CF Industries, Inc.

CF

 

Please see disclaimer at bottom of this document

 

 

 

November 10, 2005           CC Notes based on conference with CF

 

1.                  Any guesstimates on 2006 minority interest?   CF claims the inability to disclose.  CF claims that guidance here is not possible because of the commodity price constant changes (fertilizer and NG).

 

2.                  What would prevent large customers from buying finished fertilizer directly from lower cost imported companies, just like you do? CF claimed that nothing could stop this.

 

3.                  Do you buy finished goods, or are you processing?  Are you just a distributor for those imported purchases?  CF claims to be finished goods distributor only. This is when purchased rather than manufactured.  I think that Agrilliance is part of LOL, and they have imported fertilizer.  I need to model some how the performance in a recessionary market.  My guess is losses, and recessions are seasonal, hence figure out 4 or 5 years of sub par margins and periods of business distress.

 

4.                  If farmers put greater emphasis on wheat and soy and beans, how would that affect CF?  Wheat and beans use phosphate.  CF claimed that phosphate does not have to be put on as regularly as nitrogen products.  Corn was the only application that CF was familiar with as a nitrogen reliant crop.  I need to check that, that seems odd, yet I would guess that it is an accurate observation.  I have been wondering if wheat and soy could be replaced as necessary type production, as opposed to a variety, just thinking nutritionally.  Would it be logical to do such?  Can corn be substituted as a staple?  Nutritional benefits of either?  What has corn intake % been for the world, and what changes have occurred in last decade?  Any paradigm shifts expected?   Website that might track this?  One non-authoritative person responded with this answer, “Soy beans. It is one crop. Beans are a legume and can transfer nitrogen from the atmosphere into the soil for their own consumption. So they need only a little N fertilizer as a starter. Wheat consumes much less N than corn (because it doesn't yield 200 bushels per acre.) Given the high price of N fertilizers and the low price of corn, farmers are expected to shift acres away from corn to other crops. It will not be a wholesale shift. The best corn ground will likely remain in corn. But I think it is fair to say everybody in the fertz business expects demand to be reduced in 2006.U.S. farmers are already getting over half of their N fertilizer from lower cost off shore producers. CF and Terra and Koch are still making N fertilizers only because prices for these commodities are at all time highs. That is unlikely to last. The U.S. will import its total nitrogen requirement; not next month, but unless natural gas values crash, within the next few years.  The only paradigm in corn is that congress has mandated a minimum ethanol content in gasoline. That may marginally reduce corn exports.”

 

5.                  How can one model financially, if you haven’t at all guided to what gross margins could possibly be from a hi/lo standpoint?  I mentioned how I would be totally cool with CF stating, “we expect, but do not promise, gross margins of somewhere between 5% - 20% for F2006.  These expectations are based on production levels at 50% for the first 6 months and XX% for the last 6 months of fiscal 2006.”  I think this is answered in item 6 below, but will still bounce it by CF during our discussion.  Ultimately, we had a lengthy discussion.  The answer is that CF claims they do not have the ability to guess at gross profits.  As I type this, I just can’t understand such.  Here are the last 4 years of gross margins.  One needs to understand that prior to 2002, CF was not operating under a maximized profit incentive environment.  CF mentioned to me “it was real bad in 2000 – 2002.”  CF says, “Conditions have changed.”  I guess in theory I need to model in a range of potentials, using realistic high / low possibilities.  I outlined 7% gross margins, and that seems like it might be optimistic.  Keep in mind that it is my understanding that certain sell sides are projecting 10% margins going forward.

 

 

 

Gross Margins Historically

 

 

 

 

 

6.                  Any expected growth rate or contraction of revenues you would guide for?  Hi – Low of revenue expectations for F2006?    CF responded as follows, “One point in advance.  I understand your concern about guidance, but we have made it clear from Day One of the IPO process that, given the extreme volatility of this industry, we were not going to give earnings guidance.  There is no guidance in the Prospectus, and there was no guidance on the road show.  I know many companies do provide it, but we have been forthright from Day One in indicating that we were not going to.  We'll provide info on our FPP tons, and we have provided a great deal of information on our cost structure in one-on-one briefings.

 

But frustrating though it may be to you -- and to us, to some extent -- we have decided that we did not wish to stumble in our first days as a public company by issuing guidance that ended up discredited.

 

And if we had issued even the broadest guidance on the road show, it would have been based on $7 natural gas, and with natural gas accounting for 90 percent of our nitrogen costs, we would have been terribly out of line when the hurricanes pushed gas prices to almost double that level.”

 

 

7.                  This part was confusing for me.   Upon discussion with CF, it was mentioned, “the fall looks similar to last year in total tons.”   According to CF, what is not so clear is the spring 2006 FPP program.  I thought during the conversation, CF mentioned that they were hoping for a strong spring.  CF said that farmers were waiting to make their decision on fertilizing.  CF mentioned that there is an application in the fall or spring, rarely if ever, both.  CF explained that this is fertilizer season.  CF witnessed on casual weekend of Wisconsin applications.

8.                  CF discusses the benefits of corn with ethanol.  I asked if “soy diesel” had anything to do with Soy (which is not nitrogen needy).  CF was not sure.

 

9.                  I sensed that there will be an option vote coming in 2006.  I don’t know how that will affect dilution.  I received confirmation that the insider buying that occurred this week, were all open market, independent of CF purchases.

 

10.              No fix on SG&A per CF.

 

11.              CF suggested treating the $14M in hedging income in 3Q05 to be unusual.  This will not be recurring.  They closed a hedge based on forward purchasing requirements.  I took this as greater importing and distributing to their customers.  CF claimed that the CF infrastructure was not a great benefit for their customers.  This needs to be verified.

 

12.              I need to look at Terra Industries, Inc., as CF considers them the most appropriate comparable competitor.  Wait a minute, as I write this, I seem to remember that they are perhaps CF’s Trinidad  partner.

 

CC Initial Notes

 

13.              4Q05 volume expected to be similar to 4Q04.

 

14.              Worldwide supply and demand remains tight.

 

15.              Natural gas still at troubling levels.

 

16.              There is a corn inventory overhang and low pricing.

 

17.              Ethanol driven demand is up to 15% of total corn crop, also up 3 fold from several years ago.

 

18.              Russian Urea unknown.

 

19.              Crop rotation from corn to beans is a concern.

 

20.              4^th quarter production should be at ½ of capacity.

 

21.              Phosphate is at capacity.

 

 

 

November 2, 2005          Questions still pending  

 

1.                  What percentage of CFL revenues are to other than CF and related owners? CF responded that all CFL revenues are from one of the two owners.  Are CFL revenues from related companies and former coops eliminated in financials?  CF claims yes.  CF claims these are eliminated.  I did not leave the conversation feeling warm and fuzzy about CF and CFL revenue and cost recognition reportings.  CF told me to think of CFL as just another plant.  My concerns were mentioned to CF as being if CF buys from CFL, then does the revenue show up on CF’s books.  CF did not seem clear and concise with their answer.  That is merely an observation on my part, and in no way is the above any type of accusation or claim of impropriety. I asked if this was an item that is looked at by audit team, and was assured it was.  I was assured that revenues are being eliminated in the consolidation.  I need to keep my eye on this in the future, only because I have some type of internal discomfort on this (right side of my brain). 

 

CFL Revenue Structure is the same as their ownership structure

 

 

 

 

2.                  You mentioned that you buy a forward contract on NYMEX the same day that you enter into a FPP contract.  Do you have internal controls in place to make sure that actually occurs?  CF responded by saying this, “there is a formal, multi-stage sign-off process, including officer-level approvals, to assure that every FPP order is matched to either a natural gas futures purchase, product in inventory, or a purchased finished product.  Any daily discrepancy is automatically routed to CFO.”

 

3.                  You were going to find out if land was marked to market at IPO, or if there might be hidden value there. Per CF, on a secondary offering balance sheet is brought over at cost.  CF would not comment on the land value.  CF claimed that any alternate use has not been considered, and that any such value is not material to the valuation of CF.

 

4.                  We discussed CFL and you were going to get back to me on US Dollar and Canadian Dollar potential impacts.  What happens when USD is Strong?  What happens when CND is strong?  CF claimed that it adds a level of diversification.  I need to further discuss with CF and get clarification here.

 

5.                  Are Gross Margins in Canada and US expected to be different?  CF explained that lower costs in Canada, hence better margins.  I did not get a warm and fuzzy feeling on that item either.

 

6.                  Please explain post IPO tax rate.  What is effective rate supposed to be?

 

What are expected breakeven revenues?  CF responded as follows, “More complex issue is that of breakeven revenues.  This is along the lines of the gas question we answered on the call.  I think we discussed the fact that there are so many moving parts in this business.  Our labor and other fixed costs are a relatively small part of the cost of goods sold.  Natural gas in recent weeks has accounted for nearly 90 percent of the cost of our products on the nitrogen side of the equation.

 

During the quarter, prices for gas have ranged from the $7 to the $14 range, according to published reports.  Similarly, fertilizer prices have varied greatly, on the spot market.

 

As Steve noted, this is a business where you produce a volatile commodity (fertilizer) using a volatile commodity (natural gas).

 

This is not, for example, like steel or autos, where you know that, once production or sales exceed a certain level, you will be profitable.

 

The breakeven point at $7 gas is one thing, $8 gas another.  As Steve said on the road show, we have made money at $6 gas (because of high fertilizer prices in relation) and lost money at $3 gas (because of low fertilizer prices.)

 

Long-winded way of saying that there is no breakeven sales point.

 

The volatility of the cost of sales and revenues sides of the equation make this an industry where that sort of analysis just does not work.”

 

7.                  Please guide me to text, or review with me the asset retirement program.

 

Please verify that Wilson and other insiders do not own portions of former Coop owners.  CF response was, “None of the company's officers are owners of our former co-op owners.

 

Broadening the group to insiders, keep in mind those three directors are/were executives of those former owners.  The organizations they represented are all co-ops, so the only way they could have an equity stake in those co-ops would be by being a farmer who joined that co-op.  In that case, their ownership stake -- taken to secure co-op benefits as a farmer -- would be so tiny as to be immaterial.

 

I believe that at least one of the co-ops, Land O'Lakes, does have public debt outstanding.  I do not know if Mr. Gherty owns a share of that debt.  I would suggest that you would need to examine LoL's filings to determine that.”

 

8.                  Has Refco had any effect on CF? Per CF, no connection whatsoever.

 

9.                 In prospectus you mentioned the following, “Note payable of $4M is to CFL (a minority interest holder).  Due 12/31/09 (they say CFL can prepay, I wonder if they mean, “CF can prepay?” CF was rushed, we chose not to discuss and was told it was immaterial

 

October 26, 2005          more notes and conference with IR 

 

1.                  Thinks LNG will grow in the USA, and that will give access to lower cost Natural Gas.

 

2.                  Trinidad decision will be made towards end of year.

 

3.                  Looking of converting feedstock in Donaldson to alternative fuel.  Petroleum Coke would be produced.  This would be costly and capital intensive. Speculatively, someone else could build the plant.  Half of Donaldson could be converted to this. This would be used by CF and replace NG component.

 

4.                  No guidance so far.

 

5.                  CFL is used by CF for Northern Tier of Corn Belt.  Westco sells it share of the product to Western Canadian Markets. 

 

6.                  FPP walk through….CF sales department looks at all parameters, then they give a memo on how much they will sell for, and based on a specific margin.  Customer needs to accept price on next day.  CF then buys forward on NYMEX the same day futures contracts and margin is locked in.  If CF tried to outsmart the gas market, they could theoretically get hurt.  An aggressive policy could hurt business. Typical FPP is 2 to 4 months.  Some go as far out as far as 15 months.  None go beyond that.

 

7.                  Former owners have a “sticky” relationship.  CF built infrastructure around the former owners sites.    All owners signed agreements for 3 – 5 years of purchase commitments at market rates.

 

8.                  Existing headquarters building in Illinois.  The possibility of selling that and moving to less costly space is an option.  This was called “million dollar properties.”  I asked if there is any hidden value in this land?  Was it marked up at IPO?  60 – 70 acres at headquarters, Long Grove.  Considered to be residential potential.

 

9.                  Soy and Wheat are not nitrogen sensitive.  Corn is nitrogen sensitive.  Corn was mentioned as being an alternative energy source.  The energy source is Ethanol.

 

10.              Steve Wilson drives a modest car, likes sports, non-smoker and collects wine.  It is my understanding that he is health conscious and works out.  Joined the company in 1991.

 

11.              Ernie Thomas, likes fast cars, drives a bit of a nicer car than Steve, but doesn’t seem extravagant, not as fitness minded as Steve and is a non-smoker.

 

12.              Expected tax rate is 39%.

 

13.              I asked if credit line was expected to be tapped.  Not expected to be tapped unless Trinidad plant goes online.  They would need $50M to $70M the entire project is expected to be $500M to $700M, with 3 partners (mentioned below).   The extra money would be gathered via letters of credit, all non-recourse.

 

14.              I asked about capex plans.  I noticed that capex was high from 95-99. I asked about plant conditions.  It was mentioned to me that 95-99 was a major phosphate expansion.  Capex is not expected to rise.  Plant conditions are fine, no major upgrades or unusual repairs needed or expected.

 

15.              Mentioned, “Normal ebitda is $190M, +/- $100M.

 

 

October 25, 2005 

 

Some theoretical modeling is below.  This is a back of the envelope analysis.  I used fairly conservative numbers for the “high” side, and I think (hope) I used aggressively pessimistic numbers for the “lo” side.