Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Executives

Christine Battist - Director of Investor Relations

James T. Prokopanko – President and Chief Executive Officer

Dr. Mike Rahm – Vice President of Market Analysis and Strategic Planning

Lawrence W. Stranghoener - Chief Financial Officer

Analysts

Edlain Rodriguez - Goldman Sachs

Donald Carson - Merrill Lynch

Michael Judd - Greenwich Consultants

Neal Wolin for Mark Connelly - Credit Suisse

David Silver - JP Morgan

Mark Gulley - Soleil-Gulley & Associates

Brian Yu - Citigroup

Vincent Andrews - Morgan Stanley

Steve Burn – Merrill Lynch

Mosaic Co. (MOS) F1Q09 Earnings Call October 2, 2008 11:00 AM ET

Operator

Welcome to The Mosaic Company fiscal 2008 fourth quarter earnings conference call. (Operator Instructions) Your host for today's call is Christine Battist, Director of Investor Relations, of the Mosaic Company.

Christine Battist

Joining us for the call this morning are Jim Prokopanko, President and Chief Executive Officer, and Dr. Mike Rahm, Vice President, Market Analysis and Strategic Planning, and other members of the Mosaic senior leadership team.

We will be using presentation slides during the conference call today. You may view the slides simultaneously with the audio webcast. The slides are available on our website, www.mosaicco.com/investors and they enhance our discussion but are not a requirement for the call. If you are unable to download the slides, please contact me after the call and I'll send the slides to you.

We will be making forward-looking statements during the call. The statements include, but are not limited to, statements about future financial and operating results. They are based upon management's beliefs and expectations as of today's date, October 2, 2008, and are subject to significant risks and uncertainties. Actual results may differ materially from those projected in the forward-looking statements. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements is included in our press release issued yesterday and in our reports filed with the Securities and Exchange Commission. This call is the property of Mosaic. Any distribution, transmission, broadcast, or rebroadcast in any form without the expressed written consent of Mosaic is prohibited.

Now, I'll turn the call over to Jim who will recap some of the highlights from our first quarter results. Then Mike Rahm will share some insights on the agricultural sector and outlook, and finally Jim will share some updates to our financial guidance and comments on our cash position.

James T. Prokopanko

Unquestionably we are facing historic events in both the financial and commodity markets, with much yet to be sorted out. Against this volatile backdrop we began Mosaic’s fiscal 2009 year by delivering another quarter of record performance with quarterly earnings nearly four times the prior year. We continue to believe that we are well positioned financially, strategically, and operationally, to serve our customers worldwide and execute on the strong, long-term fundamentals of the agricultural sector.

I will begin by highlighting a few financial metrics related to our first quarter results, as summarized on Slide 4. Our results were driven by higher selling prices due to strong customer demand, underpinned with strong agricultural fundamentals, and our ability to operate our mines, plants, and supply chains effectively. These factors more than offset higher sulfur and ammonia costs, higher Canadian resource taxes and royalties, and mark-to-market derivative losses.

Net earnings for the quarter were $1.2 billion, or $2.65 per diluted share, or nearly four times the first quarter earnings of fiscal 2008. Gross margins improved 12% to 38% compared to a year ago at 26%. These results included net unrealized mark-to-market derivative losses of $115.0 million, or $0.18 per share, and a foreign currency transaction gain of $87.0 million, or $0.13 per share. Our Potash segment delivered a strong quarterly quarter, primarily driven by higher selling prices.

Operating earnings were $478.0 million, quadruple the same period last year. Potash price increases more than offset higher resource taxes and royalties and unrealized mark-to-market derivative losses such that gross margin grew to 52% versus 31% last year.

Our Phosphate segment posted another outstanding quarter despite higher raw material costs and lower than expected selling prices. Phosphates posted operating earnings of $951.0 million, or triple the operating earnings for the same period last year. Gross margins expanded to 39% versus 30% last year.

The average DAP selling price for the quarter was $1,013 per tonne, modestly below our guidance. Following strong increases of the past year, DAP prices leveled off toward the end of the first quarter. The combined effects of softer seasonal demand, higher customer inventory levels, and falling raw material costs have led to a shift of customer sentiment resulting in more conscious purchasing behaviors.

With better balanced inventories and supply chain demands, we will adjust our phosphate production levels downward during the next several months by 500,000 tonnes, to as much as 1 million tonnes. And adjust our sales volume guidance by similar amounts.

We anticipate stronger phosphate buying activity in the second half of the fiscal year and remain very confident that the long-term phosphate fundamentals are positive. Dr. Mike Rahm will speak more about the market outlook in a moment.

Our Offshore segment once again posted strong performance with operating earnings of $159.0 million, well above any prior quarterly results. This increase was the result of higher selling prices and gains earned from positioning inventories in a period of rising selling prices.

Gross margins were 17% versus 10% last year. In the future, the Offshore gross margins is expected to be lower than in recent quarters if selling prices do not continue to increase.

I have asked Dr. Mike Rahm to share some insight on the market outlook with the focus on the longer-term fundamentals that we believe to be positive.

Dr. Mike Rahm

A number of factors, ranging from the current turmoil in the financial markets to uncertainties caused by government policies, have clouded our crystal ball. But as we peer through the fog, we continue to see a very positive outlook for agriculture and for our two core businesses.

Let’s begin with agriculture. Agricultural fundamentals still look rock-solid to us. Farmers have responded to record high agricultural commodity prices by growing bin-busting crops during the last two years. Slide 5 shows that global grain and oilseed production has increased more than 200 million tonnes during the last two years.

That is an outstanding supply response, yet Slide 6 shows that back-to-back record harvests have barely moved the needle measuring overall grain and oilseed stocks. We can see from the cross-hatch bar that inventories now are projected to increase 23 million tonnes and stocks as a percentage of use is forecasted to inch up just slightly.

The record crop this year has calmed agricultural commodity markets following the near-panic attack earlier this summer when heavy rains and flooding delayed planning and damaged crops in many parts of the U.S. Corn Belt. However, our analysis indicates that another bumper crop is required next year to meet the demands for food and fuel, as well as to build stocks to more secure levels. That means farmers will need to plant more area and intensify cropping processes in order to increase yields.

The three bars on the right of this chart illustrate the potential outcomes for low, medium, and high production and use scenarios in 2009. We draw three conclusions from this analysis.

First, trend-line yields next year are not good enough to meet projected demand, let along build stocks to more secure levels. In fact, under the medium-term scenario global grain and oilseed stocks decline and stocks as a percentage of use drops to the lowest percentage since 1973/1974.

Second, a severe weather problem next year would likely send commodity markets into a real panic attack. Under the low-yield scenario stocks decline more than 90 million tonnes and the stocks to use percentage would drop to less than 13%, the lowest percentage in modern history and even less than the low levels of the early 1970s.

Third, ideal growing conditions and another bumper crop are required, not only to meet projected growth and demand, but also to build stocks to more secure levels. Under the high-yield scenario stocks increase to a level that provides more cushion to absorb a potential supply shock in 2010.

Despite fallout from the current financial crisis, this analysis indicates that agricultural commodity markets will have to price in this need for more area and higher yields in 2009. We expect that the main field crops, and especially corn and soybeans, will wage another fierce battle for acreage during the next several months.

Slide 7 shows that 2009 futures prices, while down from the peaks earlier this summer, and hit hard this past week, still remain at high levels with new crop soybean, wheat, and corn price trading in the $11, $7.50, and $5.50 per bushel range respectively. Those prices still support profitable farm economics and solid crop nutrient demand prospects.

There is optimism on the farm. That may sound hard to believe for those of you listening from large financial centers, but many farmers are harvesting record crops this year and selling them at the highest prices they’ve ever received.

As Slide 8 illustrates, the U.S. Department of Agriculture recently estimated that U.S. net cash farm income would climb to $101.0 billion in 2008, despite the steep increases in crop input costs this year.

As noted at the start, a number of factors have riled up our crystal ball, but the agricultural outlook looks clear and rock-solid to us.

Now let’s turn to the market outlook for phosphate and potash. In the case of phosphate, fundamental drivers continue to look positive, but as Jim noted, a number of factors have combined to slow new sales, increase producer stocks, and cause us to reduce planned production during the next few months.

Slide 9 shows that DAP and MAP stocks held by U.S. producers at both on- and off-site facilities climbed to 1.2 million tonnes on August 31, 2008. That was up 28% from the low level a year ago and was up 8% from the three-year average for this date.

Many customers have stepped out of the market in order to assess how the recent decline in sulfur prices and an expected decline in ammonia prices will impact phosphate prices.

Many buyers, especially those in the Americas, have that luxury, given a full distribution pipeline.

The magnitude and speed of the drop in sulfur prices, as illustrated on Slide 10, is worth noting. A $450 per tonne decline in sulfur prices lowers DAP production costs approximately $180 per tonne. Lower sulfur and other raw material costs provide price relief for customers as well as cost relief for phosphate producers.

Distribution pipeline stocks increased last year, especially in the Americas. Slide 11 shows that global processed phosphate imports outside of China jumped 14% to [audio noise] million tonnes last year. World phosphate use increased in 2007 but some of the large increase in shipment last year was carried over for use this year. As a result, we expect that global import demand this year will decline slightly from the record of last year before increasing at a more normal rate in 2009.

The largest pipeline stock builds took place in Brazil and the United States. Slide 12 shows that Brazilian-processed phosphate imports surged about 50% last year. Phosphate use increased 16%, so more product was positioned throughout the entire supply chain than was used by farmers last year. As a consequence, the imports are projected to drop 21% as distributors work down inventories this year before rebounding in 2009.

In the United States, Slide 13, shows that U.S. DAP MAP shipments increased 9%, while we estimate that phosphate use declined slightly during the fertilizer year that ended on June 30. As a result, we expect that domestic DAP MAP shipments will drop from about 7.8 million tonnes last year to 7.1 million tonnes in 2008/2009.

Recent statistics indicate that the destocking of the pipeline has begun. Domestic shipments from June through August dropped 24%, or almost 500,000 tonnes compared to the high levels a year ago.

Swings in pipeline inventories should not be confused with changes in use. Despite the projected drop in producer shipments this year, our Brazilian team forecasts that crop nutrient use will remain flat to up a couple of percent and we estimate that U.S. phosphate use will remain about even with last year.

Managing through swings in pipeline inventories is part of this business and is not unique to phosphates. As I noted at the start, phosphate fundamentals still look positive to us. You can see from Slide 14 that India is expected to import a record-smashing 5.3 million tonnes of DAP and MAP this year and as you can see from Slide 15, high export taxes have reduced Chinese DAP MAP exports during the last several months.

Our assessment is that it may take another 60 to 90 days for raw material costs to stabilize, for customers to work down large pipeline inventories, and for the return of a more normal flow of phosphate through the very long and very large distribution pipeline.

We continue to advise our customers to monitor three fundamental factors. Grain and oilseed prices, raw material costs, and Chinese export policies for a cue on the direction on the phosphate market. As I noted earlier, our crystal ball is clouded a bit, but at this point it looks to us like each of these drivers points in a positive direction in the medium term.

In the case of potash, the most recent statistics indicate that the market remains tight. Slide 16 shows that stocks held by North American producers at both on- and off-site facilities dropped to just 550,000 tonnes K2O on August 31, the lowest level in modern history and equal to only two weeks of production by North American producers.

Record demand continues to fuel the potash markets. Slide 17 shows that after surging 16% last year, world import demand is projected to increase modestly this year and then increase another 6% in 2009. The small increase this year is especially impressive, given that imports by China likely will drop more than 35% due to the delays in settling 2008 contracts.

Slide 18 shows that shipments to China dropped significantly during the first half of this year but large increases in almost every other market more than made up for this decline. The resumption of more normal shipments to China during the second half of this year, the expectation of more timely settlements of the 2009 Chinese contracts, and strong demand prospects in other major importing markets, are expected to keep potash moving at a break-neck pace, not only for the rest of this year, but throughout 2009.

On the domestic front we project that potash shipments and use will remain about flat in 2008/2009. This forecast assumes that corn and soybean acreage will increase to 91 million and 76 million acres respectively and that wheat acreage will decline to about 60.5 million acres. It also assumes that application rates on major crops will remain flat to down modestly as farmers respond to record prices by utilizing advanced technologies such as variable-rate application.

Those are the key points I wanted to make. I am sure we will have time in the Q&A to go into more detail on some of them.

James T. Prokopanko

I would like to reiterate a few points that Mike just made. First, swings in pipeline stocks should not be confused with changes in use. The fundamentals of our core businesses, beginning with the basic need to plant more acres and grow higher yielding crops, remain positive. Record demand continues to fuel both the potash and phosphate markets, but we are taking the decisive steps necessary to work through the temporary slowdown in the movement of phosphates through the distribution pipeline.

I would like now to shift to our financial guidance, as summarized on Slide 20. Due to the near-term factors we have outlined, phosphate sales volume guidance for fiscal 2009 is being reduced modestly to a range of 8 million to 9 million tonnes. We expect the majority of the reduction in sales tonnes will occur in the second fiscal quarter.

Mosaic’s realized DAP price FOB plant for the second quarter of fiscal 2009 is estimated to be $1,010 to $1,080 per metric tonne, slightly higher than Q1 levels.

Potash sales volume guidance for fiscal 2009 remains unchanged at 8.2 million to 8.6 million tonnes. We are producing all we can, as fast as we can, and we wish we had more inventories at hand to satisfy customer demand.

Mosaic’s second quarter fiscal 2009 average realized MOP price FOB plant is estimated to be $560 per tonne to $620 per tonne. We are tempering our second-quarter outlook for phosphate volumes, though our full-year results should still be outstanding by any measure, including the generation of substantial cash flow.

Now let me comment briefly on Mosaic’s cash position. As all of you are keenly aware, we are experiencing tumultuous events in the financial markets. Clearly, liquidity is king right now and our strong focus on building cash and a fortress balance sheet is serving us well. You can expect us to maintain our disciplined approach to liquidity management in cash allocation decisions.

As a reminder of our intentions regarding the use of cash, our first priority is to invest in our plants and mines for high-return growth and energy-reduction projects, as well as sustaining projects to ensure efficient operations. To this end, our capital expenditures will more than double this fiscal year to approximately $1.1 billion.

Our second priority is to maintain a substantial amount of cash as a liquidity buffer. The need for this is obvious given recent credit market dislocations and would be even more so if our business was not performing as well as it now.

Third, we intend to distribute excess cash to shareholders when appropriate. To this end, we implemented a modest regular dividend just last quarter, far sooner than we originally expected. We know that some of you are looking for more and we are evaluating more meaningful distributions of cash in the future and the appropriate means for doing so.

Before that can happen, note that our current credit agreement limits the amount of distributions we can make, so a necessary first step, we have to redo or amend our credit agreement, not a simple task in today’s credit environment. In the meantime, current events suggest this is a great time to maintain a substantial cash balance.

In closing I want to emphasize four key points as summarized on Slide 22. First, we had a very good first quarter and expect strong year-over-year earnings growth throughout the rest of this fiscal year. Agricultural fundamentals remain positive and Mosaic employees around the globe are executing effectively.

Second, potash fundamentals remain robust and we like the outlook for this business and we are moving ahead with our previously announced expansion plans.

Third, we also like the outlook for the phosphate business and hereto we are well positioned to capitalize. We are responding aggressively to a near-term hiccup in the supply and demand fundamentals and expect more robust market conditions in the second half of the year. And though volume may be weaker this year than we first thought, margins remain excellent. This is a very good business in an excellent industry and we are executing our plans with discipline and focus.

Finally, we are certainly aware of the instability in global financial markets and are closely monitoring and evaluating the risks this may pose to use, as well as to our customers and suppliers. This is not, however, distracting us from our primary goals of serving our customers well, engaging all of our employees in the execution of our strategy, and generating strong returns for our shareholders.

You can count on this management team to maintain our focus and perspective, even in the midst of these challenging circumstances. Thank you very much for listening. Now we will be happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Edlain Rodriguez - Goldman Sachs.

Edlain Rodriguez - Goldman Sachs

Jim, quick question for you. What gives you confidence that DAP prices will remain at those levels, despite the decline in the one or two years?

James T. Prokopanko

What I would suggest is the focus needs to be on margins, not on sales price. And that’s what’s driving our bottom line, is the very strong margins we’re seeing. So although we may miss, and could possibly be wrong, with what our sales forecast is, we’re comfortable and confident in our margins, that we see input costs go down, the drives that reduce sales price, we still see good margins in this business.

Edlain Rodriguez - Goldman Sachs

In the factors that you cite and Mike cite, some of them that result in the softness in phosphates right now, which ones are more concerning to you, which you think of these are likely to persist for a while and which ones do you think is just a temporary blip?

James T. Prokopanko

What is the most concerning? Well, we’ve got to watch what is happening with grain prices and returns to farmers, and that’s going to drive final use numbers. Less concerning, but very real, is the bulge in the pipeline stocks, and we see this as a bulge in the pipeline, not a reflection of actual farmer use.

Operator

Your next question comes from Donald Carson - Merrill Lynch.

Donald Carson - Merrill Lynch

Jim, on margins, which you rightly noticed the focus here, your call on sulfur was pretty good, because it has come crashing down, at least internationally, what kind of a lag do you see, though, for sulfur pricing coming down in the U.S., given that there is still some tightness post all the refinery outages?

And then a couple of questions for Mike Rahm. One, if fall fertilizer applications fall a little short because of a compressed season, can you make that up in the spring?

And then secondly, in terms of, you gave us your acreage outlook for corn and soy, you know, corn margins are still above soy but in a world of constrained credit, soy takes a lot less working capital. I’m just wondering what impact that might have on the acreage balance next spring?

James T. Prokopanko

On the sulfur prices, we have quarterly contracts, as you know. We have just concluded our third calendar quarter, July, August, September. We are negotiating with sulfur producers, they have not been prepared to capitulate on the price but the world prices that we’re seeing reported to be down as low as $400 and some unreported but stories of $200 sulfur prices being posted. We expect that that will start hitting our production facilities over the next three months, [ac novem dies] when we conclude our fourth quarter calendar contract. So it’s around the corner for us.

Donald Carson - Merrill Lynch

So you don’t expect any lag to that international fall then?

James T. Prokopanko

There will be a lag in terms of our inventories. We do have product purchased at the higher prices so it will get blended in, a little slower going down, just as it’s slow going up, to get the full negative impact. But we see, over the next few months that we will be getting much lower sulfur prices.

Lawrence W. Stranghoener

And just to be clear, we would expect higher cost per tonne in our second fiscal quarter because of this lag effect that Jim cites, before what could be a very significant decline in cost per tonne in the third and fourth quarters of the year.

Dr. Mike Rahm

In terms of your two questions, we expect a good fall season, assuming the weather cooperates. Farmers are taking a big crop off, we think they are in a very good financial position, strong balance sheets. We have not picked up wide-spread stories about serious credit constraints, so I think we are poised for a very good fall season. And as you say, if the crop is two to three weeks late, that could be the only fly in the ointment there.

If the fall turns out to be disappointing, can we make it up in the spring? I think, although our supply chain will probably cringe, I think the answer to that is clearly yes. We have had a couple of analog years in the past where fall shipments, for whatever reason, have been down, there have been huge shipments requirements during the spring season, and despite a lot of grinding and gnashing of teeth, a product has been delivered to people in time for the spring application season.

The second question on soybean acres and working capital and how that might impact soybean versus corn, that’s a very good question. Again, I would go back to what we said earlier, that we are not picking up a lot of issues with respect to credit at this point, in the country side. I agree with your assessment that corn prices I think may have to move up to pull in the acres that we think need to be planted to keep that S&D in balance.

So as I said in the remarks, we fully expect that there will be another battle for acres once the harvest is in and once these crops start competing for what we think is the area they need for next year.

Operator

Your next question comes from Michael Judd - Greenwich Consultants.

Michael Judd - Greenwich Consultants

Your [Tapp] plant, can you talk a little bit about the impacts of that, I believe it was out for part of the quarter. And is it back up or is that part of the plan to keep that down so that would be an area where you wouldn’t produce as much DAP?

James T. Prokopanko

No, we haven’t addressed that question. You said [Tapp], you are referring to our Uncle Sam and Fostina plants in Louisiana. Yes, they suffered some damage, mostly wind damage. Thankfully not water damage in the Hurricane Gustaf. We have been down and probably will be down now for about a month. We are getting the plant back up and in production and it’s not a plant that, it probably was out approximately 30 days, back running now. And with its capacity to produce phosphate and load it on the river, that’s a plant we’re going to keep running.

I think it will answer a question that you may have implied in there is how are we going to take out the 500,000 to 1 million tonnes. What we plan to do is just feather back production at our Florida facilities and I don’t see taking a curtailment of any plant, but just take the foot off the accelerator a little bit.

Michael Judd - Greenwich Consultants

For those of us who aren’t farmers, I certainly can appreciate that they’re having a good crop and their balance sheets are going to look pretty good, but don’t farmers basically have to borrow a lot of money in order to basically finance the purchase of a lot of raw materials, including fertilizers? I’m just trying to understand how that works out for your average farmer. Can you kind of walk me through that?

James T. Prokopanko

Well, Mike quoted a number, I think it was 2007, their crop year, we’re estimating farms to have a net farm cash income of $101.0 billion. That is the third consecutive outstanding year they’re having. I think two years ago they had a good year and it was about a $60.0 billion net farm cash income. Farmers have got good balance sheets, good farmers have cash on hand, and yes, they may have to get some financing, but that’s a solid place for banks to be investing. Good security on the farm. And we’re sensitive to it, but we are not seeing, at this point, farmers being stressed for capital to plant their upcoming crop.

Operator

Your next question comes from Neal Wolin for Mark Connelly - Credit Suisse.

Neal Wolin for Mark Connelly - Credit Suisse

I had a question about inventory levels in Brazil. Obviously that’s one of the key issues here. Is there any specific area where you are seeing inventory build? Is it sitting at the ports? Is it at distributors? Is it already at the farm just waiting to be used? Could you give some color on that?

Dr. Mike Rahm

Inventory levels are high in Brazil and our assessment is it’s pretty much throughout the distribution pipeline. As you know, we are approaching peak application season there and our expectation there is that those will get pulled down. To give you some numbers, through August, shipments to farms in Brazil were up about 10%. I think at the end of July they were up almost 19%. So August and the expectation for when the numbers for September come in is that shipments to farmers have slowed down, as they have bought early.

We expect that [ac novem dies] will be respectable month and that by the end of the year, when all the tonnes are counted, Brazilian fertilizer use will probably be equal to last year, which was 24.6 million tonnes of use, to maybe even up a couple of percentage points, depending on how things play out between now and the end of the calendar year.

So, yes, pipelines generally are well-stocked, prior to the start of the season. And that’s what we’re seeing in Brazil. And we saw a lot of product get placed early and things are slowing down now in terms of movement to the farm. We expect them to pick up in the fourth calendar quarter.

Neal Wolin for Mark Connelly - Credit Suisse

We’re hearing in regions like Montegrosso that they are actually giving a drop in prices, that farmers may be underwater to a certain degree. What is your sense of the farmers down in Brazil able to fund their purchases of fertilizers? Are they going to cut back? Will this necessarily mean that it will take longer to draw down the inventory in Brazil?

Dr. Mike Rahm

That’s a good question. A couple of points. Two things in play. We have seen the real weaken and that has given us a boost to the export-oriented agricultural sector there, and in fact, the depreciation of the real has to some extent made up for much of the recent decline in soybean prices. So I think you have to keep that in mind. Think in terms of reals per bag or reals per bushel as opposed to dollars per bushel.

And in our assessment, from the team down there, is that generally we think overall planted area is going to be up a little bit. How intense they are in terms of applying inputs is more uncertain. We think there may be less intensity than we’ve in the past but we think acreage or area will be up.

Operator

Your next question comes from David Silver - JP Morgan.

David Silver - JP Morgan

I wanted to ask you about your industrial potash business. So that’s an area where Mosaic, I believe, has a leading market position. You key competitor, I think, is suffering either official force majeure or unofficial force majeure. Does that present any opportunities for you or is that business that because you are a little bit short on inventories heading into this year, that that business is fundamentally just going unmet? Can you talk about the opportunity that you have there from some unmet demand on the industrial potash side?

James T. Prokopanko

You picked up on an important point and particularly if you are the industrial customer that relies on the various products that come from potassium chloride, potassium hydroxide, and so on, food preservatives are a big user of it, plastic packaging goods. And yes, one of the major producers is, with their supply problems, some industrial accounts have had force majeure declared on them and they have called us.

We have not been able to find the extra production or the inventory to serve them. So that’s not something we can step in and fill. Our industrial potash production is fully committed. Every tonne that we are pulling out of the ground and producing has got a designated customer on it. So simple answer, no, we can’t fill some of the unmet needs right now. But all of our customers are being taken care of.

David Silver - JP Morgan

Jim, or maybe Mike, I would like you to maybe comment, this is going to be a question of how we should think about the DAP market here versus the potash market. So in other words, when I think of the change in supply capability for DAP and potash year-over-year, I think it’s about the same, couple of percent up, when I think of the demand profile, corn, wheat, soy, cotton, etc. I also think that the ultimate end market demand profile for P versus K is pretty similar. However, here through the end of the summer we have had a very different pricing action between potash, which seems to be stable to higher, and DAP, which seems to be weaker. Can you talk about, from your perspective as kind of a member of both of the export marketing agencies for potash and phosphate, can you talk about what you think the key differences are that have led to this difference in recent price performance? Is it the distribution channel? Is it the size and the shape of your different customers? Is it long supply chain? What kind of gives the potash market that firmness here that seems to have eluded the DAP market?

James T. Prokopanko

Let me give an answer and, Mike, if I miss something you can just add to it. I think what has occurred this last couple of quarters is that we have seen the rise in phosphate prices precede the increase in potash. And so over the last couple of quarters, with rapidly escalating phosphate prices, dealers, distributors, retailers, have been eager and motivated to get the phosphate product into the warehouses before they saw further price increases. So what we see now is this bulge in the pipeline. They filled up, anticipating just for their price increases.

Potash was later to start seeing escalating prices. We had a reduction in China last year of potash demand. So it was just a little later that potash started facing growing, strong global demand. Phosphate space and dealers and warehouses are full, they can’t really take much more.

There is view now, and I think a correct view that I subscribe to, that potash demand is going to come back, particularly with the Chinese having to restock their pipeline, which is contrary to what we’re seeing in North America, very low, particularly in potash.

So the Chinese have to come back and start buying product and so the anticipation is with them having to buy as much as 50% more than they did last year, it’s potash’s turn to sort of be out of balance in terms of supply and demand.

Dr. Mike Rahm

That’s a great question. And I think the answer is that we don’t necessarily see as many differences as what might appear today. I think if you think of our business as, let’s say, a long distribution pipeline or supply chain, at one end you have farmers who are using the product about two days out of the year. There’s either a spring application or a fall application.

At the other end of the pipeline you have mines and processing plants that are operating 24/7/365 and throughout the course of the year you have a flow of product moving through that very long and very large pipeline. There aren’t all that many sources of supply in terms of where these minerals are found and as a result we sell product to farmers in every corner of the globe.

So that the pipeline is long and given the differences in how we produce it and how farmers use it, it has to necessarily be a very long pipeline. As I said in the comments, the swings in the pipeline are not unique to phosphate. We have short memories. Go back about two and a half years, the first half of 2006, we were in the same boat with potash. The inventories had built sharply in North America, the Chinese and Indians were in a protracted negotiation with suppliers, and we were scaling back our potash mines because the system was plugged.

And so think of it in terms of our production facilities in phosphate have about three weeks of production space. So we have to continually move product through that pipeline. And when we say we believe the fundamentals are good for both of these nutrients, that sort of relates to what’s coming out at the end of the pipeline and what’s going in. We think that balance is very positive and that’s why we like both of these businesses.

Now, I think just to elaborate a couple of points that Jim made, phosphates are different in the sense that there are two important purchased raw materials, namely sulfur and ammonia, for integrated players. And this past year we have seen wild swings, unprecedented swings in those raw material costs, which have caused prices to go up and now they are causing prices to come down.

And when prices go up, that increases the rates of flow of a product coming from producer points. And pipelines will build and it’s a very, very large pipeline and as we’ve said, we think it will take 60 to 90 days to pull that down. And the pipeline will probably go to very low levels.

But at the end of the day, if you’re concerned about how much needs to come out of the end of the pipeline versus how much needs to go in, we like both of these businesses.

Probably another factor that is important between the differences is the China factor. Last year when pipeline stocks built, China was there pushing product into the pipeline, feeding the tremendous demand on the part of distributors to build these stocks. This year they haven’t quite disappeared by they certainly have cut back a great deal.

So, the fact that there are purchased raw materials for phosphate that causes prices to swing up and down, and the China factor, are two differences I think that make phosphate a little bit different than potash.

Sorry for the long-winded answer but I think that’s how we view these two businesses.

Operator

Your next question comes from Mark Gulley - Soleil-Gulley & Associates.

Mark Gulley - Soleil-Gulley & Associates

In the real world, farmers, it sounds like dealers are going to have to take LIFO charges with given the fact that they have purchased product on the DAP side at much higher prices and are going to be pressured by their customers to perhaps sell at lower prices. So are LIFO charges going to be a problem for your customers, the dealers? And what about LIFO charges for Mosaic, given how you account for these things?

James T. Prokopanko

Dealers have been buying over the last three to four months, that’s what is in their warehouses. And there are some very handsome prices they have in those warehouses and by that I mean low prices, so I think the dealers are going to do just fine when you look at their average, blended fertilizer prices. So the bottom line, I don’t see this at all as an issue for the retailer and dealer.

Lawrence W. Stranghoener

It’s not a concern for us at this point with our inventories. There is still a very healthy margin between the average cost of the product and inventory and current selling prices. As we indicated earlier, we would expect that the cost of product to be coming down over the coming months, over the next three to six months. So we don’t think this is an issue for us.

Mark Gulley - Soleil-Gulley & Associates

And Mike, you talked about the optimism that farmers feel based upon the 2008 harvest and I appreciate that, but I can’t think that they’re that optimistic about the price/cost squeeze facing them for 2009. Those crop prices ease, as your graph shows, and these costs are rising, do you think you’re going to see a lot of sitting on hands by farmers and/or demands for lower prices and they try to confront a price/cost squeeze for next year?

Dr. Mike Rahm

Actually, when you look at the 2009 farm economics they, if you plug in 2009 new crop prices versus current spot prices for crop nutrients, expected prices for seed corn, diesel, and so forth, those economics are not a heck of a lot different than the 2008 economics. Assuming that a producer sold the crop at these new crop prices less a basis.

So our assessment of farm economics still remains very positive.

Operator

Your next question comes from Brian Yu- Citigroup.

Brian Yu - Citigroup

Jim, taking what we’ve learned from the current destocking phase in the phosphate market, does this alter your approach to selling product in the future or your restock plans at [South Pierce]?

James T. Prokopanko

To your first question, does it change our approach? Well, we had some advice from analysts and investors that when the prices were going up we should be more spot-oriented and I don’t know if you are suggesting that we should be longer-pricing now, but no, we haven’t changed our pricing.

We are being thoughtful about when we price and how far out we go. It’s a long supply chain, you’ve heard that from us a number of times, so there is just the logistics and the physics of it all, you have to price out six to eight to ten weeks out. So we’re not really changing that. We’re being cautious in terms of our potash pricing beyond our November time. We’ve got programs out and have made our, call it the fall sale program has been done. So we’re being cautious going out much beyond the next eight weeks.

And so the [South Peirce] question next is something that is going to be caught up in this reduction of our phosphate production and we will put that on indefinite hold. And we’re partially down that road but in terms of the capital spending, nothing really material on that, so that won’t be coming on line until we see this bulge in the pipeline being reduced.

Brian Yu - Citigroup

My questions wasn’t so much with pricing, but just more of how your approach to shipping product, you have a pretty good sense of what demand is going to look like, and given your leadership role in the industry, is there any way for you to control the outbound flow of product so that you don’t end up over-supplying the chain?

James T. Prokopanko

What I hear you asking is should we take a management approach in what’s in the pipeline. We’ve got a production engine that produces in the range of 800,000 tonnes a month and we’ve got about three weeks of storage capacity. So we’re going to move it as the various markets in the world need it and as we produce it. So there’s not a lot of room to control that throttle.

Brian Yu - Citigroup

You commented earlier that with the phosphate business it’s more about margins rather than pricing so taking a look at margins in phosphates, Mosaic generated $517 per tonne of product sold in the phosphate business, excluding very smart market adjustments. What type of margins do you think Mosaic needs to get for its products to fully value the resources going forward? Is it in the $500 per tonne area? Is that the type of margins you see yourself trying to defend?

Lawrence W. Stranghoener

The margins that we are currently generating, that we generated in this past quarter, are at historically high levels, at very attractive levels. As we indicated earlier, because of the lagging effect of rising sulfur and ammonia costs before we start to see the downturn we think that that margin will likely decline in the second quarter. We do believe, however, we will see very healthy margins and recovering margins in the second half of the year and I would emphasize again that the margins that we are currently seeing, that we expect to see, are high by any historic measure for the phosphate industry.

Operator

Your next question comes from Vincent Andrews – Morgan Stanley.

Vincent Andrews - Morgan Stanley

You mentioned earlier that there were some analog years where you were able to make up for the fall and the spring. Could you just provide us with what those years were?

Dr. Mike Rahm

I think that the best year was 2006 or 2007 where you looked at the total shipments of all fertilizer products. And I’m talking primarily about solid fertilizer products. So we looked at DAP, MAP, potash and you compared it to shipments during the previous five years, they were off dramatically. I think it was the fall of 2006. That was the year where I think we had 93 million acres of corn, so there were big demand requirements next spring, and yet we ended the first half of the fertilizer year with shipments below normal for, I think, virtually all those products. And there was a huge shipping requirement for the spring of 2007, I believe it was.

And I think we had some help from weather. I think there was a pretty orderly break to the season and in the end, after lots of concerns about people not getting product, and I think there were a few scattered outages here and there, but by and large the supply chain was able to produce or deliver the tonnes that were needed. So the best analog year, I think is 2006/2007. We can go back and take a look at those numbers if you would like to follow up with that.

Vincent Andrews - Morgan Stanley

Could you talk about how you came to the production cut volume numbers and how you see kind of the delta between one or the other and why you think that the high end is the max you will have to do?

James T. Prokopanko

We did our forecast of global demand by geography, by customer, worked it up from what our sales force in the country anticipate for customer requirements and backed it into our production schedule and our judgment is something in that range, given all we know today and grain prices that we’re facing, this is our best judgment of what will balance out the supply and demand chain.

Vincent Andrews - Morgan Stanley

What price of corn were you assuming in that analysis?

James T. Prokopanko

The kind of values that we’re seeing today, this week, we’ve seen a bit of weakening in the commodity markets, the grain and oilseed markets the last couple of weeks, and just sort of projecting that in that range.

Dr. Mike Rahm

Some key assumptions there, we’ve mentioned before domestic DAP MAP shipments dropping from 7.8 to 7.1 or 7.2. We expect Chinese exports in 2009 to DAP and MAP to remain in that 2.5 million tonne range. We expect a rebound in Brazilian imports, I think we mentioned a 9% climb. So there are a number of assumptions that go into that and those are our best estimates, guesses, at this point.

Vincent Andrews - Morgan Stanley

What do you assume for the Chinese export tariff?

James T. Prokopanko

That’s a difficult call. You saw from the chart that Chinese exports have really tailed off. I wish we knew. I’m not sure the Chinese officials are agreed upon what they intend to do.

Vincent Andrews - Morgan Stanley

Let’s assume that the tariff goes away, what would that mean to your production forecast, do you think?

James T. Prokopanko

That’s hard to say. It’s difficult to speculate on that. As we’ve said all along, China is a big swing factor.

Vincent Andrews - Morgan Stanley

And if we think about the non-integrated phosphate producer now, how should we think about the break-even cost of production there and how are you thinking about what their production plans might be? I mean obviously you think the raw material costs are going to come down.

James T. Prokopanko

Right now I think for fourth quarter acid prices in India, they were settled at 19 and 20 roughly, given the spot prices of ammonia. We think the cost of those raw materials delivered per tonne of DAP is about $1,085. So they have reflected those differences. When you look at Indian DAP production we think it’s going to be below 4 million tonnes, 3.7 million tonnes, down dramatically from what we’ve seen in the past. So India is importing more DAP and less raw materials and intermediate products to product DAP.

Vincent Andrews - Morgan Stanley

How are you thinking about the seller of rocks to the non-integrated producer? How do you forecast the risk or think about the risk that there would be a price cut in rock for the non-integrated producer?

Christine Battist

We need to wrap up the call so you can take this off line.

Operator

Your next question comes from Steve Burn – Merrill Lynch.

Steve Burn – Merrill Lynch

Were there any unusual costs in the fiscal first quarter in either business? It looks like unit costs, backing out provincial taxes on potash and backing out the sulfur and ammonia costs on phosphates just appeared higher than they have been in the last few quarters. Was there anything unusual?

Lawrence W. Stranghoener

The mark-to-market charges.

Steve Burn – Merrill Lynch

I backed that out, too.

Lawrence W. Stranghoener

The other issue would be volume just being generally lighter and so on, absorbed overhead was an issue in the quarter. Otherwise there was nothing of any significance that stands out. We re-estimated reclamation costs, that was a minor bit in the phosphate business but nothing else that was particularly noteworthy.

Christine Battist

That concludes our formal comments of the call today and we will be happy to take your questions back at the office.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Mosaic Co. F1Q09 (Qtr End 08/31/08) Earnings Call Transcript
This Transcript
All Transcripts