Bunge Limited Q1 2008 Earnings Call Transcript

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 |  About: Bunge Limited (BG)
by: SA Transcripts

Bunge Limited (NYSE:BG)

Q1 2008 Earnings Call

April 24, 2008 10:00 am ET

Executives

Mark Haden - Investor Relations

Alberto Weisser - Chairman, Chief Executive Officer

Jacqualyn Fouse - Chief Financial Officer

Analysts

Diane Geissler - Merrill Lynch

David Driscoll - Citi Investments

Pablo Zuanic - J.P. Morgan

Christine McCracken - Cleveland Research

Vincent Andrews - Morgan Stanley

Ken Zaslow - BMO Capital Markets

Christina McGlone - Deutsche Bank

Robert Moskow - Credit Suisse

Operator

Welcome to the Bunge Limited first quarter conference call. (Operator Instructions) At this time for opening remarks and introductions, I'd like to turn the call over to Mr. Mark Haden.

Mark Haden

Welcome to Bunge Limited's first quarter 2008 earnings conference call. Before we get started I wanted to inform those of you who may not have seen it in the press release this morning that we have prepared a slide presentation to accompany the discussion of the first quarter financial results. It can be found in the Investor Relations information section of our website, www.Bunge.com under Investor Presentations.

With me today to discuss our results are Alberto Weisser, Bunge's Chairman and CEO, and Jackie Fouse, Bunge's Chief Financial Officer.

Reconciliations of non-GAAP measures disclosed orally on this conference call to the most directly comparable GAAP financial measure are posted on our website in the Investor Information section.

Before we proceed, I would like to read the safe harbor statement. This call may contain forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, including statements about future financial and operating results.

These statements are based on management's current expectations and beliefs and are subject to a number of risks, uncertainties, and assumptions that could cause actual results to differ materially from those described in the forward-looking statements. The pertinent risk factors can be found in our SEC-filed reports.

And now let me turn the call over to Alberto.

Alberto Weisser

The first quarter Bunge capitalized on strong global market conditions and generated outstanding results. It is a unique time in the global agribusiness and food industry. High commodity and fertilizer prices reflect the fact that global demand for key commodities and products is very strong. For example, the USDA estimates world demand for soybean meal will rise nearly 6% this year.

High crop prices, which should continue in the near term, and the large local harvest are helping to improve the profitability of Brazilian farmers. A volatile, high-priced environment presents some challenges, however. It creates demands on working capital and leads to inflationary pressures that can influence national policy decisions. And though farmers are generally benefiting from higher crop prices, their profitability depends on the relationship between these prices and those of agriculture inputs such as fertilizer, which are rising.

In this environment, effective risk management and a global business that mitigates exposure to any one region while providing the ability to navigate market dislocations are essential. So, too, is efficient management of working capital. Bunge possesses these strengths, and we will build upon them through continued strategic capital investments while managing our businesses according to the demands of today's markets.

Now I'd like to turn over the call to Jackie, who will take you through the first quarter results and outlook.

Jacqualyn Fouse

As Mark mentioned, I'll just remind you that there are slides on the webcast to accompany my comments. Looking at the high level line items and key line items of the income statement for the first quarter of 2008 we see that Bunge Group volumes were up about 7% and all of our segments produced strong volume and profit growth. We'll talk about the segment results in just a minute.

Profits were significantly higher than last year, though we should keep in mind that last year's Q1 was affected by the marktomarket loss we had then.

Margins in all segments are quite good. Again, we'll talk about those more in a moment. The fundamentals that we saw in the last half of 2007 are carrying through in the first half of this year.

With respect to SG&A, the quarter was somewhat impacted negatively by currency as a result of the stronger real, and in addition we took an approximately $30 million provision for receivable in Paraguay as a result of a recent court ruling in the collection process we are pursuing. Without those items, our SG&A growth would have been much more modest than the increase you see in the tables accompanying the press release.

You may also have noticed that we have moved to an EBIT presentation for our segment results. We've done this for a few reasons. We think that it increases visibility to minority interests and to equity and earnings of affiliates, so we think we're giving more transparency to the numbers. We will continue to give the details by segment of interest expense and income so that you can look at the numbers before or after interest. And given that we've had an increasing proportion of equity in our financing mix, we think that the operating profit comparisons may have been becoming less meaningful so we moved to the EBIT presentation.

Turning to the segment results, Agribusiness volumes grew by 6%. Gross margins are up versus the same quarter of last year and are about in line with where they were in the fourth quarter of last year. Gross margins were higher across all geographies and we had strong distribution results. All in all, the structural margins in the Agribusiness were very solid.

With respect to the Fertilizer segment, margins for the quarter were better than we expected, driven by higher international prices which more than offset higher input costs. Volumes were also good. These were driven by accelerated purchases by soybean farmers, and our retail segment was up about 28% with a slight increase in market share, but this was somewhat offset by lower volumes in Fosfertil. Given what we are seeing so far, we expect a higher proportion of profit in the Fertilizer segment to take place in the first half of the year versus prior years.

Look at Food Products; we see the recovery that we expected this year versus 2007. We're seeing the benefits in profits of price increases that we took in the fourth quarter of 2007, and we continue to proactively manage price, though there are some constraints in that regard.

Looking at some high level line items of the balance sheet, operating working capital grew in the quarter. It was higher versus a year ago, mostly driven by higher commodity prices. It was somewhat higher than 12/31/07 driven by higher inventories in part. Those are readily marketable inventories. It also reflects somewhat higher fertilizer inventories in the first quarter of this year and higher wheat inventories in our milling business.

We continued to focus on working capital efficiency and saw the trailing 12-month cash cycle days down 4 days versus a year ago and stable versus the end of the year 2007. We continue to grow debt slower than working capital and produce solid growth in shareholders equity.

Slide 6, if you're following the webcast, just shows the past few years since the company went public in terms of the evolution of some key line items of the balance sheet. Our balance sheet remains stable and is getting stronger as we manage the growth of our business, and we're also managing liquidity well, particularly in this volatile environment. We closed on two new syndicated bank facilities during the quarter for a total of $900 million, and we continue to focus on working capital and being careful with respect to the forward business that we do, like others in the industry.

A summary of the cash flow is shown on Slide 7, again if you're following that. We saw significant growth in funds from operations, which was driven by higher net income. Despite this, cash flow from operations after working capital changes was negative in the quarter, which is not unusual for Q1 given some seasonality in our inventory patterns and given the working capital increase I've already mentioned.

Nevertheless, we continue to improve our profitability. Our credit metrics have improved, and our liquidity situation is quite good.

With respect to the outlook, as Alberto mentioned in his opening comments, market fundamentals remain very solid. We see good demand for protein meal and oil, so the demand side of the equation is good. So far it looks like, on the supply side of the equation, that the South American harvest should be a record harvest and the Northern Hemisphere situation seems to be developing well, though we don't have a lot of visibility into that yet as it's still early in the year.

We think that fertilizer demand should remain strong, and we continue to forecast 5% to 7% overall volume growth for the year for our business. And as we already mentioned, Food Products is showing recovery versus where it was in 2007. It looks like it will come in in line with our expectations for the full year.

There are a number of challenges out there. Both a stronger real and higher farm input costs are putting pressure on farmer economics in Brazil, so we watch that very carefully. Higher input costs are also or could also pressure margins in our Fertilizer and Edible Oils businesses. We did not see that in Q1, but we are very cautious about that as we work our way through the rest of the year. And we could see government policy changes that could disrupt the trade [fault] flows, and we've seen some activities in that regard at the beginning of the year.

So in line with that outlook and the results for Q1, we've revised our full year guidance. The new net income range is $980 million to $1.02 billion. In EPS terms on a fully diluted basis, that is $7.10 to $7.40 per share, and we're assuming a weighted average of 138 million shares outstanding.

We're confirming our effective tax rate guidance in the range of 24% to 28%. It was on the higher end of the range in Q1 due to the mix of earnings in the various jurisdictions, so we expect it to be in the range for the full year.

So with that, I will open it up to Q&A.

Questions-and-Answer Session

Operator

(Operator Instructions) And we'll take our first question from Diane Geissler - Merrill Lynch.

Diane Geissler - Merrill Lynch

I'd like to ask you about your commentary on the volume declines that you saw in the Nutrient business, the Fosfertil piece. Obviously retail up very strongly, could you elaborate on that a little bit?

Alberto Weisser

We would characterize that more as a seasonal situation. The blenders, the mixing companies, have increased their inventory, so this is just a momentaneous situation. We believe that the volumes of Fosfertil and the rest of Nutrients will be in line of what we're expecting, 5% to 7% growth.

Diane Geissler - Merrill Lynch

And then on your commentary that you saw some early farmer purchases - certainly this would be really early for fall usage - could you give us an idea about how you expect that, then, to trend out sort of second quarter, third quarter, and fourth quarter? We saw a little bit of this last year. I'm just trying to get a feeling for how you think the remainder of the year will trend.

Alberto Weisser

Yes. It was very early. The farmers took advantage of very high commodity prices in the middle of the quarter, and they expected the fertilizer prices to increase so they moved early. So it was a significant amount. And so we expect that the second half of the year would be a little bit lower than average. So there's a little bit more shift in the first half than the second half.

Overall it is a little bit difficult to estimate exactly where it will be. It's early in the year. But that is why we're expecting volume growth for the whole year of 5% to 7%, and that's the way we - you could calculate how much would be in the first half and how much would be in the second half.

But overall, the performance of Fertilizer should be higher than we expected originally.

Diane Geissler - Merrill Lynch

That brings up the question about, then, your new expectations for earnings this year. This is obviously sort of a massive beat here versus what the street has been looking for and yet the guidance up - I guess around $1.00 per share on an EPS basis, is that just - I'm sure people will say oh, they're just being conservative, but is that  I guess what I'm trying to say is is that factoring in sort of a slowing Fertilizer, is it factoring in Agribusiness was very strong last year and you're already kind of factoring in a big uptick there? I guess if you could talk about kind of why the guidance wouldn't be higher given just the magnitude of the earnings in this quarter.

Alberto Weisser

I think first of all we are very happy about the results. They were higher than we expected, and I think you could see it - let's go through the three different segments.

Food Products performed as we expected. We were finally able to increase the prices to catch up with the increase in the input costs, so that is positive but it is in line with what we expected.

Fertilizer has been a little bit higher than we expected, but also there is more anticipation for the soybean farmers on phosphate bean products. That's why also you see a higher margin. Now we expect overall the Fertilizer business to be better than we originally thought based on the farm economics, but some of them show a higher increase in the first quarter. So you have to allocate that when you think about it on a yearly basis, allocating it more through the year.

Now Agribusiness was much better than we thought, and it reflects the situation that in this environment we are in, with high volatility, high demands on working capital, you do need to have a large global network, a footprint of assets, of teams, where we can move around the world the products. So we have an advantage in this type of difficult situation when you are a larger company. So the margins have been stronger than we expected and so the volumes have been better than we expected, so now when we look at the rest of the year we have to be a little bit careful. Prices are very high, and we do include in our guidance some worries. We don't know yet how the Northern Hemisphere harvest will be. We don't know how the South American harvest will be. So it's very early in the year. But overall I would say that we are optimistic about the year.

Diane Geissler - Merrill Lynch

And then, if I might, just one question on the cash flow. The foreign exchange gain on debt in the quarter was fairly large and yet the P&L impact kind of below the line $7 million. If you could just help me understand the dynamics there, Jackie, on the differential?

Jacqualyn Fouse

Well it comes mainly from the stronger real and from the stronger Euro as well.

Diane Geissler - Merrill Lynch

Okay, so I guess what I'm saying is that do you net the difference into COGS, then, because you're backing it out on the cash flow, or if you could just walk me through how that works?

Jacqualyn Fouse

Yes, substantially, yes.

Alberto Weisser

Are you talking about the $160 million?

Diane Geissler - Merrill Lynch

Yes, the FX gain on debt.

Alberto Weisser

Yes, they do not go through the P&L because they offset each other in different parts of the P&L.

Operator

We'll take our next question from David Driscoll - Citi Investment Research.

David Driscoll - Citi Investments

Just to make sure I understood what you just said to Diane, the beat in the quarter relative to your internal forecast was predominantly due to Agribusiness, number one, and then Fertilizer, number two. Is that a correct characterization, Alberto?

Alberto Weisser

Yes, that's correct. And on Fertilizer mix, half of it is being anticipation and half of it better business environment, volume and margins.

David Driscoll - Citi Investments

Okay, on the Fertilizer side, the margin per ton on that business was an all-time record according to my dataset and something almost nearly double what we saw last quarter, not quite but close. This feels extraordinary to me. Can you break down the difference here between the retail piece and the wholesale piece of the Fertilizer business? What's driving these amazing results in the quarter? And then as you go forward, can you maintain at this kind of gross profit per ton number or does it come down for some factors?

Alberto Weisser

In the case of Fertilizer, first of all we - very, very seldom we sell the phosphate-based products at this time of the year. Most of the farmers start planting end of June, mostly in July, so it is very early buying. So that is why the comparison to previous quarters is complicated because you have the much higher margins per ton because of the SSP and all the other kind of products we sell to the soybean farmers. Now the margins were also a little bit above normal on the retail side.

David Driscoll - Citi Investments

So I don't know that I followed 100%. You're saying that in the quarter, this quarter does not see the major sales of phosphate products like you would in future quarters, thus this is not the quarter where - the wholesale operations have the smallest impact here, retail is the bigger impact. Is that it?

Alberto Weisser

Yes. Yes, you're right. Normally this time of the year we sell to the corn farmers for the winter corn crop, for the sugar cane, for coffee, where you have much more nitrogen inputs and pottage where we - basically, in the retail business, we import most of the inputs and we don't use our own nutrients, our own raw materials. That's why normally in this time of the year the margins are lower.

You might remember that in the past we normally see that one-third of the business is done in the first half, twothirds in the second, and on the earnings side you might even have a stronger skew towards the second half. But last year it has been different and this year has also been different. The farmer took early decision to buy early for the summer plantings.

David Driscoll - Citi Investments

So then given the fact that sulfur prices are up so much - and I think that really begins to impact your wholesale business; it should really hit in the second quarter and beyond - would you expect, then, the margins overall within this Fertilizer business to be somewhat less than where they were in this quarter? Still very good, but not quite as strong as Q1?

Alberto Weisser

Yes, that's correct. We expect that at the end of the second quarter we will start seeing some of the changes in the new prices of input, especially sulfur, start to reflect our business, but in the second half there will be more of that.

David Driscoll - Citi Investments

Alberto, big picture you've argued for a long time that Brazil itself has all of the attributes necessary to see fairly substantial agricultural production increases. Is it your opinion right now that we would see a very substantial increase in acreage in production for next season, the season that would plant in October and November? Is this really the answer to the global problems? It seems that a day does not go by where we don't read in the newspaper the food versus food problem and the major concerns that this is generating with the major world organizations that deal with the poor and the hungry.

Alberto Weisser

I expect that Brazil will contribute significantly, but it will take a little bit more time. We have to remember that the area for expansion is in the grassland area. It's Mato Grosso. It is also some of the conversion of pasture to agricultural. And this is not exactly very close to the coast, so the biggest problem for the farmers is the petroleum prices, it's transportation. A lot of that has to be transported by trucks so the railways and waterways are increasing their market share, but it's taking a little bit longer than we hoped. So I would expect the agriculture land to grow on a more normal basis, which is probably only at a 5% per annum.

So we expect that we will continue seeing higher commodity prices through this year and probably next year because the breakeven or the profitability at the farmers closer to the coast is very good, but the ones that the market needs, which are more the new land which is in the pasture conversion and the grassland, it's further away. So the breakeven calculation that we regularly give you is some place around $11.50 per bushel for the soybean. So as long as the soybean is higher than that, the farmers will continue expanding.

But obviously it is a very high level. There's a lot of consumption of working capital, so the farmer goes slowly about it. It will not have a massive expansion.

Operator

Our next question will come from Pablo Zuanic - J.P. Morgan.

Pablo Zuanic - J.P. Morgan

Just to follow up on the Fertilizers front, first of all the increasing guidance of $150 million for the year, would you say, Alberto, that increase is mostly coming from Fertilizers?

Alberto Weisser

No, I would say I think it is half and half, if I would split it. We didn't do it exactly like that, but we increased it in Agribusiness and we increased it in Fertilizer. It's probably not exactly half and half.

Please remember that on the first quarter there was an anticipation of sales that we will not see in the next three quarters, which is the sales to the soybean farmers, so the guidance increase is divided between Agribusiness and Fertilizer. Both are doing well.

Pablo Zuanic - J.P. Morgan

Right. But I don't want to do it on the volume number, but at the end of the day your guidance for the year is 5% to 7%. You're up 9% in the first quarter. Okay, the second half will be slighter [inaudible] 5% to 7%, but it doesn't seem like a huge delta. I mean, you're still giving your guidance of 5% to 7% for the full year, right?

Alberto Weisser

Yes, but you also have to see we are going to have lower margins because of higher sulfur prices. Petroleum is higher. So there's going to be a squeeze in the margins.

Pablo Zuanic - J.P. Morgan

Okay. And I want to follow up on that, then, Alberto. When I look at [MAP] prices, around $1,100, $1,200  they were about $400 six, seven months ago - then I estimate sulfur is about $400, but that's about 40% a year MAP cost. And it would seem to me that the increase in MAP, if prices stay where they are right now, it would more than offset the increase in sulfur in the second half. And you just said before to a prior question that the phosphate fertilizer's MAP are stronger in the second half and they have higher margins.

So I'm still trying to reconcile the idea that margins would be lower. You have more phosphate in the second half; you have a huge increase in MAP, which, in my view, is more than offsetting the increase in sulfur. And so I'm doing the math on your 2 million metric tons of phosphate rock, and it would seem that you have quite a bit of delta on fertilizers in the second half. Can you help me understand that?

Alberto Weisser

Yes. We have to be careful that - there is a limit to how much the prices can go up, and sooner or later there is a risk that the farmers use less technology. And the petroleum where it is, just think about all the logistics costs. So there comes a point where the farmer cannot take any more the global price increases. So there is a risk that either we cannot pass on all the prices that we have therefore have a little bit lower margins, we have to think about that, and secondly that there will be some drop in one or the other areas in demand.

Now other crops are very good. We always talk about the four big ones - which is soybean, is corn, is sugar cane and coffee - but there are also ones like pasture and vegetables and so on. So we do see a volume increase, but we don't know exactly how the mix will play out. So we have to be prudent here when we look into the second half.

Pablo Zuanic - J.P. Morgan

Thank you. And then just to follow up on the Agribusiness side, obviously you're a global company, but you have more exposure to Brazil in relative terms to other companies and the harvest obviously takes place in the March quarter. You would think that there's more commercialized volume being done in the March quarter, but your volumes in the March quarter are lower in Agribusiness than in the September and December quarter. Why would that be the case? And related to that, when I calculate your EBIT per metric ton in Agribusiness, that number in the March quarter was lower than in September and December. And again, based on market conditions, inflation, larger crops in general, I would have expected those earnings per metric ton to be higher in the March quarter than what you saw in the second half of '07.

Alberto Weisser

I'm not so sure if I am able to follow exactly your thought. What we see is that the -

Pablo Zuanic - J.P. Morgan

I guess if I can clarify, Alberto, I'm just trying to understand, a lot of the volume - obviously volumes get commercialized throughout the year but I thought that in the Agribusiness side, on the [inaudible] piece, not the [crashing] side, that you would be commercializing a lot more volume in the March quarter given that that's the time when we're receiving harvest than you would in the second half of - in the third or fourth quarter last year. I'm trying to understand why would that be the case.

Alberto Weisser

The volume we see as very positive because the demand is good. To be honest, Pablo, I don't see a significant difference between previous years. The one difference is that the demand is strong. In vegetable oils, the demand is strong. In meal demand, the meal was strong, corn was strong. And one of the - a big explanation is that especially some smaller and poorer countries over the past years have increased their income and have shifted away from just consuming cereals to consuming more meat. That is why we see an increase in the demand a little bit above what we have seen in the past. So oil is above average, meal is above average, and corn is above average. This is much more related to the population, to the consumption around the world. From our point of view, we don't see any significant change. Am I getting this right?

Pablo Zuanic - J.P. Morgan

No, that's fine. And just to follow up on the EBIT per metric ton, the number in the March quarter was lower than in the second half of '07, and I'm trying to understand does that mean that crashing margins were lower? How do we explain that?

Jacqualyn Fouse

Did you look at it versus the last six months?

Pablo Zuanic - J.P. Morgan

No, this is the number in the third quarter and the fourth quarter. The third quarter and the fourth quarter were about 11 to 12. In the first quarter, in the March quarter, that was about 9. I'm just trying to understand why the number would be lower, but we can follow up offline.

Jacqualyn Fouse

Yes, because when I looked at it it looked to me like they were consistent the way that we look at it. So maybe we should look at the details of your calculation.

Alberto Weisser

Let me say overall normally this time of the year is where the margins come down in the Northern Hemisphere, in the first quarter. U.S. starts winding down, and South America is not completely up there. Normally, the first quarter of the year is a quite low quarter in terms of Agribusiness.

This year the volumes are up, as I said before, but also the margins are very solid around the world, so it is a little bit unusual this part of the year. So I would characterize this as very, very positive, the way it is going.

Pablo Zuanic - J.P. Morgan

On the CapEx front, I think the number for the quarter was $148 million. The guidance, I think it's north of $1 billion for the year. Have you had to cut back CapEx because of credit market conditions or should we see more CapEx later in the year?

Jacqualyn Fouse

No, we have not cut back at all. In fact, you see that number being driven upward because we are moving ahead with a number of major projects that we've got. Then we've got the sugar business being incremental this year versus last year. So those plans are going along according to our expectations, and we're maintaining the $1 to $1.1 billion of guidance for CapEx spend for this year.

Pablo Zuanic - J.P. Morgan

And one last one now to do with the debt gain. But if you have debt in Euros or Portuguese real, when you converted that to dollars that would be a loss so I'm trying to understand - I mean, given that the dollar is weaker  so why would there be a debt gain?

Jacqualyn Fouse

Well, we've got gains in some instances on the inventory positions and so the debt - whichever direction it goes, those two things will offset each other. But they're in different line items of the P&L and they show up in different ways in the cash flow. But we can walk you through that as well.

Operator

And our next question will come from Christine McCracken - Cleveland Research.

Christine McCracken - Cleveland Research

I'm having a little trouble, I guess, reconciling some of the comments from your peers on the outlook for pricing, specifically in Brazil, and volumes. One of your competitors comes out this morning with increases in volumes of 35% to Brazil and goes on to say that pricing is sticking in that market. I'm a little bit surprised with your, I guess, your conservative outlook given some of the price increases we've seen, specifically in phosphate, in recent weeks.

Alberto Weisser

If we would, Christine, if we would extrapolate where we are today, I think that view is fine. The only thing is we have to look at what is going to happen as we approach the big crop. So just think about how close we are where the farmer has to decide if he will expand or not. So in order to increase 30% year-over-year, there has to be a massive expansion. And the farmers are still not completely out of their debt situation, and opening new land is not cheap. So if the breakeven is around 11, 11.50 and the soybean prices are at where they are at the moment, not every farmer is going to grow to reflect an increase in 30plus percent.

In addition, there is all the working capital issue. Somebody has to fund them. The government is limited on it. We are being careful on it, and the banks are being careful on it. So I'm not so sure that we can say it now, in April, how it will be. At the next call we are going to have - at the end of July we will have much more visibility.

But remember I think we have been more realistic in the last two years, and I think we have been - in terms of volumes, we have been closer to a more prudent view.

Christine McCracken - Cleveland Research

Just, then, on Argentina, you haven't talked about the impact of the strike there. Clearly, it didn't show up as a major drag on earnings in the quarter, but the situation seems to be a bit unresolved at the moment. Can you provide any color on that?

Alberto Weisser

At the moment the farmers are selling, we are buying; we are shipping, so the flow is normal at the moment. And we were relatively well positioned for the strike. I think it was early in the crop year, so we didn't have so much commitment. So we had enough inventory to serve our customers, and that gave us time to readjust worldwide to cover our customers from different parts of the world, from Europe and from North America as well, and from soybeans from Brazil to Europe. So we were able to adjust ourselves, and we didn't have a significant hit.

Now if we would have another strike, obviously this would affect. But we are preparing ourselves for that to serve our customers.

Christine McCracken - Cleveland Research

And then just in terms of the U.S., you're looking at a double-digit increase in the crop, potentially. Is it, from your perspective and given your global operations, is it actually better to have a big U.S. crop or something more balanced?

Alberto Weisser

I think we really would like to have a big crop. The stocks are very low. I think it is very important that we have a significant increase. We would really like to have a significant increase in the crop.

Christine McCracken - Cleveland Research

As we all would.

Alberto Weisser

Yes.

Operator

And our next question will come from Vincent Andrews - Morgan Stanley.

Vincent Andrews - Morgan Stanley

Maybe I'll just follow up on that Argentina issue. You know, it's easy to think about how a strike in Argentina can hurt you, but maybe you can talk about how it might help other parts of your business or other geographies.

Alberto Weisser

It really helped our business in Europe and North America because we had very fast to shift the business from Argentina to the U.S. and also to Europe. So because of the - some of them had to declare force majeure and had no access to products, and we were prepared so we were able to serve customers around the world from different sources. I think that was the main reason. And then when you have a situation like this, obviously normally the margins are a little big higher.

Vincent Andrews - Morgan Stanley

So would you classify the event as neutral to your P&L overall or modestly positive or modestly negative?

Alberto Weisser

I would consider it neutral.

Vincent Andrews - Morgan Stanley

And what about - there's been some chatter about the farmers in Brazil. Obviously they have contracts with different grain originators, and some of them might have sold forward at 8, 9 - I don't know, pick your soybean price  and obviously soybean prices are higher now. What should we make of all this chatter that farmers are going to break contracts with yourself and with your competitors to sell to you or one of your competitors?

Alberto Weisser

As you can imagine, this is a concern we have all the time. When prices go up - also go down - we always have a concern on this, and this is part of our business. It's part of our expertise of the whole industry, so we are very, very careful about it. And it can happen and we price it in. It does happen, basically, every year - sometimes more, sometimes less - and we price it in.

But I think what you also have to remember, there are a lot of mitigating factors. One of them is that if somebody defaults on us, somebody else has to buy it. So this new food processor who would be buying it, next year around, when somebody will have to finance them, they will be very careful with this specific farmer because they know that this farmer defaulted. So the farmers are very worried about it even themselves because they know they will have a more difficult time to have access to funding the next crop around.

In addition, we have - normally the advances to farmers are very rigid contracts. We have access to their assets. Also often they are linked to contracts with sales of fertilizer. And the farmers know and we explain them very closely and very carefully every time we don't benefit from these situations. The moment we buy the crops we resell them, either to customers or we hedge them, so we have no benefit on that and the farmers know it because they see it all the time. So it is very human and very natural that they will try, but we're on top of it.

Now, is it going to happen? Yes, but it's priced in.

Vincent Andrews - Morgan Stanley

And then just on, Alberto, you talked a little earlier about in Agribusiness - or, in particular, towards the Ag services - how your global footprint and your vertical integration is an asset here. And presumably, I mean, everybody has working capital issues, but I would imagine some of your competitors, particularly the smaller ones, probably have larger working capital concerns than you do. Can you kind of address or give some examples of how your - are you taking market share from the smaller players, I guess is my real question.

Alberto Weisser

I think we are. We have taken market share, but I think it is more marginal. It is more a question that the margins expand because everybody gets more nervous in the market and is prepared to pay a little bit more to have the safety of a supply. So they know that from us, from the large players, they will have the certainty of the supply. So for that we need to charge more because we have to access the markets and not always - the debt market - in not always the best environments. So I think we do see some marginal market share expansion, but what we really see more is the margins expand.

Vincent Andrews - Morgan Stanley

And just to follow up a little bit on that, there's been some news reports that companies such as yourself are no longer kind of putting through forward selling contracts for farmers because of the increase in the marks that have taken place as the commodity prices have gone up from a futures contract perspective. Is that correct and how's that impacting your business?

Alberto Weisser

It is correct, and I think it is quite normal. But with these very high commodity prices, farmers would like to lock in prices not only for this year but for next year and for the years after. But this is very expensive. If we buy them, we obviously would have to hedge them, and if they go up, there are margin calls. We have to carry them. So all of this is very expensive.

So there is pressure from farmers to do more forward than usual and we are not doing that, and the whole industry is not doing this because, as you can see from our balance sheet, our inventories are already quite high. The prices have more than doubled over the last 18 months. So there is no space in the industry to do these kind of transactions. The farmers cannot do it on their own. We have certain limitations; the banks have limitations.

But it is a very natural situation where the farmers would like to take advantage of the high prices of the coming years. Nobody knows if the commodity prices will stay high.

Vincent Andrews - Morgan Stanley

But it doesn’t have an effect, in other words, you still have - how does it affect your relationship with farmers if you're not entering into those forward contracts? Is there any effect?

Alberto Weisser

They are not extremely happy. They would like to make the transaction, but we are very, very candid and very direct and we show it, that we have limitations, how far we can go. So I think they understand it generally.

Vincent Andrews - Morgan Stanley

And Jackie, if you could just walk us through, there have been some - you said earlier that from a liquidity perspective you feel very comfortable. Could you just help us understand what happens if soybeans go to $20 or something like that. How do you see your balance sheet playing out?

Jacqualyn Fouse

Well, when we plan for our liquidity needs we run scenarios to stress test our models to see what the impact would be if we saw that kind of situation. So based on that modeling and the mix of business that we're doing today and given the new financing that we've raised, we think that we're well positioned to deal with that. We also have choices with respect to the operations - to do business somewhat differently, or stop buying and pull inventories down and things like that if we would need to move to that sort of a measure in an extreme situation - but without going that far, we think that we are well placed today to handle the liquidity needs as we see them.

Operator

And our next question will come from Ken Zaslow - BMO Capital Markets.

Ken Zaslow - BMO Capital Markets

There's a growing view that you need to see high soybean prices to grow your earnings. Can you help me understand what is the ideal soybean environment for you?

Alberto Weisser

I would invert a little bit the situation. If we see the kind of petroleum prices we are seeing, above $100, all the commodity prices have to be higher so that the farmers can make money and produce it. So we just suffer from this situation. When you look at the whole situation, the consequences in our business, we are more, how should I say, we are not the cause but we are the consequence of it.

Now we have to live with that, and I think if the price will stay high because the petroleum prices will stay high, all of us have to adjust. Inventory is going to be higher; debt is going to be higher. That is why margins have to be higher, to find a certain balance.

Ken Zaslow - BMO Capital Markets

But if soybean prices were to drop, would that automatically mean you can't grow your earnings?

Alberto Weisser

If soybean prices would go, let's say, below $11.00? The farmers in Mato Grosso would not grow it anymore, the stocks would go down, and there would not be beans anymore available in the world. So it is correct that the farmers need it for our Fertilizer business, but on the Agribusiness and Food business, this is less relevant.

At this moment we are having a positive environment because it benefits the large players - with the high volatility and the higher prices, where you had to have access to the markets - but this should normalize.

Ken Zaslow - BMO Capital Markets

Okay, going to liquidity concerns because obviously that's what - there's a great deal of concern on that  can you go into a little bit more detail about what your credit lines are, how your debt would be paid down, when you would think about having to do anything with your readily marketable inventories, and at what stage, if any, would you ever have to do anything with your CapEx spending?

Alberto Weisser

Yes, before Jackie answers that, let me add one more comment to your previous one. If we have high commodity prices, this is positive for the farmers. If we have low commodities prices, this is good for the consumers.

So if low prices for the consumers are good, the volume is higher. And obviously, with very high commodity prices, we have to remember this is not good for the livestock industry, it's not good for the end consumer, so we don't like that too much. What we have to find is the right balance. It's probably better to say we need a good price.

So we are - obviously we are - at the moment, we see a positive situation because it's a transition. But we have to be careful. These very high commodity prices long term are not so good.

Jacqualyn Fouse

Yes, with respect to the liquidity question, I mean, you've obviously got the details in the 10K and then you'll have additional details for the quarter when we file the 10Q so you can actually see the numbers.

But with respect to the amount of committed availability of funds that we have, we increased that during the quarter, driven by these couple of new syndicated bank facilities that I mentioned in my comments, which those particular two totaled $900 million. And despite the fact that the quarter was quite volatile, we managed through that well and as of the end of the quarter had actually increased the amount of difference between the committed lines and the drawn amounts under those lines, so the liquidity cushion has increased since the end of the year. We think that's appropriate given the volatility that we have to deal with. We also are producing higher profitability, so that helps as well.

So we continue to try to be as efficient as possible with respect to the use of our working capital, but we haven't had to leverage any of the other tools that would be available to us under some extreme set of circumstances if we really had to stop buying and draw inventories way down and things like that. So there are a number of things that we can do.

With respect to refinancings, I mean, as you probably know because the information is available to you, we have a syndicated bank facility that will roll over later this year in the fall, and we don't see any issues with respect to that. Our ability to close on a couple of new facilities during this past quarter has given us some assurance that we think that we'll be fine in that regard.

And then we've got a bond maturing in December which we had some ideas about potentially refinancing earlier and then didn't like the way the market looked and are still comfortable with the decision we made there to wait. But we don't think that we'll have an issue refinancing that. It's a question of at what price, and we've already seen spreads come back a little bit in our favor and we're going to let the markets calm down a bit and still look to do that.

Even if we couldn't do it in the bond market, we would be able to deal with that from a liquidity standpoint, but I really don't expect that to be an issue. And again the activity that we saw during the first quarter is a sort of factual basis for us seeing that we have access to the funds, and if we do it right we get them at reasonable prices as well.

Ken Zaslow - BMO Capital Markets

Would you go outside the debt markets for raising money?

Jacqualyn Fouse

Not at this time, no.

Ken Zaslow - BMO Capital Markets

So there's no reason to believe that you would have to raise equity?

Jacqualyn Fouse

No, as I think I've mentioned in other calls, given the way that we have put our plan together we expect to be able to fund our CapEx spending from internally generated funds. And we could fund a modest in working capital from internally generated funds or financing facilities currently available to us as well.

The only reason that I would see us needing to go to the equity markets would be potentially if we did a major acquisition or had something that's completely outside of our plans today.

Ken Zaslow - BMO Capital Markets

Okay, so just being clear, in the current business environment you do not need to raise equity because of your cash situation?

Jacqualyn Fouse

That is correct.

Ken Zaslow - BMO Capital Markets

If you were to sell your readily marketable inventories, would you take any charges on it if the price of soybeans went down?

Jacqualyn Fouse

What we would probably do if we got into that situation is we would just stop buying and we would crush everything out, process everything out, and draw the inventories down that way.

Alberto Weisser

And not only that but per definition, the readily marketable inventory has already a price fixed.

Operator

We'll take our next question from Christina McGlone - Deutsche Bank.

Christina McGlone - Deutsche Bank

Alberto, when you were discussing Argentina, just more forward looking, so I'm reading a lot that the strike may resume on May 2. First of all, do you think that would happen and what would that mean given that we're more in the midst of the harvest?

Alberto Weisser

We obviously hope that will not happen, and we are doing whatever we can to help that it doesn't happen. We like to have normal trade flows. But if it does happen, we will have to deal with our customers from other origins.

I think it is, at least, it's possible to deal with that because Brazil has a very large harvest, and we could cover it from Brazil. But I don't expect if there would be a strike that this would be a long strike because this is food, and people have to distribute the food. I'm sure they will be able to get to an arrangement.

Christina McGlone - Deutsche Bank

And how about the impact on plantings in Argentina next year, because I think Argentina has accounted for a lot of the growth in soybean production over the last five years and the incentive to grow has actually deteriorated. And I know there's a lot of new capacity, new crush capacity there. So what is the outlook going forward with respect to plantings?

Alberto Weisser

I would say that the crush capacity is in line with what Argentina is producing at the moment, close to 50 million tons. And I would suspect that however this goes, this is going to have an impact on commodity prices. And I don't see, Christina, at the moment anything negative outlook there. The government would be interested in also having a healthy farm sector.

If there is at the moment too much export taxes for the Argentine farmer, the government indicated with the changes of the rules that they would like to have a flexible system, which is already something positive. Now the question is to get it at the right amount.

So I think it's a little bit forgotten in the whole discussion that the flexible export tax is something positive. We only have to make sure that we get it to the right amount.

Christina McGlone - Deutsche Bank

And then it seems that the kind of global dislocation that we saw because of the wheat shortage may be transitioning to one dealing with vegetable oil imbalances, and I'm curious, given the reduction in the livestock sector in the U.S., that if we switch over to kind of an oil-driven crush, what would be the outlook for crush margins, especially in the back half when we head to the Northern Hemisphere?

Alberto Weisser

First, the good news is that the South American harvest was a good one. I think the second good news is that, based on the farmers' planting intentions that we see from USDA, is we should see also a good planting season or good expansion in the Northern Hemisphere in the U.S.

I would expect also to see normal expansion or good expansion in Europe. Remember last year we had the drop in the sunflower seed. We also have expansion in palm oil. So we are seeing that expansion on the oil is developing positively.

And I think in the case of the U.S., it is more of a question of the soybean meal, and the oil is more of a consequence or is a byproduct. And we do see relatively normal - I would say normal supply and demand picture for the U.S. We might see a little bit less demand in the second half for the livestock industry, but we are in line with the USDA to see global increase in demand for soybean meal on 6% for the year.

Christina McGlone - Deutsche Bank

Jackie, can you please repeat what you said about Paraguay?

Jacqualyn Fouse

We took a provision for about $30 million in Q1 related to receivables that we have in Paraguay that are currently in a legal proceeding where we have filed that proceeding to try to collect those receivables. What happened in the first quarter is that a ruling was handed down at the end of the quarter and we got notification of it early this month that the Paraguayan court ruled it does not have jurisdiction over the case and it passed jurisdiction to the Brazilian courts. We think that's a surprising decision and we hadn't expected that, so we obviously conferred with our counsel.

We'll continue to pursue that proceeding and we have expectations that something may change there. However, given that ruling, we think it will prolong the process, that it will take longer, and we decided that the prudent to do given that development would be to go ahead and take the provision now.

Christina McGlone - Deutsche Bank

And do you have interest expense guidance for the year?

Jacqualyn Fouse

We don't generally give interest expense guidance. I mean, it's built into our overall guidance. I think if you look at Q1, it's probably reasonably representative of where we would expect the quarters to be for the year.

Now obviously, depending on what happens with working capital average levels and how that impacts average debt levels and things like that, it'll move the number around a bit. But I think we generally see stability in interest rates or maybe a slightly tendency in the U.S. We've got about half of our debt at floating rates and about half of it at fixed rate exposure.

Christina McGlone - Deutsche Bank

Alberto, can you talk about the debt burden of the Brazilian farmer? I guess this is the first year when things really look up and they're getting cash for a good crop. And I think that the government just extended government debt, maybe for 10 years, so we're not out of the woods. So how would you characterize things progressing with respect to their debt burden?

Alberto Weisser

I would say it's already the second year; last year has already helped to reduce some of the burden. And you have some farmers who are in very good shape, like sugar cane, coffee and others. And the corn and soybean farmers who have been hit the hardest - and cotton - they had already a good year last year. Especially what we mostly don't see is the corn - corn was very, very positive last year. So this year it continues being positive.

I don't know exactly how far they are out of the woods, but it is a clearly much, much more positive environment. And we were - small amounts - but we were able to collect already on some on the legal proceedings. So I would say it's less and less of an issue, the farmer creditworthiness, in Brazil.

Christina McGlone - Deutsche Bank

And then so how should the bad debt expense move? Did it increase in the quarter or did any of it reverse?

Jacqualyn Fouse

If you look at the net number, the total did increase. But remember that about $30 million of that is related specifically to Paraguay so if you take that out, a little bit of currency impact, we're basically in line with where we were Q1 last year.

Alberto Weisser

And the rest was from Europe, so we had some bad debt in Europe. South America, with the exception of Paraguay, was neutral if we exclude foreign exchange, which is positive.

Operator

This question will come from Robert Moskow - Credit Suisse.

Robert Moskow - Credit Suisse

I'm going to get back to Diane's question on the cash flow statement. The $160 million foreign exchange gain on debt that's a subtraction from net income reduces operating cash flow. The perception out there is that, due to the hedges that you have going long the real as part of your intercompany loans, that that's a big driver of that $160 million swing, and since it is noncash and if you stripped it out - and I'm not saying that you should, but if you did  it would erase some of the upside on the EPS line - so maybe just one more chance here - could we look at that 160 and say that a lot of that is due to the intercompany loans that you have?

Jacqualyn Fouse

I'm sorry that we haven't been clearer about that. Here's what's going on. When we have foreign denominated inventory balances, we will finance those with foreign denominated debt to basically match those up, okay? So in the P&L you will see those things substantially offset each other so there's not a net impact in the P&L. Some of that financing may be intercompany financing, some of that financing could be third-party financing. It actually is irrelevant, basically. But it's a matching of the exposure there, okay?

But the foreign currency impact on the debt - and again, you're only talking about foreign currency denominated debt for the entities where it exists, where their local currency is a different currency - is a noncash item. So from an operating cash flow standpoint, it gets deducted from the net income, but when that debt is actually repaid you get the benefit of that and it moves down into the financing activity section of the cash flow upon repayment of that debt.

Robert Moskow - Credit Suisse

And then lastly on the balance sheet, cash and cash equivalents at $723 million, my understanding is that some of that is one the Fosfertil part of the business, too. Balance sheets are tricky in terms of how much cash you need to have there. Is that the right amount of cash for you to have, and is there any relevance at all to your liquidity level? Should we look at that as any relevance at all?

Jacqualyn Fouse

There's a small piece of it that I guess I would say that's relevant of that $723 million. There's about $350 to $400 million that's in Fosfertil. There's a bit of that that also is just cash that's going to be in the system, so to speak, at any point in time in our affiliates. And then there's, you know, another $150 to $200 million that would be in our sort of central treasury, so to speak, that we would be able to work with basically from one day to the next. So, I mean, that's kind of how you should think about that.

That number has fluctuated basically in line with, in terms of the number that you see on the balance sheet, with the Fosfertil balances which sit there, in some respects - Fosfertil does pay some dividends - but will be used to fund Fosfertil's CapEx projects and things like that.

Operator

And at this time I would like to turn the call back over to Mr. Mark Haden for any closing remarks.

Mark Haden

Great, [Steve], thank you. And thank you, everyone else, for joining us this morning.

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