Potash Corporation of Saskatchewan's (POT) CEO Jochen Tilk Presents at Goldman Sachs Basic Materials Brokers Conference (Transcript)

| About: Potash Corporation (POT)

Potash Corporation of Saskatchewan Inc. (NYSE:POT)

Goldman Sachs Basic Materials Conference

May 18, 2016 09:10 AM ET

Executives

Jochen Tilk - CEO

Denita Stann - SVP, Investor and Public Relations

Analysts

Adam Samuelson - Goldman Sachs

Adam Samuelson

So in the interest of staying on time, I think we'll begin our next session. I am Adam Samuelson, the Agro Business Analyst here at Goldman Sachs. We're very happy today to have Potash Corp here. To present from Potash Corp we have their CEO, Jochen Tilk; Denita Stann, who heads their Investor Relations and Public Relations effort is also here with us. I think Jochen maybe you should start with some brief opening comments and then we'll jump right into questions. There's microphones in the room, so we'll open then up to audience questions a little bit later on as well. But Jochen we're happy to have you, maybe to say opening thoughts and I'll start off with some questions.

Jochen Tilk

Thanks, Adam, good to be here. Thanks everyone for joining us this morning. What I thought I'll do, provide a few general comments on a couple of topics that are of most interest and then I'll turn it back to you Adam and happy to take any questions that you and people in the audience have. Most of you are familiar with Potash Corporation of Saskatchewan. We're the largest fertilizer producer in the world. We produce all three nutrients and also a variety of industrial products. Historically over the last five years, our gross margin split has been 60% from -- two-thirds from potash and then rest of it from nitrogen and phosphate. So most people look at us as a potash producer and given that we have the biggest or largest operating capacity in potash, people are very interested in our view in the potash market. So it won't surprise you that a big portion of the comments I made are related to potash, but don't want to neglect that we're significant [indiscernible] in phosphate produce as well.

On the potash side, the first question perhaps that I throw out there and answer it myself is what's the market right now? What do you see happening over the next six months? We've made some comments few weeks ago at our call and we communicated some cautious but supported optimism that we see the markets in a more positive light and we ought to translate that. We think that things have bottomed, if that's the right term in terms of sentiment, in terms of potash prices.

And let me explain that. We had a very tough 2015. I'll give you a very few data points; one being the U.S. market had been a premium market for potash. It opened up at $410 Midwest prices and then ended up almost $200 below that 12 months later and the premium had all but disappeared. A significant amount of inputs had come in. There were some structural matters that happened and course people who question farmer economics is always a big driver.

And so when we started 2016 at that level, we had a very cautious outlook. In fact, at the beginning of the year, we reduced our dividend, we cut our dividend from a $1.22 to $1 per share as a response to that. We convey that caution around the globe. We said that presumably it was difficult. We saw that there was price erosion, a lot of highly competitive environment. It was always true spot market. And we also anticipated that the contact negotiations in China may prolong evidence by the inventory in China, people recording those numbers and says a lot of inventory in China must keep going for a long time. So we give a cautious outlook as how pretty much everyone who has a view of the market.

We look at it today and reflect on it and we are much more encouraged in the direction things are going. First one on U.S. market, domestic market, three important points, because premium has disappeared, the market is less attractive, when we've seen less inputs coming into U.S. It's a national thing. There are other markets they're more attractive. That's a plus. We can't predict that, but I think just by the difference in a price environment, you will see less imports into the U.S. as in previous years certainly last year. The second is that certain volume has flushed the system and it's always the case volumes build up towards season, the season kicks in and then there is high demand, farmers in U.S. distributors in U.S. don't take price risk; the inventory usually stays with the producers and in certainly our case. So there's a bit of lack of engagement and then we kick our supply chain in.

Now 75% of the corn plus is planted in the U.S. So a lot of it was done, but we flushed our inventory out and we're now looking forward to the some of it and the fall season. And the third one, probably somewhat more surprising, when farmers' economics in the U.S. good, they're certainly better than they were last year and they're better than they were a year before. If you look at the affordability fertilizer versus the farmers' economics, they're quite attractive. You know that corn has come back $4 and soybeans are $11. A lot of acreage plant at $93 million acres in U.S. So they're good basics and that all is attractive.

So we see that engagement. We know that farmers are applying product and we know that as summer fill comes, a lot of products will move. We look at Brazil, we had good engagements there. Brazil is a huge producer of soybeans, a very attractive market. Political stability is welcome but is not the biggest reason there. Farmer economics are much bigger driver. They export in U.S. dollars -- 70% of resilient crop is exported. So we see good engagement and of course, the last data point for optimism is the claims [ph] in from this China contract. And every year we engage in that process. We are one of three parties negotiating with the buying committee. We have not -- we’re generally not the party meeting and we’re generally not the party settling. So we anticipate one of our competitors to do so. The fact that it’s prolonged is based on inventory in China, which provide stamina for negotiations. But at the same time, it’s also a reflection that producers more careful. They don’t want to set right away.

I can’t predict the timing; I can’t predict the outcome. You read perhaps what bid ask prices are, and you can kind of extrapolate, interpolate I guess what the number might be. But in any case, we are optimistic, because it will be happen in the weeks to come. That's a given. And it will happen at a price that we think is not inconsistent with what you see in Brazil right now, which would not be a bad outcome.

So if that is sold, a lot of volume engagement will take place. And then if you combine those three points I made in the in U.S., in Brazil and in China that we see a lot of engagement in the second half, a lot of material that has to move to those countries and places, and we’re certainly ready and positioned for that, and we see opportunity for perhaps not just price stability, but the opportunity that prices will strengthen at that point. There is piece evidence, domestic competitors have announced a price increase of $20 very recently from 225 to 245 Potash mid-West. That’s a sign that it’s a consistent anticipation of strengthening market.

When I translate that very briefly into how does it transfer to your capital allocation, we reduced the dividend year-over-year through dollar. We think very highly and for us it's very important that our dividend policy -- cap allocation policy provides stability and sustainability. We spend an incredible amount of time reviewing that in light of what we think the markets will do and when we had a cautious outlook, we certainly reflected on a payout ratio that's over 100%, we looked at how much money we have to bore if markets would take certain direction either up and down, and if markets were to be as they are today no improvement, and that includes nitrogen phosphate.

So I'd say a relatively conservative outlook and not consistent with our current optimism, but more cautious than -- Boing [ph] would be about $400 million to $500 million to support of dividend. We have some means to offset that. We've reduced our capital by about $100 million. T

that’s already reflected in that. We have some other means I want to get into right now. But we think that’s doable.

We also know that if prices improve by $20 as an example, then I would -- Boing [ph] would be reduced by $200 million. So it would $200 million to $300 million, and we think that’s very doable. And then looking at 2017, we think that in that market environment and the fact that we don’t have the first quarter of the higher dividend payout -- as a reminder first quarter, we still on $1.20, we think that overall, we would be at 100 or even less present payout ratio, which we think is sustainable.

So if the current market or an even better market evolves, then our decision to sustain the dollar dividend and that going forward sustaining going forward is definitely the right month. Of course we do have to qualify it in a way that our number one objective is to protect our balance sheet. We regard our balance sheet as being one of the most important elements and the health of our company -- the future of our company and we look at credit rating, we look at cash flow, we look at our sustaining capital to maintain our asset base.

And if things where to change in the Potash market, which is not what we anticipate at all this point, then we’ll have to look at it, reflect on it. But at our current expectations are markets, that's we decided to do. Maybe one-third and final area is the long-term prospect. So I talked about 2016, how we seen evolving on capital allocation, but just looking beyond that, and we get asked this question a lot. So our volunteers say well, you have the highest operating capacity, one of the lowest cost producers. Our anticipated cash cost after the working [ph] will be approximately at current exchange rates to the Canadian dollars -- our cost basin in Potash’s Canadian, approximately $70 all for cash cost.

And that makes us a very competitive producer. And people say well that would give you the opportunity perhaps to go for market share. Our approach to market is to balance supply and demand. And we have to be very clear, when you choose that right, we think it’s a better business model, it’s one that provides better margins. It provides better returns on all assets, it’s one that's sustainable in that market that we are in, not just for historic experience but just looking forward. And the biggest driver in making that decision and looking at the market is really how we see supply and demand evolving in the next few years. and just give you very brief set of numbers, we look at current operating capacity at approximately 65 million tons per year. So that’s what we -- and we could go through mine by mine and what’s in, what’s out, and that includes our operating capacity, but not 100% of it. So we think that $65 million is what some of our competitors can produce at maximum capacity because they will produce full out and it assumes the capacity that our biggest competitors, the Russians and the Bello Russians have 65 million. And it's been tested certainly in 2014 and it's been tested in a couple of other locations. We think that consumption is today we know about approximately 60 million tons. Our guidance has been 58, 59, 60, 61, we saw 63 in 2014, we saw 59 in 2015, but 60 million is probably a good number and we see that growing by approximately 2%, maybe 2.5%. So by 2020, that’d be approximately give or take 70 million.

Now there will be incremental capacity, we know that. There’d be further capacity coming on. There is a project by Kepler [indiscernible] legacy and there is a European Russian producer, EuroChem and we incorporate that and some other gives or takes. There will also be capacity coming off, about 7 million tons of mine closures and depletion. So we balance that out and we think that in 2020 we are in a situation where the margin between operating capacity and consumption is about 5 million tons, 70 to 75. And that 5 million tons is really -- supports in our view that matching supply and demand and not producing what the market does need in simplified terms it's by far the right approach and that’s what we do and we’ve tested our bid in the beginning of the year, we pulled out 0.5 million tons of the international market I should say when I say -- in this case it was Canpotex. 300,000 of that was in Brazil. We think that worked well. There was good response from the market.

So that’s our strategic approach to market and that will be the approach going forward, and it's based on that supply and demand balance as we see it and which we think is relatively tight. And keep one thing in mind, in the last 10 years a lot of money had been spent for expansions. Clearly there was a sense, if not euphoria, certainly enthusiasm, 7-8 years ago when those decisions were made. They were all made more than five years ago, more than half the decade ago. They’re now coming to completion. There's really very little left. But give or take maybe I don’t know $50 billion may have been spent in incremental expansions, brownfields and greenfields in the next decade. So the same period going forward. I would doubt very much that much will be invested. I think everyone will draw from their expansion, so that the incremental investments or the new investment in capacity will be very little for a number of reasons so that in the next 10 years we will certainly see a very different environment in terms of building new capacity than we have in the past.

So I’ll pause there. Those were my three areas, current markets, our capital allocation policy and how we look into the future to what future in terms of supply and demand and our approach to markets.

Question-and-Answer Session

Q - Adam Samuelson

That’s very helpful Jochen. Maybe going back to the current market decision and obviously the time of the year, with resolution, China is top of mind and I know you talked about something happening fairly soon. But I want to -- maybe more philosophically, what’s the value at this point of this annual or semi-annual Chinese contract structure? I think if you look back at 2015, the conclusion that you would draw was a lot of that optional tonnage in the second half of the year, it wasn’t consumed, just went right into inventories. They were intended to take it because of the way the contract structures work and ended up impacting the first half of 2016 in a pretty negative way. As you look at Canpotex level, how do you maybe try to change that incentive to make it a more constructive ongoing market engagement in China? Or what -- how do you think about changing that import channel?

Jochen Tilk

Yes, thanks Adam for that question. We'll think about that. I’ll take that. You look at a contract negotiation which is meant for 2016, this -- the country consumes approximately 15 million tons of potash, 25% of the world potash consumption, 15 of 60 today and it domestically produces half of that, 7 million to 8 million and then it imports the other half. And then the negotiations are still ongoing here, and so everything is kind of retrospect. And it really makes you wonder where is the logic there, and if the hypothesis should get better price on a contract negotiation than you do on spot, then I would think to defer. I think on average it's all the same. If you were to look at long-term, the spot probably gives more volatility. But on average probably a similar price, and you see Brazil and the United States working very well, extremely well on spot and so it makes you wonder if there is actually a benefit for either party. Where the true disadvantage is in my opinion for both countries and producers is on logistics. I don’t see any benefit to sit there and have ships paying the merch and producers waiting and then the magic date comes and then everything moves, there's a lot of NPK producers in China depend on product to make their compound blend. And it’s a seasonal business. The true dynamic and you see in U.S. and Brazil is whether it’s planting, those are the drivers of our business and the contract negotiations are in effect.

So I agree that, I don’t think it’s beneficial to either party, but I’m most respectful to China. I’m very respectful to the buying committee and their logic. The inventory buying is a bit of an artifact to prolong negotiations, you're absolutely right. There's an optionality in both contracts. It goes into inventory and it's brought at the price of the previous year and then the following year negotiations are defined by the amount of inventory, because that is the stamina, that the party has. And so you build that more inventory and at the end of the year looks better and then you prolong negotiations the following year. And that is to our effect and I’d be surprised if China and the Chinese -- the buying committee isn’t reflect does that really makes sense. Because you never know if you get a better deal the year before or if you get a better deal following year. It's really, it’s a bit of speculation.

It’s not really for us to change that. We're one party. We supply approximately 2.5 million tons to China. So that's Canpotex. And we will communicate that we’re incredibly supportive, we’ll put our product in there. We have a great supply chain. So we can deal with the logistics, but we would certainly communicate and say, it's just really the best way for either producers and the country, or are there better ways of doing that, and if that helps China to reflect on the sensibility of the negotiations, so be it, if it doesn’t. So but -- I’ll take your point, we would prefer a better way and I think everyone would, but we're also respectful of the fact that it’s not up to us to change that.

Adam Samuelson

Okay, great. And maybe, I mean one more on the market environment and make sure the audience has some time. We talked about North American market, the premium going away. I think it’s interesting, you look globally today, Europe has very significant premiums to the rest of the world, would seem offer the highest potential net back to Canpotex today. That's about my math. And I’m wondering, as you think about marketing opportunities, why you haven’t seen Canpotex or frankly others even be more aggressive in trying to maybe break into that European market a little bit more, just to come out and do business? Why aren’t you trying to make the money there?

Jochen Tilk

Yes. Good point and the question that we get often, why the shipping to Europe into premium market. I think -- the first answer is that, it can be short lived and a relatively small tonnage can negatively impact that market and you would argue that a premium market particularly at a time when cost of shipping is extremely low -- cost of shipping across the globe never been lower than it is today. A premium in any domestic market is artificial. Europe is unique in a number of reasons. It’s more fragmented. It's still many countries. It has more complex structure of tariffs and these kinds of things which always play a role. It also has specialty products. People are very careful about choosing the type of products they apply. They're more selective.

So it’s not about both markets. So you have to be thoughtful on all of these points, the unique countries, the unique products, the unique jurisdictions. But the most important one to me is economics 101 that if you were to be mindful or successful and doing that, and logistics can be overcome, that premium market would not be there for very long. And United States, case in point, that's the example, you look at U.S. and the premium market lasts all but 12 months.

And I don’t think that’s a good outcome either, because what will happen is Potash is in its way to zero some proposition. The tons that are produced will show up somewhere, and if they cannot be sold in Europe, they'll go perhaps to Brazil, they go perhaps to other parts in the world. And so when we look at any market, we look at it globally. We don’t look just any specific market, because we know that the tons will not disappear, they will just be rerouted. And so to answer your question, I think the premium would erode very quickly and therefore you have to be mindful to -- it would only move tons to different parts in the world, and that would have an impact. And so at this point, that’s not a real attraction to us.

Adam Samuelson

Okay. And maybe just make sure we have time, anybody in the audience who has questions, raise your hand, we've got mics here. All right, I’ll keep going. So maybe something you guys didn’t talk about in your kind of opening comments about was interest [ph] in the market. And pricing there has been equally if not more, even weaker than it has been in Potash basically. You’re about large tradition in Trinidad, maybe talk about where you actually see cost support in the mix market today and talk about how the current ammonia price environment maybe impacts some of the reinvestment economics in Trinidad on the gas side and if you have concerns there, about gas salability over the medium term?

Jochen Tilk

Yes, for sure just to give you a few data points and refresh your minds, we were a significant ammonia producer. We produced approximately 2.2 million tons of ammonia in Trinidad and Tobago. We have three ammonia plants and we also have a urea plant. We produced ammonia and other products in three sites in United States, about the same amount and so total of about approximately 5 million tons. There is a significant cost differential now in between U.S. ammonia and any offshore ammonia because of the input cost in ammonia and nitrogenous gas. 85% is natural gas and gas in the United States is the most competitive today and so domestic production is very competitive. Trinidad gas costs are higher. They used to be more attractive on the work stay and so to Adam's question and what's your philosophy what's your approach there.

For us the way we look at it is, we are in the global ammonia trade, nursing ammonia out of Trinidad. We have shifted not insignificant amount to the U.S. but we also have other customers in Chile and around the world and as we see the trade pattern evolving with domestic -- U.S. domestic ammonia and nitrogen products be competitive, and a incremental capacity coming on in the U.S. that we will ship ammonia to different parts of the world, certainly different jurisdictions, whether it's South America, the Caribbean or even India where offshore ammonia and non-U.S. produced ammonia is more competitive. There is also a possibility for us to increase our urea production in Trinidad and Tobago, meaning we use more of ammonia to make other products solid that we can then ship to fertilizer markets.

So when we look at Trinidad ammonia going forward, we certainly have to look at other markets other than the U.S. and we have to look at the possibility of maybe increasing production of others to service those markets. Now in the U.S., I think given the competitiveness of natural gas in the U.S. and given incremental plants coming online that U.S. will eventually become more self-sufficient. So the imports in the U.S. will reduce any the way you define your position in the U.S. as a nitrogen producer is having the most competitive ask that you can possibly have. That means the highest gas efficiency, the best product variety, good logistics. And that's what we have. We've got three phenomenal plants with Lima, Geismar, Augusta and logistically, when you look at the map, what we -- the areas we serve is extremely well placed. We've got very competitive operating costs and we make essentially products that go all the way across liquids and solids, the election place and so they're well positioned. We have some expansion opportunity if we feel that makes sense, some of our plants. We have just expanded Lima and added about 350,000 tons of ammonia nitrate production there. So Trinidad and Tobago, looking at offshore markets, looking at changing over the next five years and then domestically sustaining our product variety and competitive position and any potential expansion there would be somewhere -- at our plant we have that competitive position.

Adam Samuelson

And we're short on time. I want to make sure anybody in the audience -- there's a question from the group.

Unidentified Analyst

There has been some consolidation on nitrogen side. There is a few kind of smaller players left. Would that be an area that you would look to add capacity potentially?

Jochen Tilk

Yes, when there is that opportunity, we tend to look at it. As you've said they're smaller players, often single plants which not-core and we look at that and we apply those criteria, we say well where are they located, how do they fit into a sales stretch, what products do they make, and are they competitive. And then what would be the return on that investment? And it does become more one of the capital allocation. So the answer is, if there are competitive plants, if the return on capital would be appropriately and we would always compare that to an expansion to one of our own plants. If I take Geismar as an example, and we said what's the cost of putting in ammonia loop in there, what's the rate of return on that investment and then compare it to an acquisition and if it works out, we will give it some thought. If it isn’t, -- it's hard to find plants that are more competitive or it's hard to find plants are more competitive than a brownfield expansion. So that would be the challenge on that.

Adam Samuelson

Great and I think we're just about at out of time unfortunately. So I think maybe we're going to leave it there. Jochen, I want to thank you very much for attending today.

Jochen Tilk

Adam, thank you very much for the opportunity and thanks for joining us today.

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