we expect demand to remain strong for some time, we believe that global fertilizer inventory in the channel today is low and will need to be rebuilt. So far in 2021, high energy costs in Europe and Asia have lowered operating rates and reduced supply availability, particularly for ammonia and urea, further supporting global pricing. As you can see on Slide 9, energy costs in these regions have increased to over $14 for MMBtu. And Eastern European producers will become the global marginal producer for the time being. The higher energy costs have steepened the global nitrogen cost curve substantially, increasing margin opportunities for low-cost producers, such as CF. The forward curve suggests CF will benefit from favorable energy differentials for the foreseeable future. As a result, we believe we have a tremendous opportunity ahead of us to leverage our manufacturing, distribution, and logistics capabilities to deliver for our customers. With that, let me turn the call over to Chris.

Thanks, Bert. For the first half of 2021, the company reported net earnings attributable to common stockholders of $397 million or $1.83 per diluted share. EBITDA was $994 million, and adjusted EBITDA was $997 million. The trailing 12 months net cash provided by operating activities was approximately $1.2 billion, and free cash flow was $700 million. Based on the outlook Tony and Bert shared, we're well-positioned to build on these results and continue to generate significant free cash flow. I want to provide additional context to the two items we covered in our press release. First, we raised our estimate for capital expenditures for 2021 from around $450 million to approximately $500 million. The increase is driven primarily by our decision to pull a significant maintenance event scheduled for next year into this year. We believe that performing this activity in 2021 is best for the asset and reduces the risk of an unplanned outage during the 2022 spring application season. Going forward, we expect capital expenditures to return to the range of $450 million per year. With this additional maintenance project, the high level of previously planned maintenance, and the additional maintenance from severe weather in February, we estimate that gross ammonia production and sales volume will be around 9.5 million tons and 19 million product tons, respectively, both at the low end of our forecasts earlier this year. Looking into 2022, we have a more typical maintenance schedule and would expect to return to approximately 10 million tons of ammonia production and sales volume of 19.5 million to 20 million product tons. Second, we are taking additional steps in line with our focus on achieving investment-grade ratings and positioning the company to execute our clean energy initiatives. We have announced that we will redeem $250 million of our Senior Notes due June 2023, which will reduce our gross debt to $3.5 billion. We expect to lower our gross debt to $3 billion by or before the maturity of the 2023 notes. We'll also continue to return cash to our shareholders through quarterly dividends and opportunistic share repurchases at attractive levels. With that, Tony will provide some closing remarks before we open the call to Q&A.

Thanks, Chris. Before we move on to your questions, I want to recognize everyone at CF for their strong work during the first half. They successfully managed many challenges in the first six months of the year, setting us up well for the second half. Most importantly, we did this safely with our recordable incident rate at the end of June at just 0.28 incidents per 200,000 labor hours, significantly better than the industry averages. As we look ahead, we expect strong agricultural and industrial demand to create all-time record global nitrogen demand. The forward curve shows very favorable energy spreads to Europe and Asia over the same timeframe, which should support robust margins and cash generation. We see good progress on our clean energy initiatives. Taken together, we are well-positioned to create significant shareholder value in the near and longer term. With that, Operator, we will now open the call to questions.

Hi. Good morning, everyone.

Good morning, Joel.

It's very rare where your second half EBITDA is higher than your first half EBITDA. I think it's been a decade. Is that a situation you were expecting this year? And then maybe as you answer that, could you talk about what type of pricing visibility you have in the third quarter and fourth quarter? Thanks.

We're really pleased with how the year is shaping up. Obviously, we were disappointed with where UAN values were as a result of Russian and Trinidadian dumped imports in the first half of the year. But as you look at our balance sheet at the end of the second quarter, you see it – our customer advances have basically all of that had moved through the system. And when we launched our Fill at $285 for UAN, that's a substantial uptick and that's really the price environment that we're looking at in the third quarter of the order book going forward. Subsequently, we've been able to get a little bit of further appreciation off of the $285 number. So we're really pleased with how the order book is set up right now and what the back half of the year looks like. We've seen strong interest in ammonia for the fall already; urea continues to trade in a reasonable spot; and, as I said, UAN looks very good. So, we're really excited about the second half, and we think that it's not just the second half, but that it sets up well for both 2022 and 2023.

Okay. Thank you for that. And just on following up on free cash flow, do you think that this year you'll end up with more free cash flow than last year? Obviously, prices are higher and you've got some working capital outflow in the second quarter.

Good morning, Joel. From a free cash flow standpoint, as we talked about in the prepared remarks, we expect to continue to see significant strength. As you mentioned, in this particular quarter, we had a few working capital challenges, with both accounts receivable and the bleed-through customer advances, which was about $0.5 billion between those two. But as Tony just mentioned, we're seeing pricing strength due to the energy differential spreads that we're seeing globally for the second half of the year. We still do have our product tons will be on the lower end, probably around 19 million product tons. But outside of that, we see a really strong second half of the year from our free cash flow standpoint.

And overall for the year, as Chris mentioned in his remarks, we are seeing higher CapEx this year, principally due to all of the major turnaround events that we've done. That's a little bit of a hit relative to where we were last year. But we're really, again, really excited about where we sit and what the forward picture looks like.

Yes, thanks. Good morning, everyone.

Good morning, Adam.

Good morning. The first question on the balance sheet and capital allocation was hoping to just clarify the value you see in having the investment-grade rating. I'm still trying to get my head around the idea of repaying early status sub 3.5% when your stock trades at what I think would be north of 10% free cash flow yield. And just where you see the value of the investment-grade credit rating over the long to medium term as you think about the green investment figure you were contemplating.

I'll take the first cut at this, Adam, and then I'll turn it over to Chris for probably more insightful comments. But there are some real frictional costs that we face in the business from not having investment grade that has to do with lines of credit and some other embedded derivatives with our CHS venture, and those frictional costs go away if we regain investment grade. I also believe that there is a signal to the equity holders about the stability and strength of the company with an investment-grade rating. We think both of those things are important. So that's really our focus on why to get back to investment grade.

Yeah. And I would add to that. As we look at some of our growth plans going forward with having the Senior Secured Notes due in 2026, that does limit some of the asset moves we can do within our structuring to get the most efficient, whether it be from a tax basis or others in an asset. By getting investment-grade, that Senior Secured drops off, allowing us a little bit more activity. What we're seeing over the next several years here with free cash flow generation is we're really going to be able to reduce our debt to that gross target of $3 billion, invest in our clean energy initiatives, and return cash to shareholders. I think our current trajectory will allow us to do all three.

The investments that we're looking at right now, both from a green and blue perspective, are not huge dollars and are managed easily with our cash flow. The issue, as you mentioned on the yield, while the yield flow we've built on the balance sheet is terrific, we're not earning any kind of return. Even though it's taken out something that looks nominally like a fairly low-interest rate, it's still better than what we're generating on the cash. The equity trades at a higher effective overall cost to the business from a cash flow yield perspective, but getting rid of some of those residual costs and drag on the business while having the flexibility that Chris talked about in terms of internal structuring of assets to optimize tax consideration, all those things are pretty important for us.

Okay, that's really helpful. And then a quick follow-up, in the second quarter, you had about a $100 million year-on-year of incremental costs in the business related to maintenance and the fixed cost absorption with higher turnarounds. And I'm just trying to get a sense of how to think about the second half in that light. It seems like the turnaround maintenance activity is going to be heavy again in the second half. Just thinking about the P&L impact of that for the balance of the year.

Yeah, so I would put two big pieces in the cost side when comparing it to a year ago. Based on the amount of turnaround activity and other maintenance, we ended up with almost $60 million of incremental maintenance and fixed cost write-off associated with the plans in Q2 versus last year. We also ended up with about $100 million that hit the cost of goods sold through the first half of the year, based on purchased products for resale and commitments we had made to customers. With the plant outages and the turnarounds, we needed to cover those positions to provide reliable supply. In an average or normalized year, you wouldn't see that $100 million hit the COGS in that way. So, those are two big pieces that we won't see to the same magnitude in the second half. There is ongoing significant turnaround activity, which may lead to some fixed costs write-off, but that’s to be determined.

We talked about gross ammonia production at 9.5 million tons and product tons at 19 million tons. If you look at that as what we're going to produce in the second half of the year, that gives you a pretty good indication of the additional work. But as Tony mentioned, we've had some additional drag here in the first half that we don't expect in the second half.

Hi, good morning. You're purchasing 100% fuel energy in the UK, which could be renewable energy, which is a great step. What is the cost of renewable energy in the UK? How does that compare to your prior electricity contracts?

Hey, P.J. Good morning. The incremental cost to us is pretty minimally impactful. It's somewhere in the neighborhood of 60,000 to 100,000 pounds per year just to move to renewable versus what we're paying today. So the incremental cost will not be noticeable at all in the system, which is why it's very easy to transition to 100% renewable and reduce our scope to emissions. We're looking at similar opportunities in the U.S. where we can incorporate renewable energy into the system without significant costs. We provide a really good baseload for some people because of the consistency of drawing that we have across the network.

Great. Thank you. And then today's miss, if you want to call that, came from higher maintenance activity, which you outlined just now, and also higher natural gas costs. How much higher were gas costs compared to your forecast? I know it can change anytime, but based on your hedges and forward curve, what natural gas cost do you expect for the second half?

On the cost of gas, what I'd say is more important than the absolute cost is what the energy spread differential is. While last year you saw very low gas costs both in the U.S. and the U.K., you also saw global energy costs that were dramatically reduced, partly COVID-driven. Although our costs were low, our margin opportunity was also compressed due to high operating rates. Right now, there's a huge margin differential between high-cost producers running at energy costs of $10 to $11 per MMBtu compared to our network. Despite the increase in our costs, our margins are expanding much more rapidly. This is a great environment for us. The higher gas costs in Henry Hub contribute to this margin expansion. As we look forward, we anticipate the forward energy where the NYMEX trades without much additional insight on where the market will move.

I agree with everything Tony just said. Instead of looking at the overall cost of goods sold in total, it's the controllable cost side that was impacted by maintenance. The controllable cost per ton generally runs in the mid-80s, and we expect it to return to that as we forecast for normalized operating rates next year.

In a normal year, we would do about four major turnarounds, which would be an ammonia plant plus some associated upgrades. Last year, we reduced that number to just two major turnarounds. This year, we have seven instead of four, so we're bringing one turnaround from next year to this year. With the increased number of turnarounds, we are excited about setting up for the future and maximizing production. We feel very good about where we're positioned.

Good morning. This is Lucas Beaumont on for John. I wanted to follow up on your discussion about gas costs, if I can. I take your point that the differentials are high right now between Europe, Asia, and North America. Looking ahead, what gives you confidence that the European and Asian spreads will persist as opposed to return to a more normal level?

Currently, Chinese coal is about $9 an MMBtu on the anthracite side, resulting in a $5 relative differential to Henry Hub. We don't see indications that China is trying to reduce coal prices, and any further restrictions on urea exports could keep prices stable. As we examine the forward curves and markets like TTF and JKM against NYMEX on Henry Hub, this suggests a terrific margin opportunity for our network.

The spreads currently on the TTF and NBP are $11 compared to Henry Hub, and next year's Strip has them over $7. The supply side remains tight, requiring bids at a higher cost. The marginal producer is European and other Asian producers, reflected in the pricing. There's strong anticipated demand for nitrogen next year.

As I mentioned, we're expecting an all-time record global nitrogen demand next year. The market signals a very favorable operating environment, with supply tight. Therefore, this situation is encouraging for us.

Yes, thank you. Tony, you mentioned a forward book on UAN and the $285 or higher in the third quarter. Can you comment on your forward book in urea and ammonia, how much of your third quarter volumes you already have locked in, and roughly the price? Can you shift volumes to urea given its higher gross margin per ton?

We're pleased with our order book going into Q3. As we exited Q2, we had a nice ammonia book for fall with prices at $600 to $640 at the terminal level and the UAN Fill Program with $285 NOLA. For urea, the market has stayed in the range of $420 to $440 FOB NOLA. We have a healthy mix of all three products and anticipate a positive pricing environment for Q4 and into next year due to structural market factors.

Thank you, Bert. Regarding the blue ammonia opportunity for you, the engineering to capture and treat that carbon is pretty well understood. But is the rate-limiting step to move forward less about demand and more about sequestration? Would you ever consider pursuing a Class VI injection well on your own property to have control?

Hi, Steve. Yes, the availability of Class VI permanent geological sequestration is potentially the limiting factor. However, there are opportunities to sequester CO2 for EOR applications immediately. That would provide some level of 45Q tax benefits, which is currently available. We're pushing for dehydration and compression systems to be in place and ready for injection wells when permits are issued. We want to partner with experts in subsurface geology rather than trying to manage that expertise ourselves.

Thank you, Tony.

Several companies have approached us regarding the geology near Donaldsonville, suggesting it's well situated for Class VI permits. That provides good prospects for injection, both from an economic and timing perspective.

Sorry. Thank you. Good morning, everyone. Tony, last October, when you brought the green and blue strategy to the investment community, the free cash flow outlook was much lower than it is today. You characterized the spending levels would initially stay within your annual CapEx budget. Is there a dollar range you anticipate spending within? Is there a maximum level you would spend or any parameters you want to share around this?

The green hydrogen/ammonia project at Donaldsonville is in the range of $100 million. The dehydration and compression systems for CO2 in Donaldsonville may be about $200 million to provide about 1 million tons of blue ammonia by the beginning of 2024. We're also looking at a potential similar dehydration compression unit in Yazoo City, Mississippi, likely costing about $70 to $80 million. The projects we announced are sub $400 million over the next two to three years. Based on the increased margins and cash flow we're seeing, we can easily account for this spending.

So is it fair to say that the probability of a very large-scale announcement over the next three years is pretty low?

We're excited about the market for blue and green hydrogen, as they will be in short supply relative to future demand. We intend to be in a strong position to capitalize due to our scale advantages. While nothing is guaranteed, the opportunities we're seeing excite us.

Thanks. Tony, expectations for corn acres are solid next year. Assuming we continue to have the kinds of logistic challenges we've had for the past year, is there anything materially different you would do?

We continue to look at expanding distribution assets, whether it means incremental UAN tanks or other points of in-market distribution where we can either lease them or buy them to fully advantage supply chain disruptions. I’ll turn it over to Bert for other considerations.

You're spot on. The biggest step we've taken is with the International Trade Commission, advocating our case about subsidized levels of imports. We’ve worked structurally over the last few years to supply a greater amount of UAN into the market, which is growing. Our logistics on all major railroads and rivers make us well-positioned for future demand.

One other thing I would add is we have invested in building competitive rates, particularly out to California. Our logistics to satisfy U.S. demand are better than ever, and we look forward to the ITC verdict at the end of the week.

Sure, just switching gears to Brazil for a second. Brazil farmers clearly want to plant more corn. If they see that happen next year, is that going to improve your situation in terms of competition in the Gulf?

Increased international demand benefits us, reducing pressure on U.S. Gulf product liquidity. While corn acres matter, the competition for those acres is also based on soy prices. A healthy balance is best given the current supply and demand situation.

Brazilian demand is exciting for urea and overall nitrogen given structural changes anticipated and a strong export dynamic. Higher yields will drive nitrogen demand, critical for meeting future needs.

Yeah, good morning. I wanted to understand how your ammonia price realizations may trend. Can you talk about how much of your third-quarter volume is locked in and the pricing?

We have a cost-plus contract with Mosaic that aligns month-by-month consumption. We anticipate continued high pricing due to the global supply constraints. Additionally, the fall ammonia demand is strong, supported by expected corn acreage increases.

Hey. Good morning. Given your strong cash flow, would you consider a bigger share repurchase program or some sort of special dividend?

Probably not a special dividend, but certainly considering a share repurchase program. We believe executing larger chunks opportunistically provides better leverage and return opportunities for equity holders.

Good morning. A question on the timing around the anti-dumping outcomes; what are the steps after that? If it's favorable, will we see a similar phenomenon as with phosphate?

Morning, Duffy. The decision comes out on Friday. If favorable, we expect UAN to return to historical trading practices at a premium over other upgraded nitrogen products. UAN should be able to satisfy U.S. domestic demand without relying on imported tons. If not favorable, it’s business as usual with the current challenges of imported tons.

The timeline for the ITC's response will be relatively short, with preliminary responses coming shortly after the decision, and we will continue to work closely with our customers despite the challenges.

Thanks very much. In the third quarter and some other times, you sell ammonia to industrial customers on a cost-plus basis. Should those legacy contracts be revisited?

Most of our industrial business is ratable, not seasonal, which provides a natural hedge. These contracts come up for reevaluation every year or few years, during which Bert and his team evaluate pricing relative to market dynamics.

The Q3 ammonia pricing is the lowest, while Q2 and Q4 see increased Ag ammonia movement at higher prices. Overall, the yearly industrial pricing remains fairly consistent.

Thanks. My follow-up is that CF has been a good stock this year, but historically, the share price has struggled. If you don't want to buy back shares, how do people make money in CF over time?

I believe you need to assess our return relative to peers. While market challenges persist, the fundamentals of our business are stronger than they’ve ever been. The cash flow generation today and share count is better than it was during previous peaks. We’re well-positioned to capitalize on future demand for clean ammonia and hydrogen as economies decarbonize.

Good morning. I have a question about UAN volumes. It seems it went down much less than urea and ammonia in Q2. Can you explain why that was the case?

The UAN volume uptick was due to our proactive approach in purchasing urea and ammonia to fulfill customer commitments. UAN produced met demand during high-volume situations, despite pricing constraints.

Thanks to everyone for joining us this morning. We look forward to speaking with you in follow-up calls and also at upcoming conferences.