Chuck Magro - Chief Operating Officer
Ben Isaacson - Scotia Capital
Agrium Inc. (AGU) Scotiabank Agriculture & Fertilizers Conference Transcript September 24, 2013 11:00 AM ET
Ben Isaacson - Scotia Capital
So next up we have Agrium and Chuck Magro, COO is going to be speaking. Chuck?
Thanks Ben. Good morning, everyone. It’s pleasure to be here in Toronto. This morning I plan to talk about Agrium’s integrated strategy. I will talk a little bit about the fundamentals currently driving the industry, provide a high level overview of the three business units we have and wrap up with our capital allocation priorities and future opportunities for the company.
But before I get started, you will have probably seen that we increased our dividend again, made an announcement yesterday. We increased it by 50% to $3 per share. This was part of our annual strategic review process. I think it does illustrate our confidence and the ability of our company to generate significant cash flow even in these uncertain times and I think it does show the testament and the value of our integrated strategy.
Despite some short-term headwinds impacting our Wholesale business in Q3, as per our recent press release, we believe the long-term fundamentals of our business remains very strong and we expect solid crop input demand as we move into the fall season. Our Retail business is expected to deliver very strong results surpassing last year's third quarter and with that we will get started.
Our forward-looking statement. This chart shows a snapshot of the portfolio of our businesses. Back in 2005 and then again in 2012, and you can see how we've grown the company in this time period, from about $650 million of EBITDA in 2005 to about $2.7 billion in 2012.
With the 2012 EBITDA of $2.7 billion, this represents about a 23% compounded growth rate over that seven-year time period. And to put this in perspective, if you look at our Retail business earnings in 2012, while they were larger than the entire company was back in 2005. And we now have a crop protection and seed business that exceed collectively $5 billion of revenue.
And if you look at our Nitrogen business, well, in 2005 it was about 65% of the company-wide EBITDA and in 2012 it represents about 45% and has grown in absolute terms. So we now have much broader exposure to the agricultural fundamentals.
Our strategy, well, our strategy is unique. We are the only publicly traded company that is integrated across the value chain. We believe that having wholesale production integrated with the Retail Distribution business provide very significant value creation for our shareholders.
We have significant operating synergies by running our potash assets at higher operating rates to supply our retail business to the tune of about $750 million of value. Our integration has provided many opportunities for acquisition, most recently the Viterra agri-products business which had both wholesale and retail assets.
Also having two integrated businesses allows us to have a much higher debt capacity of about $750 million. And finally having a larger, more stable business and earnings allows us to increase our dividends and our share repurchase as we demonstrated yesterday.
The Viterra acquisition, while we are very excited about this opportunity to add another 210 retail facilities to our portfolio in Canada and we do welcome all the new employees into the Agrium family.
We expect this acquisition to be highly accretive with an impressive IRR and significant EBITDA contribution and it will also help improve key operational excellence metrics such as working capital, the revenue. We will provide more financial information after we close on the transaction which we expect to be in the very near future.
Before talking about the long-term fundamentals, maybe just a quick update on our outlook that we provided yesterday. The Wholesale part of our company, while we are seeing a slow volume demand and weaker pricing across all three nutrients, NP&K.
Harvest is just getting started in the southern part of the U.S. and many growers right now are taking a wait-and-see approach to buying fertilizer. Also, as a result of outages at our nitrogen facilities, we had lower Q3 inventories going into Q3 and are experiencing higher cost as a result of this.
Our factors -- all other factors considered, Wholesale is likely to be down about $200 million of EBIT less than the same period of last year. However, Retail is experiencing a solid quarter and we expect that to surpass last year and be more in line 2011 levels.
Now to the fundamentals, the long-term Ag fundamentals are really quite still are strong, really nothing is changed here. The consumption of grain is still growing at about 2% per year and crop demand is expected to continue to increase at the rate -- at the same rate for the foreseeable future. And this is driven by things we've talked about for many years’ global population increases and global wealth.
So how do we increase production to meet the steady demand? While there are two ways, you can increase the amount of crop area and you can increase the amount of crop yield. The chart on the left shows the crop area increase that we've done and this is 100 million hectors over the last 10 years that the world has put in to production.
It’s come from places like India, China, Brazil, Africa and even United States where there are finite limits to how much land can be added. And the question you have to ask yourself is what will happen in the next 10 to 20 years.
The right-hand chart shows the actual yields that have increased. And this chart actually shows that the rate of yield increase is actually slowing. In fact, the last decade, -- as an industry have only added yields to the tune of 1% to 1.5% per year. So we have to find a way to increase these yields.
What does all this mean? It means strong demand for crop inputs and what that means is strong demand for our products, fertilizer, crop protection products and high technology seed. Today, fertilizer and grain prices are being impacted by short-term supply demand issues. There is uncertainty in the market, more than usual.
There is uncertainty in the size of the corn crop, the amount of urea exported by China, phosphate demand in India and Russian potash production strategy. However, most of this uncertainty is well reflected in the current pricing levels. This chart shows that at today pricing with all this uncertainty in the market, the grower which really what matters is still making very solid returns.
And these solid returns have been going on for quite some time. In fact, the last three years, there have been record or near-record net farm incomes. Income data for -- and this income data that you see on this chart is really for all U.S. farmers. So it has the livestock producers in it as well. The grain grower economics would even be stronger and grower’s balance sheets have never been stronger.
The bottom line, growers across North America are in sound financial shape and remain very optimistic about the future. And When you put all this together, we believe there is still strong incentive to maximize yields by optimizing their inputs.
This is our retail distribution business. It is the premier Ag Retail Distribution business in the world. We are the largest Ag distribution company with leading positions in the U.S., Australia, South America and soon-to-be Canada when we close the Viterra retail business. In this business, we have the privilege of working with almost 0.5 million growers around the world.
The retail strength. Well it's now an $11.5 billion dollar revenue business. Last year’s EBITDA was $950 million. And we’re the largest U.S. retailer by at least a factor of three.
We have economies of scale, significant supply chain scale and advanced IT capability to continuously optimize our business. We have a very balanced portfolio about $5 billion of revenue from nutrients and about $4 billion from crop protection products and over $1 billion of seed revenue. And we see very significant growth potential across this entire business.
This is a chart on our seed and proprietary products. We see very significant growth potential in both seed and our proprietary chemistry products. As I mentioned, our seed business now is over $1 billion of revenue and it's been growing at about 38% for years since 2006.
But the North American seed business is the $15 billion seed business. So we feel we have significant room to grow as part of our portfolio. Our Loveland proprietary products where we've enjoyed about 28% growth rate over the last seven years. And this business enjoys margins that are about twice what we get from selling our third-party chemistry products. A real competitive advantage for Agrium and no other retail retailer has their own proprietary crop protection products.
Our goal of course is to continue to grow these products in the U.S. but also in Australia and Canada over time to further increase our overall retail margins. In fact in Australia now, we have seven Loveland products selling in that country and another 19 in the pipeline.
We’re not only the largest Ag Retailer Distributor but we’re also the best. Our sales per facility has grown 21% compounded since 2007 while our EBITDA per facility has grown at 24% compounded. This clearly shows we are getting operational leverage as we grow our business. In fact, in the U.S., we have about 18% market share but only 12% of the actual number of physical facilities.
Retail margins. This chart shows our margins and our return on capital employed. Retail’s EBITDA margins are 50% higher than both Royster-Clark and UAPs. These are two publicly-traded companies that we purchased in recent years. And given our total sales over $11 billion, this is a very sizable advantage and a significant shareholder value creation.
Both EBITDA margin and our ROCE have improved over the last three years as we continue to add our higher-margin products as well as continuously optimizing our network. And you can see we've set some very aggressive targets for 2015.
Despite 2013 being slightly behind our record 2012 results, we see a clear line of spike to our 2015 target. And we’ll provide much more detail at our upcoming Investor Day in October. Retail’s results this year were impacted by the late spring season.
We do expect to make up some of this ground in the second half of the year. However, it is a reminder that this is an agricultural retail distribution business which will be impacted by both weather and the agricultural fundamentals. In the spirit of continuous improvement, something that Agrium focuses on quite a bit, we have set five key metrics to improve on.
Our key focus areas in retail will be maximizing not only our earnings but our return on capital while we optimize our costs and our working capital. These metrics are both aggressive and achievable. But we think that we can deliver these over time and we are slightly behind in 2013 but I think when you see our information we present on our Analyst Day, certainly the second half of the year looks quite strong. As mentioned, the close of Viterra agri-products business will go a long way in delivering some of these metrics.
Moving to our wholesale business. This is the production in wholesale distribution business. We have operations primarily in North America, Argentina, Europe and North Africa. Now to be successful in this business, you need low-cost production, of course, a robust distribution network given the seasonality and the weather volatility, and preferably an in-market price advantage and our wholesale business has this and much more.
Wholesale is about a $5 billion revenue business which reported $1.9 billion of adjusted EBITDA in 2012. We have almost 9 million tons of production capacity and also distribute an additional 3 million tons of nutrients in North America and Europe. Much of our nitrogen production is supplied by AECO gas which has a cost advantage over NYMEX most recently over a dollar per MMBtu.
Our nitrogen and phosphate products supplies local markets which affords us an in-market price advantage. And we have several projects under way to expand our capacity which I will talk about in just a few minutes.
This chart shows the -- the natural gas cost curve. It is not intended to be a full cost curve but shows our position compared to the high-cost producers. And you can see that there is a natural flow at around $300 per tonne for urea. In fact with NOLA urea prices today somewhere around $320, we have seen production shut-in in the Ukraine and Central Europe.
So I think that, that shows that we are reaching a (inaudible) from urea pricing perspective. Now the interesting part, of course, is that even at $300 a tonne of urea, Agrium’s margins would be about a $150 a ton, not bad at all.
Potash. Our potash business is a low-cost business. We -- we can see-- you can see from this chart that we run our potash facility at much higher operating rates than our Canpotex peers. This is partially due to the fact that we are integrated with our retail business and therefore are able to supply our retail means with our wholesale production.
We do this at market pricing and only when the product is needed. But we have the capability to move more products through our retail distribution network and that is of value especially in these uncertain times today.
We have a sizable potash expansion under way, about a million tonnes and the increase in our capacity will move from 2 million tonnes to 3 million tonnes and startup will be in late 2014. But as importantly, it will also lower our cash cost of production by about $20 a tonne and improve our operating rate of this facility. This is a very robust project and even at today's potash prices, this project makes very good economic sense.
Moving to phosphate. We have to facilities, one in Conda, Idaho and the other in Western Canada, Redwater, Alberta; total capacity of about 1.2 million tonnes. We benefit from being integrated in ammonia and sulfur at Redwater as well as integrated in phos rock at Conda.
We also have a very strong end market price advantage that was approximately $140 a tonne over the Florida DAP/MAP prices in the first half of this year. You see in 2012, we had higher margins in this business than our peers. While many of you know that we are now moving to imported rock for our Redwater facility, this will impact our cost of rock and bring our margins more in line with our North American peers. So, overall we are well-positioned, but you will see the margins decline because of the imported rock from OCP now.
AAT. This is our smallest SBU at Agrium with 2012 sales of about $575 million, EBITDA of about $43 million. This business is focused on new nutrient technologies. Our flagship product is called ESN. It stands for Environmentally Smart Nitrogen.
ESN is a leader in the controlled release fertilizer today. This product has a high-technology coding on urea that releases nitrogen only when growing conditions such as temperature and moisture are optimal.
The benefits of this product is more of nitrogen gets put into the crop, less into the environment. So growers will see 10% to 15% yield improvements on corn. And there are very significant environmental benefits with less nitrogen going to the environment.
We have seen solid growth rates of over 18% per year compounded in ESN. And we’ve just completed a 136,000 tonne expansion at New Madrid and Missouri and that is going very well. And AAT is still quite a small business for us, but the ESN growth looks very promising.
So, when you step back and you look at Agrium as a whole, we have delivered strong financial performance, created significant shareholder value by focusing on agricultural inputs across the value chain. We had a record earnings of $1.5 billion and operating cash flow of $2.1 billion in 2012.
Retail is the premier Ag Distribution business in the world. We’ve delivered three consecutive years of significant earnings growth. There are more opportunities for us in this business. Also an AAT delivered the second highest earnings on record in 2012. Clearly, this is a reflection of our size, our scale and our stability.
And because of our size and stability, we have significantly increased our dividends to $3 a share, completed a $900 share buyback last October and we now have a 5% normal core share buyback in place and we’re about 2% complete to the 5%, as we speak. These dividends and share repurchase programs are clear indications that we’re balancing return on capital with future growth opportunities.
Speaking of growth, we currently have a solid portfolio of accretive growth projects which total about $800 million to a $1 billion of incremental EBITDA. In Wholesale, we talked about the potash expansion. We have a 122,000-tonne urea expansion at our Profertil business. This is our 50-60 JV in Argentina and that should be operational by late 2014.
And we’re currently looking at a brownfield urea expansion at our Borger, Texas facility. It’d be around 600,000 tons of urea. This decision hasn’t been made by our Board yet. We will put that decision in front of them, hopefully, by the end of the year.
And retail there is about $350 million of EBITDA growth. We talked a little bit about the proprietary products growth. The integration of Viterra’s Retail business will go away to contribute to that $350 million and we will continue with our tuck-in strategy. These are smaller highly accretive acquisitions that are of independent operators. We closed 19 locations in the first half of 2013 and the majority of these were in United States.
As well as some improvements in our Australia business, it’s a mix of cost reduction and margin improvement initiatives that will drive this a little bit. I think that chart there says 8%. All these projects not only have excellent returns but will move us in the right direction as we focus more on stronger returns of capital.
Our capital allocation priorities have been pretty consistent over time. First is to preserve our investment grade rating, sustain the assets that we do have and maintain our dividend. The second priority for capital is to grow our company earnings. We do risk adjust these based on hurdle rates and to grow our dividend as we have recently demonstrated. And then the third priority for capital is share repurchases. We do this on an opportunistic basis like the normal course we have in place today.
So to summarize, Agrium does have a unique but I think a very successful strategy. One from being integrated across the agricultural input space, the strategy has delivered very significant value.
Our Board and our leadership team are focused on driving continuous improvement and operational excellence, and we believe that this focus will drive long-term value. Agrium is stronger financially. We invest in high-value, high-return projects to grow the business, at the same time we will continue to return capital to shareholders.
So, with that, I’ll answer your questions.
Ben Isaacson - Scotia Capital
Great. Thank you, Chuck. And first question is and I think you mentioned this a little bit in the press release from yesterday, inventory in the retail channel?
Ben Isaacson - Scotia Capital
There has been a lot of concern that there could be a write-down coming in Q3, but you did mention that it’s not that bad in terms of how much high cost inventory there is. Can you provide a little bit more color there?
Yeah. Sure. So what we mentioned yesterday and even my comments today that there is a lot of uncertainty in the market today pressuring prices. There -- some retailers haven’t bought their fall means yet and our Retail business, Ben, we have just started to buy now. We have lower inventory than we normally would have this time a year, basically because we thought the prices were going to go lower and we were right and now the Retail business is starting to buy.
There is an element for some of our products that are price protected which will help and there is an element of our inventory that’s not price protected but when we look at that element it’s relatively small and we just don’t see further price depreciation to the point where we would have an issue with the write-down.
Ben Isaacson - Scotia Capital
Can you talk a little bit about the farmer’s budget and how farmer’s mindset changes towards fertilizer between $8 corn and $4 corn?
Yeah. It’s interesting. I’ve toured through most of the major growing areas of the U.S. in the last six weeks or so. And I’ll tell you the overall psychology of the grower is still very optimistic. I think the risk management plans maybe different and I’ll talk about that in a minute.
But I’ll tell you that they’re very optimistic. They’re looking at a good fall crop generally speaking across the U.S. and I think that their views are they’re still going to maximize their use of inputs for yield.
Obviously, with the price at $4.50, they’re thinking through how much do they hold, do they think that grain prices are going to go higher or lower, the amount that they have hedged is less than normal. And so I think that that is something that they are managing from the risk management perspective. I think it has also fine that they are more optimistic about the future.
But the only thing that could happen from a kind of a product perspective is and we haven’t seen much of this at all with $450 corn but if -- if corn does goes under $4, some of the higher-end portfolio application, higher-end specialty fertilizers may be, will be pulled back. But so far there has been very little sign of that today, because I think overall there is lot of optimism still in the market place.
The first signs of change will be when cash land prices start to decline or equipment purchases. And really, you know talking to our growers, I think that you’d have to see a significant structural change before they pull back on inputs. You’d see impacts on land and equipment much before you see any thing on the fertilizer and input space then.
Ben Isaacson - Scotia Capital
You mentioned on the nitrogen side that there’s been some production cuts in urea and Ukraine, Eastern Europe. So wondering how much confidence you have that this production has been cut back enough and at what price do you think that production come back -- comes back on line?
Yeah. It’s a matter of -- it’s a great question and we are spending a lot of time and energy trying to understand it like most of you are in this room. I don’t think we have a perfect crystal ball but I think the direction that we’ve seen is look that the high cost producers are shutting in and I think that is stabilizing our floor price.
If prices stay at $300 say -- let's say $320 in NOLA, I expect the high cost guys to stay shut down because they are losing in money. But if you still to see price appreciation that more than likely come back online.
The question is, I think from a demand perspective, what is the next year’s application season looks like, what is the fall application season look like, is there enough products in market that’s very important I think from a pricing perspective. And if all those parts of the equation are put in place then I think that these high cost guys will come back online, but that doesn’t mean that the prices will drop immediately.
Certainly, when we look at reinvestment economics which I think is something we probably to spend a little bit more time, looking at as an industry, $300 urea prices today doesn’t warrant a whole lot of greenfield economics. Since these projects that are illustrated for North American construction, I think when you look at the economic that $300 urea, you are going to find there going to be a challenge to make work.
Ben Isaacson - Scotia Capital
Can you talk about how -- excuse me, how you’re going to increase your market share in the U.S. with respect to retail. I mean to me it seems like Viterra was the last big acquisition and you have to focus much more on tuck-ins, so you don’t trip over antitrust…
Ben Isaacson - Scotia Capital
Okay. So, great question Ben, when you look at our market share in the U.S., we’re still about 18% market share. In fact, the U.S. is our lowest market share region than any of our other region that we operate in our retail business. So, my message to you is you know there are still a lot of room in United States to grow. And I think though that your analogy of using the retail tuck-ins is probably right. We don’t see a big bang acquisition in the U.S. from a retail perspective.
There are a lot of tuck-ins, still a lot of independent operators that we’re able to consolidate overtime. And that’s really the strategy that we have is optimizing our existing network, managing our costs and building the tuck-ins. But what I would tell you is that we still think that we have some market share growth, actually plenty of market share growth in the United States.
Ben Isaacson - Scotia Capital
Can you just give us a little bit of a hint to sneak peekers to how you’re going to grow your retail mostly to 15%?
Yeah. Sure. So, we’ll provide a lot more detail at our Investor Day in October. But the ROCE, there’s not a silver bullet, there is multiple parts. We need to improve and manage our working capital. And we’ve got some ideas on how to do that. We’re learning some things from actually the Viterra acquisition, how they manage their working capital and we’ll share with you some of that.
So from a bottom line perspective, it’s really reducing and optimizing our working capital. But the top line is to grow our earnings, but to grow it with higher margin products and that really comes down to our proprietary seed and our proprietary chemistry products. And if you look at that growth rate on the charts that I provided to you today, all we have to do is grow up even less than that rate that we’ve already been growing at for last seven-eight years or so and that will actually drive the ROCE up quite nicely.
So, it’s a combination of top line growth, but really optimizing on higher margin products and then delivering our reduction in our working capital by doing something that may be a little different that we’re learning in different parts of our business and applying that across the company.
Ben Isaacson - Scotia Capital
Great. Thank you very much Chuck.
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