Yara International ASA (YARIY) CEO Sven Tore Holster on Q2 2016 Results - Earnings Call Transcript

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Yara International ASA (OTCPK:YARIY)

Q2 2016 Earnings Conference Call

July 21, 2016, 03:30 ET

Executives

Thor Giaever - Head, IR

Sven Tore Holster - President & CEO

Forger Vidal - SVP & CFO

Dag Tore Mo - Head of Market Intelligence

Analysts

Bent Janssen - Carnegie

Jon Gerstein - Pareto Securities

Presentation

Operator

Thor Giaever

Welcome to the presentation of Year's Second Quarter Results. Today's presentation will be by our CEO and CFO, after which we will have a Q&A session. It's then my pleasure to introduce Year's CEO, Sven Tore Holster.

Sven Tore Holster

Thank you very much Thor and a very good morning to all of you. We start as usual with safety. Safety is at the top of Year's agenda. I am informed about each and every accident and near miss in Yara. This is to ensure that we follow up and learn from each of these accidents. Because behind these statistics that we see on the screen are real accidents taking place in our operations. We have seen an increase in the TRI rate compared with last year, moving from a 12-month moving rolling rate of 3.4 at the end of 2015 to 3.8 at the end of the second quarter.

The reason for this is that we now from January 1 have both OFD and Galvani included in our numbers with a full year impact starting from January 1. In the 12-month rolling numbers, OFD is in with a total recordable rate of 6 and Galvani is in with 8.8. But year-to-date numbers for OFD is at 3.6 and it's at 2.8 for Galvani, so the underlying safety performance is improving. However, our improvement in safety so far this year is overshadowed by the fact that we had a fatal accident in the second quarter. On April 26 we suffered a fatality at our Barrack site in Costa Rica where we had a sub-contractor [indiscernible]. He received an electrical shock in connection with welding work that was taking place in our blending tower structure.

Our thoughts and prayers are with Eric's family, friends and colleagues. This accident does not make us doubt whether we have the right safety measures and procedures in place, rather it makes us more determined to drive and enforce that these measures are put into place in all our sites. Yara must be a safe workplace for all our employees and contractors.

Moving then to the summary of the second quarter, Yara delivered a weaker underlying second quarter result in a challenging market with lower prices. However, deliveries were strong with stronger sales in Europe and Brazil in particular compared with a year earlier. Our production performance was also good in particular for ammonia.

We have completed the sale of our CO2 business on June 1 for approximately €300 million with a strong valuation for a mature part of our industrial segment, representing a 9.3 multiple on 2015 EBITDA. As communicated on our Capital Markets Day on March 1, we're establishing a program to drive and coordinate both existing and new improvement initiatives. I'm pleased to announce that we have so far identified at least $500 million of annual improvement potential.

Year's underlying earnings were 33% lower than last year. The decline mainly reflects lower sales prices which were only partly offset with positive energy cost, currency and volume effect. Our reported earnings were higher this quarter mainly due to the CO2 business divestment in addition to NOK122 million foreign exchange gain in the quarter. Last year reported earnings included NOK342 million foreign exchange gain. Second quarter nitrogen fertilizer deliveries in Western Europe were up by an estimated 6%, catching up almost all the shortfall from earlier in the season as you can see on the right-hand side.

On the left side you see that leaves the full season only 1% lower than a year earlier despite weather related delays and delayed purchasing in the earlier parts of the season, pre-buying incentives are now significantly improved with lower nitrogen prices generally and also the seasonal reset of nitrate premiums which took place in May. Fertilizer demand growth remains strong in Brazil where the improved agricultural export competitiveness and the credit availability compared with a year earlier. Total industry deliveries were up 14% for the quarter and 13% year-to-date while Yara Brazil deliveries were up 15% for the quarter and 19% year-to-date. Year's premium product deliveries showed the strongest growth, up 85% for the quarter and 47% year-to-date.

Also a brief comment on the trade volumes which you can see are reduced over several years. We have deliberately focused more on domestic sales where we typically have both higher profitability and better credit risk management compared with trade sales. As you can see from this overview, our fertilizer deliveries were higher also in North America while Latin America excluding Brazil was in line with last year. The decline in Asia is mainly due to lower NPK sales while Africa is down since we last year had large deliveries under a commodity fertilizer tender which was not taking place this year. But you can see from the product overview that premium product sales increased overall as positive developments in Brazil and Europe more than offset lower sales in Asia. Lower urea prices have reduced export attractiveness for Chinese producers.

On the right side you can see the impact, urea exports at 4.3 million tonnes for January through May compared with 6.1 million tonnes in the same period last year. Season to date, meaning July through May, China exported 11.3 million tonnes, down from 15.5 million tonnes in the previous season. Chinese urea production and export costs continue to be the main reference point for global nitrogen pricing. But ongoing production increases in other key trade locations like the U.S. and North Africa are gradually displacing some of the Chinese export tonnes. This has led to structurally lower prices in those locations compared with Chinese prices, as you can see on the left side, especially the Egypt price and a similar development has also taken place in U.S. Gulf urea prices.

So China remains the swing producer and main price reference but the premiums seen for urea in other locations in the past will most likely not return in the foreseeable future. Here is an overview of the ongoing urea capacity increases outside China. The largest increases are coming from this year and next year. They are well in excess of the roughly 3 million tonnes needed to match trend consumption growth in a normal year. I should add that these numbers represent gross capacity additions as estimated by the consultancy, CRU. So they do not include closures of existing capacity or any potential delays in the completion of the projects, but it's highly likely that in the next couple of years there will be oversupply of urea globally.

As communicated at our Capital Markets Day on March 1, we're in the process of establishing a companywide program to drive and coordinate both existing and new improvement initiatives. This is something I strongly believe we and actually any company should have in place. But it's crucial that the process is fact based and achieves involvement and buy-in from the whole organization. As we now start to roll out the process I want to share the value potential with all our employees. In addition to a strongly supply-driven situation we see now and for the next few years makes it even more important that we work every day to strengthen our competitive edge. The full program scope and targets are not yet established but we have made significant progress and therefore communicate today that we have identified at least $500 million of annual improvement potential in EBITDA terms by year 2020.

The program will deliver both revenue and cost improvements and includes initiatives in all parts of Year's organization from production through the supply chain organization, commercial organization and corporate functions. We will provide an update on the program in connection with the third quarter results and present the full program scope and targets at latest in connection with the fourth quarter results.

Now having distracted you a little from the second quarter results I would like to hand you over to our CFO, Forger Vidal, who will take us through his analysis of the financials. So, over to you Forger.

Forger Vidal

Thank you, Sven Tore. Let me then begin with the development in Year's EBITDA. You see that in the second quarter we reported an EBITDA of NOK5.489 billion, up from slightly less than NOK5.2 billion a year ago. If we adjust for so-called defined special items for this year, gain on the CO2 business is the biggest, we reported an underlying EBITDA of NOK3.958 billion and 22% down from last year. Previously you know that we have characterized our earnings as strong if you have a CROGI about 10%. We ended slightly below that this quarter if you look at the quarter in isolation and take away the special items, we ended up a CROGI of 9.9%. Let me then go into some more details on the numbers of why the underlying EBITDA is down.

As Sven Tore commented on, the biggest explanation is lower fertilizer prices. Compared with last year realized urea nitrate prices are down 25% on average NPK prices are down 11% which gives a reduction of EBITDA of NOK2.7 billion. That effect explains the full drop. That drop then is partly compensated by lower gas prices. Gas prices are down from last year with 33%, giving a saving of NOK1.165 billion. Further we're partly compensated by more advantageous currency rates for urea. The stronger U.S. dollar is an advantage for us as we mainly sell fundamentally in U.S. dollar while a lot of our fixed costs are in other currencies. So from last year the dollar has appreciated with 7% compared to the Norwegian krone and that is the main currency effect which gives a NOK367 million positive translation effect on our EBITDA.

Further we have increased the sales of our own produced fertilizer. We sold 8% more own produced fertilizer this quarter compared with last year. That is mainly related to increased nitrate sales in Europe. As Sven Tore mentioned we had a good catch up in the second quarter volume wise. It also reflects increased sales of premium products particularly in Brazil, as also shown earlier. And then we have the positive special items which is net year-over-year NOK1.4 billion which is slightly more than NOK1.5 billion due to the CO2 gain this year and we had smaller positive special items also last year of NOK124 million. If you then look at the three global segments with our profit reported, you can say that the main drop is shown in the production segment. The production segments take the major effect of lower fertilizer prices and are then only partly compensated by the positive energy and currency effects.

While Yara have an underlying CROGI of 9.9% the production segment's CROGI in this quarter is down at 6.6%, also underlying the need for an improvement program. You see smaller drops in crop nutrition which have more stable marketing and distribution margins. But the minor drop there is related mainly to lower nitrate premiums which influence crop nutrition's earnings. Then you see that industrial segment is a nice hedge when commodity prices drops. The industrial segment has actually improved their margins this quarter on the top of falling commodity prices. That means that in that segment prices dropped slower and less than in the global fertilizer market since it's more differentiated and more local markets. In addition, we have a positive product mix change, the overall volumes in industrial is quite flat from last year, but we continue to grow strongly the environmental segment where the AdBlue product which is NOx abatement for trucks and cars, continues to grow strongly and is up 16% from last year.

The CROGI in the marketing segments are strong even if some decline in profitability, crop nutrition shows a CROGI in the segment of about 15% and industrial shows a CROGI excluding the big gain that they have on the CO2 sales of 26%. Let me then comment upon the biggest positive CROGI, sorry, EBITDA effect in the quarter which is lower energy prices. I see that in total Yara saved NOK1165 million on lower gas prices this quarter compared with last year.

The biggest saving is in Europe. You see on the left-hand-side here that realized Yara gas prices have dropped from $7.5 a year ago to $4.6 per million BTU this quarter, a drop of 39%. That gives a saving of NOK970 million. In addition, our gas costs in Belle Plaine in Canada have also declined from last year. So in total we had a saving on you can say our spot-based gas purchases of NOK1.042 billion. Then you have additional savings in our ammonia sourcing in Trinidad since we there have an ammonia price link in or a gas sourcing. In total NOK1165 million saved. Going forward then, if you use the forward prices for the next two quarters and they are now back to a more normal contango where forward markets tend to increase typically from current price levels, if you use that we still foresee a saving compared with last year of NOK900 million over the next two quarters.

Moving on to some more details on our sales price development in this quarter then, Sven Tore already commented upon the decline in the urea prices. On the left-hand-side here you can see the urea price development over the last years and the nitrate price development. Yara sell more nitrates and more NPKs than urea. So this so-called nitrate premium on top of the urea price or the global nitrogen price are an important value driver for Yara. If you look at the development of the nitrate price over the ended fertilizer season in Europe, what you see is that while urea prices have declined quite steady all through the season the nitrate prices held up well the three first quarters of the season.

When we get closer to the end of the season then you typically have a repricing of nitrates to start to motivate farmers and distributors to start the pre-storage for the next season. So you normally have a seasonality where prices drop from the first quarter to the second quarter. You see that you have a significant drop from April into May and June this year. If you then look at the right-hand side and see how the so-called nitrate premium which is the nitrates value on top of the urea value have developed, you saw that we had an increase in the three first quarters of that premium since nitrate prices were quite stable and urea prices dropped while the urea price -- [indiscernible] industry repriced nitrate significantly in the second quarter.

Going forward then currently the nitrate premium is if you look at current sales prices of nitrates and urea prices is roughly in line with the average of the second quarter. I also can tell you that we have a strong order book of nitrates now in Europe. It's better than last year, so that also shows that this price has been well accepted by farmers and distributors. They are willing to take a bet that it was a good opportunity to buy at these prices when it comes to expectations for forward development of nitrate prices. Let me then give some comments on NPKs which as I said is among the two biggest fertilizer products that we sell.

Nitrates and NPKs for us is more important than urea in isolation. In addition to the global nitrogen value represented by urea, Yara creates value through our NPK sales and production partly in addition to the nitrate value of upgrading phosphate rock to phosphate fertilizer. That is shown on the left side of this slide where you see the cost of phosphate fertilizer which is phosphate rock and ammonia, compared to the commodity price of DAP. The commodity price of DAP has dropped with about $120 since last year, about 25%. Then input prices have also dropped somewhat but you could say Year's margin on this has dropped from about $120 to about $80, so we have a negative effect on that commodity drop.

But if you look at the value add that you are able to get out of our NPK sale which is the NPK price compared with the commodity and nutrient value of phosphate, potash and urea and we also add on the nitrate premium. Then if you look at the value of that complex NPK you can say that that is quite stable from last year, actually slightly up from last year. So while commodity prices are down the added value that you are able to create based on high quality NPK and the sales work or the sales force and agronomists continue to show a good profitability.

Finally, then I will end my presentation with some comments on the cash situation and cash development of Yara. We started the quarter with a net interest bearing debt of close to NOK8.5 billion, giving a debt equity ratio of 0.11. In the quarter we have invested NOK3.8 billion, so we have quite a significant investment program going on, building an ammonia plant in Freeport in Texas expanding our NPK production system, upgrading our urea plant in Sluiskil with urea and sulfur. Building a phosphate mine in Brazil and so on. These are projects that we have announced to you earlier. In addition to growing our business we're returning significant cash back to our owners.

We pay those a dividend of NOK0.15 per share in the second quarter, being a pay out of NOK3.9 billion. In addition, we redeemed and cancelled shares from the Norwegian state as part of our buyback program. So total cash return to owners were NOK4.150 billion. If you look at where the funds came from, we had a cash earnings in the quarter of NOK1.9 billion. We released significant working capital in the quarter with lower receivables which is a seasonal effect of lower prices and also slightly lower volumes in June seasonal wise as the European season came to an end and then we received close to NOK2.8 billion in cash from the sales of our CO2 business.

In addition, we had a currency gain on NOK122 million as Sven Tore commented upon. In the other sector of NOK869 million, two-thirds of that is actually also a currency effect but which is not taken over the P&L but is translation effect taken directly into our balance sheet. So we end the quarter with a strong balance sheet with a debt to equity ratio of 0.13. So we're well positioned for possible tougher times but also to be able to grab opportunities if profitable opportunities come up in the future.

So with those comments I give the word back to our CEO for his summary prospects.

Sven Tore Holster

Thank you, Forger. So to conclude let me round up with some comments on the prospects going forward. The global farm margin outlook and incentives for fertilizer application remain supportive overall. Although crop prices have had a weak development over the last year, input prices, including fertilizers, are significantly lower than a year ago and as a result farmers are often as well off as a year ago. We see this for example in Brazil where exporting agricultural sector has strengthened its position. We see the ongoing production increases in our locations gradually displacing Chinese urea exports.

This has already led to a repricing of urea in those locations. The significant ongoing capacity additions mean that there will likely be oversupply of urea globally for the next few years. In Europe pre-buying incentives are significantly improved with lower nitrogen prices. We're entering the third quarter with a stronger European order book than one year ago. We continue to see strong fertilizer demand growth in Brazil but in other regions such as Asia phosphate and potash demand is impacted by lower crop prices as application of these nutrients in some cases can be reduced without an immediate yield impact.

Finally, we expect further energy cost improvements in the next two quarters as already presented by Forger, of approximately NOK900 million based on the forward market quotations as of July 12.

So with that we move over to our Q&A session. Thank you.

Question-and-Answer Session

A - Thor Giaever

In the Q&A panel our CEO and CFO will be joined by Dag Tore Mo, Year's head of market intelligence. So if you have a question, please raise your hand and my colleague [indiscernible] will hand you a microphone. Shall we start with Carnegie and anyone else please do state your name and company when you ask the question.

BentJanssen

Yes, Bent Janssen from Carnegie. I have a couple of questions. On the improvement program can you say something as [indiscernible] now about the mix between revenue and cost at least? On the premium product uptake in Brazil is there any particular crop that has driven this or is it the general trend? To Forger on the CapEx I think that CapEx guidance was raised for NOK16 billion to NOK18 billion, so any comments on that? Also to Dag Tore, if he can summarize the European season that has there been any particular surprises to you for the season that you can comment on?

Sven Tore Holster

Okay, so let me start with the improvement program and I'm sure there are a number of questions related to that. So let me give a few comments to this. It's important for me that this is not a CEO improvement program or a Yara corporate management team improvement program, it's a Yara improvement program. We've had significant involvement in the process leading up to identifying at least $500 million of improvement potential. But for me now going forward it's important that we get this rolled out into the organization and that we get involvement, we get into action plans at the level where we have a very broad involvement throughout the whole Yara organization.

We'll work on rolling this out now in the next few months and quarters in order to get all the details in place. But we were already at this stage at the level where we felt that the numbers were of such a significance that it should be communicated. As part of our communication process internally we wanted to be able to be open about what the numbers are. So we will get back to the details on where we see the potentials and how it will be phased in, but this will be updated throughout the quarters going forward and with a more thorough presentation in connection with the fourth quarter result.

ForgerVidal

Yes, maybe on crops then if I could comment upon that on you can say related to our NPK sales particularly then. We are working on that, we presented during the Capital Markets Day you could say a crop roadmap, will use resources on you can say gathering market information on sales to crops and targeting different crops. So we still have less detail on which crops are we actually ending up selling all of our NPKs to compared to where we would really like to be over the next year or two on statistics. But if you look at the information however and if you look at where did we sell more NPKs this quarter compared with last quarter, a big growth is in Brazil where we see gradually that we're able to introduce NPKs into segments which earlier have been covered by both plant and more commodity products.

It goes into cash crops in Brazil. Another part where we had increased sales of NPKs in the second quarter is in Europe which is maybe partly more of a catch up. We talked about catch up in nitrate where we had the biggest part where farmers and distributors were sitting and waiting and see would prices in the end have to go down also with the lower urea prices. But we also had a catch up of NPKs where farmers had been maybe waiting and delaying phosphate and potash consumption and we had an increase in that. A big part of the second quarter sales in the northern part of Europe due to the season there where we sell in Scandinavia, Finland, UK and so on. If you look carefully on the slide of the NPK price development you see actually that NPK price is one of the few fertilizer prices increased from the first to the second quarter. That's a little bit of a geographical mix where we in the second quarter tend to sell more in Northern Europe close to our plants which give a better net back price because that price referred to was a net back price then.

If I then go to the CapEx and investment program, you're very right in that, that over the last quarters we have guided on our announced plans of investment in the coming year 2016 and our last guiding a quarter ago was NOK17.9 billion in CapEx this year based on our maintenance program and announced growth. If you look at the presentation, no I didn't comment upon that but we have a slide, one of the first additional slides there, showing now a new update of NOK16.1 billion. If you compare that with the previous guiding, you can see that you have reduced maintenance with about NOK100 million. That's a little bit of delay or postponement. It tends to be that the plants ask for frames and approvals of projects. Even if most projects are on time there tend to be more projects being delayed than coming in before the plan at least when they ask for the frames to be on the short side. That's NOK100 million, so it's a small part. And then we have reduced what we call capacity and cost improvements, smaller improvement projects there with roughly about NOK300 million which is probably also more of a delay or maybe that ask for frames and approvals are on the safe side. The biggest part is on specified growth projects where we also see some later use of money. The biggest part of that is the ongoing Solyndra project, the mining project in Brazil where we have a reduced estimate for 2016 of NOK400 million, but that will come back and is moved over to 2017 then. And then it's the upgrading of our NPK production in Porsgrunn where NOK300 million in investment is moved from 2016 to 2017. Then it's the upgrading project in Rio Grande in Brazil that we presented a quarter ago where we're expanding capacity in Brazil where we also moved over NOK200 million from this year to next year.

Finally, [indiscernible] with shifting NOK100 million, so it's to a large extent later spending of those money without any significant effects I would say in startup timing. There could be smaller delays in some of the projects but no big delays in final start up time.

BentJanssen

Then it was your surprises.

Dag Tore Matthew Ouimet

Yes. Your question on the European season, I think it's almost remarkable how stable the deliveries are now in Europe on a seasonal basis, I mean after falling trends up to let's say four, five years ago they have really stabilized with only a few percentage points variation from season to season. I think that we're at the level where the nutrient efficiency is very high, amongst the highest in the world, if not the highest in the world. It's difficult to get out the crop levels that are produced without these nitrogen application levels. So in that sense I guess it's not surprising at all that we see this stability in Europe with positive farm margins as Sven Tore was talking about et cetera. I guess also if we look one quarter back we were -- I think we were ready for let's say a drop of 2%, 3% personally, but so in that sense the second quarter was quite positive but actually very close to what our commercial organization were trying to guide us at. So yes, it's hardly surprising on the nitrogen side in Europe I think.

Thor Giaever

Okay, I think that was the first lot of questions. Do you we have -- yes certain, we have Pareto.

Jon Gerstein

Thank you, Jon Gerstein from Pareto. Just one question on the improvement program, how should we think about the CapEx requirement behind realizing the EBITDA benefits? Thank you.

Sven Tore Holster

Well, as I mentioned we're still in the process of identifying the very details of how to achieve this. A large chunk of this is related to process efficiency and other cost improvements. But certainly there will be some CapEx and cost related to it. I will get back to the details of that at a later stage.

Thor Giaever

Are there more questions? There is another opportunity later today. At 2:00 PM we have a conference call, so you're more than welcome to join that, but until then thank you very much for joining us for this presentation. Thank you.