Yara International ASA (YARIY) Q1 2019 Results – Earnings Call Transcript – Forex Crypto Currency News Trading Strategies

Yara International ASA (OTCPK:YARIY) Q1 2019 Results Conference Call April 26, 2019 3:30 AM ET

Company Participants

Dag Tore Mo – Head of Market Intelligence

Lars Rosaeg – EVP and Chief Financial Officer

Terje Knutsen – EVP of Sales & Marketing

Thor Giæver – Head of IR

Conference Call Participants

Oliver Rowe – Scotiabank

Andrew Stott – UBS Investment Bank

Joel Jackson – BMO Capital Markets

Neil Christopher Tyler – Redburn

Operator

Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to today’s Yara First Quarter Results 2019 Conference Call [Operator Instructions]. I must also advise you that the conference is being recorded today, Friday, the 26th of April 2019. I would now like to hand the conference over to your speaker today, Lars Rosaeg. Thank you. Please go ahead, sir.

Lars Rosaeg

Thank you very much, operator, and good morning, good afternoon everyone, and welcome to the Yara First Quarter Results Conference Call. I’m sure most of you have already seen our report and the presentation from this morning, so I will limit my opening comments and make sure we have adequate time for Q&A.

Our EBITDA excluding special items in IFRS 16, FX increased by 17% in the first quarter, as improved margins and positive currency effects more than offset lower deliveries. The improvement was largely due to higher European nitrogen margins and a stronger U.S. Dollar. However, we did experience technical issues after turnarounds in three of our largest plants impacting our results and our improvement program performance in the quarter in isolation.

Our return on invested capital at 4.1% is improving however, it is not at a satisfactory level while trending upwards. And our operating cash flow will significantly improve while capital expenditure spend is reducing and the cycle fundamentals are strengthening. We remain focused on improving our returns through strict capital discipline and driving operational excellence.

With these introductory remarks, we are indeed ready for the Q&A. And Operator, I kindly ask you to open for questions.

Question-and-Answer Session

Operator

[Operator Instructions] We now have your first question from the line of Ben Isaacson. Your line is now open.

Oliver Rowe

It’s Oliver Rowe on for Ben. Thanks for taking my question. Could you maybe just discuss your Brazil strategy? Are you still seeing opportunities for further M&A and consolidation, or are you happy with your positioning in that market once Salitre and Rio Grande are fully commissioned?

Lars Rosaeg

So in Brazil, we will come out of a period of significant structural changes, and as you indeed mentioned we also have two significant projects ongoing. So our main focus there is, is the overall strategy is to focus on delivering on the ongoing project, and also deliver on our strategy of value creation and value over volume.

Oliver Rowe

And so I guess when we think about where the next sort of regional opportunities would be around the world, I know that you’re still in cost improvement mode. But when we get a few years out, where do you think that opportunities may lie?

Lars Rosaeg

Well, there could of course be opportunities in many parts of the world and in many regions, and our mindset is indeed that focusing on improving our underlying operations and our project is the right approach regardless of how different opportunities may pan out.

Terje Knutsen

We couldn’t add that we recently acquired the Tata Chemical business in India, as you know, one year ago. And we are very much in the mode of scaling up, particularly our premium product sales into India, and that means that we are expanding even in our existing portfolio of markets.

Operator

We now have your next question from the line of Joel Jackson.

Joel Jackson

I had a few questions; I’ll go through them one by one. So obviously the lower European gas costs are really helping your margin and helping your costs, but can you talk about the impact on the overall nitrogen market? As fourth quartile producers have some cost pressure relief. How does that impact the overall market as you see it? Thanks.

Dag Tore Mo

I think it has limited impact at the moment, already before the drop in gas prices as you mentioned it was really the Chinese situation that set global prices, either through an export logic that we sometimes see when prices are very good like during the last fall when the global urea market was in a deficit ex-China. So that urea had to be pulled out from China. Then you had this export logic which is currently at a price of let’s say around $300. Then the market turned into a situation where ex-China had a small surplus and what you saw then, or that you didn’t actually see any containment by let’s just say the fourth quartile producers outside China, because at an even higher price level than that cost level.

The Chinese were starting to look at imports. They’ve actually imported, they’re at least 3 to 5 cargos just recently because the global market was sufficiently low compared to the Chinese price level. And of course, know then the price market has moved up again. Somehow it seems to be, again in their opinion to a slight deficit outside China. So, now their prices are kind of in between those price logics. So I would say that the costing, the cost improvement for the fourth quartile producers, as you mentioned, outside China, has not led to a price drop for urea. It’s led to increased margins for those producers.

Joel Jackson

So if I decode what you’re saying, you’re saying that the utilization of European production was the same or is the same at $5 gas versus $10 gas? Is that what you’re saying?

Dag Tore Mo

That’s pretty close to reality. I mean, if you assume that Ukraine is out on both locations, you could say, which they have been because of all kind of other problems, that could have been an area where they would have struggled at $10 and probably produced at $5. But we haven’t seen any difference there. Then you had some producers in Eastern Europe that are in export-oriented nitrogen areas, like in Poland, Romania, Lithuania, etc., that could also be swing factors at the $10 scenario but not at a $5 scenario.

So there are some that for us in Western Europe, and we also had positive urea margins let’s say half a year ago when the gas price was around $9. But of course then you get to $10, the margins are of course very slim. But if you look at the reality over the last year or so, I don’t think there has been many market-related adjustments to urea production anywhere outside China. You’ve had some in the fall with Pakistan possibly reducing production a bit and importing some more urea, say maybe in [Bangladesh]. So maybe some adjustments, I don’t think its right to say that there were none, but I would say that it was limited, at least.

Dag Tore Mo

So another question is, I want to talk about your digital ag partnership or platform partnership with IBM, so first of all I want to know how much you expect to put into investment into this in the next few years? Maybe you could break it out by year? And a lot of your larger crop input competitors and other competitors have put a lot of money is digital ag this decade in terms of cost investments and acquisitions. And as we know, they’re not making money. They’re losing money, they’re not getting returns, they’re not getting $10 an acre or $20 an acre from growers. They’re getting maybe $1 an acre. So what I wanted to know is, what will you be doing differently? What product, what services will you be offering differently? How will this make money? How will you differentiate? Thanks.

Terje Knutsen

I think this is important that this is not an ordinary supplier agreement. This is the partnership where two companies who had very different, but also very complementary competencies, come together. And what we actually bring in is primarily our competence. That means they bring in their competence. We bring in our competence which obviously is in crop and agronomy. Where the uniqueness here is that IBM is searching for a way to approach the farmer, have access actually to farmers. And we have that access to the farmer and to the field. That also leads me to, why is this different? Others have bought themselves into knowledge and competence.

We have been building knowledge in this company for many, many years and we don’t think the best way of getting into a digital position is acquiring such position, we or other companies, we have chosen to do this more in-house by building and investing into own people in four regional hubs around the world. We are presently 250 people working on that digital part. And then we rather complement that with partnerships in competencies where we don’t think we should invest, like for instance, data management and the expertise and services that they have for instance in data analytics. So this is rather than talking money in terms of investment, it is bringing competencies together in a hopefully smart way that can make us come to market with high quality solutions at a relatively low-cost investment.

Joel Jackson

So just as a result of this announcement, is there an incremental investment Yara is making this year, 2020, 2021, can you give us a little more elaboration?

Terje Knutsen

It’s very much not so. I would not even say it’s relevant in terms of talking investment level.

Operator

The next question is from the line of Neil Tyler.

Neil Tyler

Might as well start with a follow-up question to the previous one, on the IBM agreement. Just so we’re clear, I understand you say that there’s not going to be any meaningful incremental investment. But the recent digital effort has led to a step-up in operating costs that you’ve been quite clear about. Given that you’re accelerating those efforts, can we just sort of close that debate and could you tell us whether there will be any further step-up in operating costs related to the additional efforts you’ll be investing in digital from this point? That’s the first question, please.

Terje Knutsen

Yes. So I think we said last quarter that we have, in a way reach now a level which we think will be our level. We might have marginal adjustments to that, but we are in the magnitude of $40 million to $50 million spent per year. The focus we have right now is to commercialize the solutions that already are being launched, and partly scale up that commercialization, partly experiment a bit with different models.

We are, for instance, now on subscription models with our new YaraIrix, which is a small device that you can click onto a smartphone where you can measure the nitrogen, needed nitrogen level for a crop, let’s say a low-cost model of our N-Sensor and N-Tester. And these are different tools that we now focus on commercializing. There are a slight shift from development costs to let’s say commercialization capacity in our digital area, but nothing significant. We think we can develop and grow the income side of the digital based on the cost or investment level that we have presently in simply human capital.

Neil Tyler

Second question is on the unplanned outages that took place in the period. Since the inception of your improvement program and capacity expansions, there’s been a higher incidence of these sorts of outages as you’ve tried to bring the expanded facilities back on-stream, for example. How do you think that’s just coincidence, or how can we feel comfortable that actually the sort of underlying operating rate is not going to remain hampered for the next year or two as that process continues? That’s the next question, please.

Lars Rosaeg

So you are correct that in the quarter, as such we have an impact on these three outages of a significant amount while at the same time the remaining plants show an improvement. And it is important to note that we still have an improvement to date, of the improvement program of $320 million of sustained improvement. So to us it is no doubt that this is the right track that it is showing underlying improvements, and we remain fully committed to the target of $500 million by the end of 2020.

And in addition to that, we have signaled that at our capital markets day we will come with new and even more ambitious targets for the programs. So while we will, or have had these kinds of outages related to turnarounds in the quarter, from time to time we’ll have outages in plants, maybe be underlying improvement trends. To us it’s very clear.

Neil Tyler

Thank you. And the last question, I suppose on a similar topic, the growth investments. You no longer disclose the anticipated EBITDA contribution and your CEO on the webcast this morning suggested that would be partly because the calculation is slightly arbitrary. But what I suppose isn’t arbitrary, is the volume contribution from those investments so far, and more importantly, the return on capital on those growth investments at current prices. Can you give us an idea of what you anticipate that to be once all of those investments are brought on scene at current prices?

Lars Rosaeg

Yes, you are exactly correct that we commented also a bit on this, this morning. And entering a new year, now we plan to launch an updated, longer-term earnings improvement ambition and an updated tracking methodology at the capital markets day on 26th of June, highlighting for example that the current tracking is based on 2015 margins. And I think if you for example look at 2015 margins for ammonia, those were at a much higher level in 2015 than what they are today, impacting for example then, Freeport.

And we then want to make sure that the new methodology in reporting is more relevant in addition to current earnings and market conditions. So for that reason we don’t really believe it’s feasible nor meaningful to provide earnings guidance while that goal objective work is ongoing and we’re actually only a few weeks away from that. And since there are significant disconnects between previous methodology and current earning and market conditions. But what we have said is that we were able to put Freeport and Koping on-stream at the start of the second quarter while we had some delays on some of the others. And we said that in total, we believe that that has a slight negative impact in isolation on 2019-2020.

Neil Tyler

So just to finish it off, on Freeport and Koping investments, at current prices are the earnings from those two expansions clearing the return threshold that you set yourself?

Lars Rosaeg

These are indeed in its ramp-up phase now, and in its early days of the profile. But there is absolutely nothing about the fundamentals of those business cases where we have changed our view on that.

Operator

[Operator Instructions] The next question is from the line of Andrew Stott.

Andrew Stott

A couple really trying to pursue the slide that you put in on the commodity versus premium volumes. You earmark Brazil as an area that you’ve deliberately chosen to retreat from, and I’m just wondering if you could walk through why that is? Is it purely the freight rate, and so the net backs? Or are there other issues about Brazil versus other export markets? That’s the first question on the commodity volumes. I’m sorry, actually, related to that, when do you actually think this will all level out? When do you think you’ve sort of taken the pain you want to take, if that’s the right way of verbalizing it? And then the second question was more market-related. I see that China in general is exporting quite aggressively again. I saw a number about February volumes out of China being six-fold year-on-year. What do you think is behind that? Thank you.

Terje Knutsen

First of all, I think we are clearly not retreating commodities from Brazil. We still have a very significant share of our volume in Brazil being what you could call commodity products, being at least 75% of what we sell in Brazil. So what we do is to look at the marginal tons that we are doing and whether it makes sense or not to let’s say, at any point in time, commercialize the volume that we have done historically. And right now we have seen that there are pressure on commodity margins. These are third-party products that we sell in Brazil and we are by design, I would use the word, even marginally reducing sales of blended products. Because in the total picture we are not here talking about big changes. But these are significant changes we are doing, primarily in a combination of not satisfactory margin but also being now very disciplined when it comes to capital and therefore trying to optimize our working capital and spend that capital on products that will give us a better margin.

We have mentioned Brazil explicitly in the presentation earlier today. I could also mention other Latin American markets where we have similar development. But if we are turning into a situation where we do not see an interesting return on that working capital, we from time to time choose to [flex out], so to say, those volumes. Fundamentally I think it is clear that we are shifting gradually more to premium products and also more value growth versus maybe pure product growth, but there is no doubt that also Yara needs scale and some of that scale comes through commodity products. So it’s not a question of stepping out of commodities, but gradually trying to upgrade volume to volume that gives us a better return.

Thor Giæver

I just wanted for anyone listening, because Terje mentioned it briefly, that the commodity part in Brazil is third-party product-based primarily, and that’s an important difference from a lot of the rest of our business. But this is not about, you know, a big chemical production machinery that we need to keep utilized. The commodity part of our sales in Brazil is, a lot of it is based on third-party imported product. And that means that we have a very different and much higher flexibility to, as Terje has just described where we compete and at what margins.

Andrew Stott

So in other words the vast majority of that lower volume in your commodity side is actually of distribution margins, not of production margin?

Thor Giæver

Yes, very correct.

Andrew Stott

Okay.

Thor Giæver

Your second part of the question was China?

Andrew Stott

China exports, yes.

Terje Knutsen

Yes. As we write in our report and we try to highlight in November, February period, in the report because then China exported 2.1 million tons. That’s quite a lot in a 4-month period. Now, we also have the March numbers which came in at 330,000 tons compared to 100,000 tons March the previous year, so 2.4 million tons in five months. And as you say it’s a pickup, a significant pickup. And I think it’s important to note that this is a demand call, not an export push from China. This is because urea prices spiked during September, October, and into November last year so that the world was actually calling on China to export urea which they then responded to because the prices went sharply up and above the Chinese domestic prices.

And so then China started to export, and they exported both, let’s say to spot buyers. But they also offered a lot of volumes into tenders in India, Bangladesh, elsewhere that had quite long lead times when it comes to the shipments. So that price spike that will serve the period led to extensive exports for many months. But you could say, does that cover all the way through March and probably not. There are other problems on delays in the reporting and during customs shipments we have probably taken place before that could be payment timing and so on as well. But I think the bottom line is that China exported 2.4 million tons in 5 months, I mean, the same as them. You’ll figure for 2018 because the prices went up to a level where that made sense for them compared to the domestic markets. It’s actually good news. I hope we get back to that good position again, that the world outside China needs Chinese urea to cover the total demand. So that’s positive, it’s not a negative.

Operator

[Operator Instructions] It’s a follow-up question from Andrew Stott.

Andrew Stott

Just to do one more. Did you give the number for the effect of the three shutdowns in Q1 on volume? I know you gave this 55 million number and we need to adjust for that for current pricing, I get that. But did you give a percentage effect for volume?

Thor Giæver

Andrew, if I’ve got you rightly, you’re asking the production issues that we had, whether we quantified that in those terms. And I think I can maybe start the answer there, because what we quantified is the impact on the improvement program, the way we measure it, which assumes two things. One is that prices and margins are at 2015 levels, and the other is that production equals sales. In other words, if you lose production, you lose sales. The reality is rather different, firstly because we are in 2019 and not 2015, and I would venture to say that probably for the ammonia shutdown in Pilbara, lost production equals lost sales and we quantified that to roughly a $10 million effect. The other two finished products in Europe, I think it’s an open question whether we lost any sales due to lower production. And maybe at that point I can hand over to Terje.

Terje Knutsen

I think for Q1 it’s not the right to say that we have lost sales from those…

Andrew Stott

So you were able to sell from inventory is what you’re saying?

Terje Knutsen

Yes.

Operator

There are no further questions at this time.

Lars Rosaeg

If there are no further questions, we should just thank everyone for participating and then for your continued interest in Yara. Thank you very much.

Operator

Thank you very much, and that does conclude our conference for today. Thank you for participating. You may all disconnect.