CF Industries Holdings' CEO Presents at Credit Suisse Chemical & Ag Science Conference (Transcript)

Sep.17.13 | About: CF Industries (CF)

CF Industries Holdings, Inc. (NYSE:CF)

Credit Suisse Chemical & Ag Science Conference

September 17, 2013 03:30 PM ET


Steve Wilson - Chairman and Chief Executive Officer


Christopher S. Parkinson - Crédit Suisse

Christopher S. Parkinson - Crédit Suisse

Thank you. I think we’re ready to get started. Good afternoon. I am Chris Parkinson here on behalf of the Agriculture Science team. So it's with great pleasure that I’m here to introduce Mr. Steve Wilson, Chairman, President and CEO of CF Industries Holdings.

Mr. Wilson has been with the company over two decades, originally serving as the President and Chief Financial Officer. He currently is also the Chairman of the IPNI and Vice Chairman of the Fertilizer Institute.

And with that, Steve the floor is yours.

Steve Wilson

Thank you, Chris. It’s great to be here. Thanks for your interest in CF Industries. Being close to the end of the day I’ve got this handy because we have been doing a lot of talking today and talking with a lot of good interest of investors in CF.

Please read this at your leisure.

Usually I skip right by this particular slide, mostly because I don’t like looking at pictures of myself. But we made an announcement yesterday and I’d like to just make a comment or two about that announcement.

First, I think most of you probably know Dennis, that Dennis Kelleher is our Chief Financial Officer, sitting at the table here. Dennis has been with us for a little over two years and he’s doing a great job for us as we craft our capital allocation strategy.

Yesterday, we made an announcement that has been a while coming. We announced that I’ll be stepping down from active management at the end of the year. I’ll be succeeded as CEO by Tony Will, who is right here. Those of you haven’t had a chance to meet Tony, I’m sure will have a chance in the months and quarters and years ahead.

Tony has been with us since 2007. One of the objectives I think a lot of CEOs have is to be able to go out on your own timetable. And I’ve been privileged to be in this spot for ten years. It’s been eight years since we went public. Those of you who’ve been following us, for all of that time or most of that time know that we’ve had an incredible run. It’s been quite a privilege to be in this position. It’s been an honor to work with a team that we have assembled at CF and to work for the great Board of Directors that we have.

I’m going to be staying on as Chairman and a Director; I will be Non-executive Chairman. Tony is going to step into the CEO role. And I know that the company is in good hands. My focus over the next three months will be to make sure that we have as seamless a transition as possible, and I’m confident that that’s going to happen.

There are four main points that I’d like to make that are indicative of the core strengths of the company. We have, which on a historical basis is a high base earnings level. That high base earnings level is a function of the sizeable amount of demand that is served by imports in North America. And because of that American nitrogen fertilizer capacity assets, normally run at 100% of capacity. And there is certainly no indications on the horizon that that’s about to change.

The floor price for nitrogen is and like probably most commodities is set by the marginal producers’ production cost. The marginal producer is not in North America and our production costs are far below those of the marginal producer. And so that provides a great spread between our production cost and the production cost of imports that are required to serve North America, providing a great base margin for our business.

We have in-market asset base. Our company grew up as a cooperative. It was designed to serve farmers in the corn-belt. It is arguably the most productive agricultural land in the world. We produce -- we plant 90 million acres to almost 100 million acres of corn a year. And so we are positioned to serve exactly the best marketplace.

We are investing currently in two projects, a total investment of $3.8 billion of additional capacity at existing sites. These are projects with attractive returns in the mid-teens. We’re well on the way in executing those projects and we are confident in our ability to get those done and in the margin opportunities they present.

And then finally but not unimportant certainly is our history of returning cash to shareholders through dividends and share repurchases and I’ll illustrate that in a slide later in this discussion.

The solid nitrogen foundation is depicted on this graph. There are two segments on this bar chart; the green bars are domestic production, the blue parts of the bar are imports. You can see that today roughly 40% of the nitrogen fertilizer consumed in North America, and this is on a nutrient tons basis, is imported. That’s about 9 million tons on a nutrient ton basis.

Because of that high level of imports it really almost doesn’t matter what the acreage is that's planted to corn in the U.S. North American nitrogen assets are going to run at capacity and that’s certainly a good underpinning for shareholders in our company.

We are embarking on an expansion program as are a number of others in the industry. Some are existing players, some are not existing players. It’s our view that come the end of 2017 when the current wave of expansions is largely complete that the U.S. and North America will still be substantial importers of nitrogen fertilizer.

That 6 million tons of ammonia that’s referred to in the last point on the slide is equivalent to about 4.8 million nitrogen nutrient tons. And you can see that, that still leaves about half of the current imported volume still being needed post-2017.

This is really the story that supports our desire to invest in new capacity. It’s needed to serve American farmers but most importantly it’s being constructed in a cost advantaged location and it’s being constructed by a team that’s got great expertise in constructing and managing nitrogen fertilizer assets.

We talk a lot about the cost curve in our business and the change that has occurred largely because of the evolution of shale gas in North America. This is a little bit different depiction of this phenomenon than we’ve used in the past. And I would like to walk you through this.

This shows three snapshots that illustrate the evolution of the cost structure to the point that exists today. Back in 2008 when the notion of shale gas is being developed by the people who were intimately involved in the oil and gas industry we were still disadvantaged in our own marketplace. You can see that the marginal producers supplying North America were pretty tightly bunched. North American producers, Ukrainian or Black Sea producers and although Chinese product doesn’t find its way to North America we can certainly use that as another marginal producer serving the global marketplace.

And you can see that while we have no transportation costs associated with our product because we were in the marketplace, we had over $200 a ton cost of just on the cost of natural gas per ton of urea compared to the combination of gas and transportation cost of $220 or so for Black Sea and Chinese production.

The world began to change in 2010. The gas cost that we’re using in the U.S. that was on average available in the U.S. in 2010 was $4.40 MMBtu compared to twice that in 2008. And so you can see in that short period the cost of the gas component of urea was cut in half in North America. That provided the jump start to our business that has led to the robust earnings that we had. And then if we move further to right to 2013 we are using 2013 gas cost of about

$3.65 an MMBTu, we are using $8 for the Ukraine.

And we put this on a current basis for Chinese production we are using anthracite priced at $120 per metric ton. And that yields about a $175 cost if a ton of urea will be landed in the U.S. that’s just the cost of the transportation, plus the gas.

The range of coal cost in China right now is actually a $120 per metric ton and up. It’s kind of bracketed by $120 and $165 and we’ve used the low end of that range in this analysis. So you can see that we have a substantial advantage that exists today even at what are viewed as kind of cyclical low coal costs in China.

This is the urea cost curve that we’ve been using for a couple of years but we’ve updated this curve again to reflect a more current view of China. The capacity that's shown to the far right of this chart which is the Eastern and Western Europe and some of the former Soviet Union, a lot of that is shut down today because we’ve seen lower urea prices. In effect what we’ve seen is this cost curve at work as the price declines capacity shuts down.

Today the marginal production on the world market is Chinese urea. They are in their seasonal export window. That product is being sold. This year we expect 7 million tons to 8 million tons of Chinese urea to find its way on to the world market. We’ve used the same $120 per metric ton of for anthracite cost in China. That gives rise to about a $290 landed cost of urea at the Gulf of Mexico if that were to occur. That happens to be coincident with roughly with today’s urea price. So this floor price model is being tested, that’s about the third time this is being tested in the last two years.

You can see there is a lot of capacity that is accounted for by that white bar of China production. It’s not all of that specific cost -- I made the comment a minute ago about the range of anthracite cost being about $120 and $165. So it’s actually a cost curve within that bar of the cost curve. But there is lot of production there.

When that export window closes next month than in order to attract the amount of product that will be needed on the world market for the spring season the price should rise to the level of the cost or above the cost of the previously marginal producers in the Eastern Europe and the former Soviet Union.

This is, as you can see, just even in this environment the hypothetical floor margin for North American urea production is about a $150 a ton. That’s that base floor margin that’s provided to us and above which we expect to see increases and decreases in the normal volatility that exists in the price of the commodity.

This graph shows on a quarterly basis the level of capacity outages globally and you can see in the third quarter of each of the last four years there is been a spike in plant closures; that’s coincident with two things.

It’s coincident with the opening of the Chinese export window which is the shaded area around each third quarter and it’s coincident with the seasonal slowness in the market place in the Northern Hemisphere; the end of the planning season in North America being the biggest example of that. Again I think that’s more support for what is our view of how the urea market works on a global basis. It’s a very, very efficient market.

Moving more specifically to CF Industries, those who know us well know this map well. We have seven nitrogen complexes in North America. They either bracket or are in the middle of the corn belt; the darker the shading on this map, the intense the use of fertilizer in those particular states. You can see by the diamonds that our production assets are configured in a way, our footprint is configured in a way to serve those marketplaces. We do have our phosphate operation highlighted in Florida.

We have a tremendous opportunity to optimize our system. Associated with these production points we have about 70 distribution points. We have access to rail, truck, river and pipeline transportation; we have a supply chain group back in Chicago that works to optimize this whole system and subsequent to the Terra acquisition, we had a great opportunity for optimization.

Importantly we utilize 23 ammonia terminals, including a couple now in Canada. And that’s a pretty much unique portfolio of assets because ammonia needs specialized storage and particularly careful handling. And that enables us to access the ag market in the two strong seasons that we have, in the fall and in the spring.

We operate a fleet of barges. We also operate about 5,000 railcars and in season, this whole mix of assets is a tremendous toolkit for us to optimize in order to create the EBITDA levels that we’ve been able to generate the last few years.

These two graphs illustrate the value of our ammonia distribution system. The right hand graph shows the trend that’s occurred in our own fall ammonia business. This shows the trend in the number of days that have been required in order to ship two-thirds of the ammonia demand in the fall. It’s roughly been cut in half in the last 15 to 18 years from about 22 days down to 12 days.

We’ve been able to do this because we have substantial storage. We have loading facilities that enable trucks to get in and out and we have a resupply capability that enables us to drain a tank and refill it still in the same season in order to meet that demand.

The bar graph at the bottom of the page illustrates the incremental margin that’s available because of this terminal system. It is ranged mostly in the $50 to $100 range. We’ve had spikes in that premium, as much as $200 a ton. It’s a tremendous portfolio of assets. It’s one in which we take great pride and one that’s created a lot of value for our shareholders.

I mentioned our capacity additions. We’re expanding our basic nitrogen capacity by about 25%. We’re spending $3.8 billion; $2.1 billion is being deployed at Donaldsonville, Louisiana, which today is the largest nitrogen complex in North America, soon to be the largest nitrogen complex in the world. 1.7 billion is being expended in Port Neal, Iowa.

In Iowa, we’re building state-of-the-art ammonia plant and a state-of-the-art urea plant. You can see on the lower part of the chart most of the ammonia being produced, 850,000 tons a year is going to be upgraded into granular urea. There will be small amount of ammonia; it shows here 81,000 tons a year as ammonia that will be sold principally to the ag market.

In Donaldsonville we’re building a world-scale ammonia plant, annual capacity 1.3 million tons. Virtually all of that is going to feed new upgrading in urea and UAN. You can see that the capacity of the urea plant at Donaldsonville is exactly the same as the one at Port Neal. There's certain economies available to us by building twins. We’re building exactly the same plant in the two locations.

We are also building nitric acid and UAN capability. That will give us a lot of flexibility to ship between urea and UAN. You can see in the, we are on the [verbiage] on the left that our urea production through this expansion we’ll be able to be between 2 million and 2.7 million tons because we have the ability to take up to 700,000 tons of incremental urea and instead of granulating and we can send it into the UAN process and we can produce UAN.

Our UAN flexibility will be between zero and 1.8 million tons. This gives us a great a flexibility in order to take advantage of market opportunities that occur actually throughout the fertilizer year. We have the air permits for these projects, the construction is already under way. We’ve committed a lot of money and we are on a good path in terms of our schedule and our budget for those two projects.

I mentioned our record of returning cash to shareholders. We’ve done since 2010 about $270 million of common dividends. We’ve done since 2011, since the second half of 2011 $2.6 billion of share repurchases. In the second half of 2011 in the first half of 2012, $1.5 billion of that was spent buying shares back at an average of $157 a share and through the beginning of August when we had our second quarter conference call we had expanded $1.1 billion of current $3 billion authorization to buy shares back at an average of $191 a share.

We believe we’ve been good purchasers of our own stock. We believe that we are investing in our stock when we buy shares back just like we’re investing in capital equipment and we’re looking to generate good returns for shareholders.

We do have $1.9 billion remaining as of the beginning of August on that $3 billion authorization. We were recognized by a Credit Suisse analysis a little over year ago for the effectiveness of our share repurchase program. I believe that we were rated second out of the S&P 500 in terms of the effectiveness of our share repurchase program.

And then finally on the financial front in May, we issued $1.5 billion of bonds. This was our first investment grade issue; half of that was 10 year money at 3.45% coupon and we did half of it at 30 years at 4.95%, obviously our timing was very close to impeccable.

We think our record stacks up well against our peers with respect to returning capital to shareholders. We show two measures here, one as a percent of equity market value and the other as a percent of EBITDA.

This is a depiction of the evolution of the leverage that our shareholders have to the nitrogen fertilizer industry. And you can see highlighted in yellow this is a number of nitrogen nutrient tons per 1,000 shares. Before we did the Terra acquisition we owned 53 -- a 1,000 shareholder owner owned 53.5 tons of nitrogen capacity. Even though we issued stock in conjunction with Terra acquisition, after Terra acquisition that number rose to 87 tons per thousand shares.

Given the number of investments that we’ve done since then that number has risen to 115 tons per thousand shares, that reflects both share repurchases and modest capacity additions. And that 115 tons per thousand shares would turn into 148 tons per thousand shares if we all did was to complete our expansion program.

But remember we have $1.9 billion remaining on our share repurchase program; you can do your own math, assume whatever price you want on the stock we buy back. But obviously we are increasing on a very consistent and dramatic basis the amount of exposure our shareholders have to the basic business in the nitrogen cycle that I described earlier.

So in summary, we have a high base level of we have a high based level of earnings that’s a function of industry structure and related floor pricing dynamics. We have upside earnings opportunities because of your strategically positioned asset base and because of our very targeted investment program. We have been returning cash to shareholders and increasing our balance sheet efficiency and we’ve increased and continue to increase our per share leverage to Nitrogen production capacity.

And I would conclude by simply adding that we have a history of making strategic decisions that are few in number but are substantial in terms of magnitude. And we have executed those transactions I think in a very, very effective way. I am certainly very proud of the work that our management team has done and all of our workforce down to the shop floor level.

We have a great team, we operate in a world of high integrity and in a safe way. And I will certainly change my role at the end of the year with my head held high and with a lot of humility for having been give them opportunity to do what I’ve gotten to do.

So with that maybe we have a few minutes for question likely.

Question-and-Answer Session

Christopher S. Parkinson - Crédit Suisse

Thank you very much Steve and congratulations. You hit on a lot of your strategic positioning within the global nitrogen market as well as your transportation-logistics capabilities. Do you think something you could tell a little bit more include not only within the North American market your natural gas procurement even within your different facilities and how you are advantaged there?

And then also longer term how do you think the North American supply demand is going to evolve given you seen some project cancellations over the last six months?

Steve Wilson

Sorry, Chris your first question was about how we buy natural gas.

Christopher S. Parkinson - Crédit Suisse

Natural gas procurement…

Steve Wilson

Well we’ve operated through our life as a manufacturing company, in the spot market in North market in North America. And I think we’ve done it effectively. We did it effectively even during times of relatively high prices and difficulty in achieving positive book margins. So in today’s world we have shale gas and we believe that we are in a range of $3 to $5 on a sustainable basis.

We continue to be very comfortable operating essentially in the spot market and that’s one of the reasons that we're comfortable putting $3.8 billion into the nitrogen business in North America because we like being exposed to North American natural gas.

Now we do, do hedging, we have through the years we’ll go out as far as may be nine months, twelve months, fifteen months and fix some gas costs. We used to fix it in concert with nitrogen prices and we've decoupled that to a great extent. Recently we’ll do swaps, we’ll put caps in place but overall we like being in the spot market.

With respect to other projects, that was your other question. We’ve seen some project cancellations. I really don’t know any more about project cancellations than what the sponsors have said when they’ve cancelled them. I do feel quite comfortable with the way in which we made our decisions and the timing of those decisions.

We made the decision, we announced the decision on November that we are going forward with these two projects. We got in at the front of the line in the fabrication shops. We have the engineering and design ready to go. I think if there is a preemption value in projects like this than we’ve achieved it. That doesn’t mean that nobody else is going to build plants. There are other facilities -- one other complex that's already under construction as ours is.

We know there will be a few other built but we are certainly confident that come say four years from now when this wave is done that North America will still be dependent on imports to meet demand. But that doesn’t really drive our decision framework because we’ve got the Donaldsonville assets sitting there and we have access to export markets which we have exploited in the past and they are available to us certainly going forward in an even bigger way.

Christopher S. Parkinson - Crédit Suisse

So another one, so on top of, when you look at your production footprint, and the versatility of production you have from your upgrading capabilities, can you talk a little bit how you’ve benefited from that also not only the domestic market but your international opportunities? And how you are positioned now versus how you believe you will be positioned after the completion of your two projects?

Steve Wilson

Well, some may think that we’re a North America -- we're building North American production because we started out in North America. That’s actually an over simplification because a few years ago we were determined to diversify away from North American natural gas. We felt the salvation for our North American assets was going to be LNG imports. So that’s how long we were in that.

Fortunately a project that we spent a couple of years on in Peru didn’t get built. And so we’re now in a more competitive position building in North America.

We would entertain having production in other places in the world other than North America but we’ve got to have a few things that are essential. We need a low cost and reliable supply of natural gas; we need a stable political and economic climate; we would need a site with access to deep market -- to deepwater because these are -- world traded products. And we need a reasonably attractive close to home market. And we put all those criteria together and you look at the world it points right to North America.

So that’s the most logical today. Whether it will be most logical in the next generation of leadership, I don’t know.

Christopher S. Parkinson - Crédit Suisse

Anything Tony? What about even just extrapolating that and looking at within the North America, just looking at upgrading capabilities between urea and UAN and how you see the domestic market evolving over the next few years on those fronts.

Steve Wilson

Well, the product mix in North America has evolved over the last 10 to 20 years as follows: Ammonia -- ag ammonia on a volume basis has been flat as the product that has grown in use is UAN, and today it’s about a third, a third, a third; ammonia, urea and UAN. UAN is only used in a few places in the world, although we’re embarked upon a project to try to spark demand in other places in the world for UAN.

We expect the ammonia users to stay as ammonia users. It’s the most cost effective source of nitrogen because it’s 82% nitrogen. But you need special equipment to deploy it in the field. We like the fact obviously that we’re the biggest in all three. And we have the flexibility to switch among all three. We can always stop upgrading if we want to. And we will have a substantial ability to shift between urea and UAN when the -- expansion is done.

Christopher S. Parkinson - Crédit Suisse

So I guess the final question to wrap it up, you’ve a lot of future shareholders in this room and a lot of potential shareholders in this room, what main thoughts would you express to them regarding where do you think the street, the buy side particular is missing from your story? I mean where do you think you’re undervalued and people should find additional value in your stock?

Steve Wilson

Well, the major point is the one that I hope has come across, is being emphasized this afternoon. And that is that we have a business model that is robust and it is robust because it has substantial fundamental underpinnings on a global basis. And that provides us with a base level of earnings that is quite substantial. And we’ve demonstrated in the last couple of years about the upside is when nitrogen markets are robust and generating $3 billion of EBITDA and $6 billion of sales is a just tremendous performance.

And I think we’re still working on convincing a wide group of investors that this cost curve actually works, that there is a responsiveness there and that, that floor margins that I described is in fact the floor margin.

That’s the main thing that we consider -- we continue to work on. And of course we will augment that by making good investment decisions and making in general good decisions about deployment of capital, whether it be capital investments or returning cash to shareholders through repurchases and dividends.

All of those things work together and we are always interested in ideas from all of our shareholders.

Christopher S. Parkinson - Crédit Suisse

Thank you very much.

Steve Wilson

Thanks Chris.

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