Nutrien Ltd

TSX:NTR

Earnings Call Transcript 2018-Q3

[Operator]

Greetings, and welcome to the Nutrien's Third Quarter 2018 Earnings Call. [Operator Instructions] And as a reminder, this conference is being recorded. I'd now like to turn the conference over to Richard Downey, VP of Investor and Corporate Relations.

[Richard Downey, Vice President of Investor & Corporate Relations]

Thank you, operator. Good morning, everyone. And welcome to Nutrien's Conference Call to discuss our third quarter results and outlook. On the phone with us today is Mr. Chuck Magro, President and CEO of Nutrien, and other Heads of the executive leadership team. As we conduct this conference call, various statements we make about future expectations, plans and prospects contain forward-looking information. Certain material assumptions were applied in making these conclusions and forecasts, therefore actual results could differ materially from those contained in our forward-looking information.Additional information about these factors and assumptions are contained in our current quarterly report to our shareholders as well as our most recent annual report, MD&A and annual information form filed with Canadian and U.S. security commissions to which we direct you.I will now turn the call over to Mr. Chuck Magro.

[Charles Victor Magro, President, CEO & Director]

Thanks, Richard. Good morning, everyone, and welcome to Nutrien's third quarter earnings call. Before I discuss our results this quarter and the outlook for the remainder of 2018, I'd like to make a couple of comments on the progress we have made on our strategic priorities and how we are positioning the company to enhance shareholder value going forward.First is the progress we've made on synergies. At the onset of the merger, we targeted $500 million annual run rate synergies within a 2-year period and we now expect to achieve that goal in the first 12 months. Furthermore, we have increased our total synergy target by 20% to $600 million by the end of 2019. I have been very impressed with how our teams have rolled up their sleeves to accelerate the pace of synergy capture. You can see the value it is creating by lowering production costs for potash and nitrogen, increasing volumes through our integrated platform and reducing sustaining capital spend.The second strategic priority is the sale of our equity stakes. In October, we closed on the sale of our APC investment for proceeds of approximately $500 million. And expect to complete the sale of our SQM A shares to Tianqi by the end of the year. We anticipate net proceeds from all equity stakes of around $5 billion, which will provide tremendous opportunity to deploy the cash to generate additional shareholder value.And finally, we moved aggressively to complete our 5% share buyback, repurchasing a total of 32 million shares since late February at a weighted average price of $51.62 per share. Combined with our dividend payout, we will return over $2.6 billion to shareholders in 2018 alone.With that overview, I will now turn to our results for the quarter. Retail performed well again this quarter with EBITDA up 10% from the same period last year. Despite challenges from low pest pressure this season and low crop prices. This illustrated the strength of our business model and benefits of our geographic and product diversity. Ideal growing conditions and rapid crop progress contributed to higher fertilizer demand than normal for the third quarter but limited crop production sales. The lower demand for crop protection products was also due to grower caution related to trade tariffs.The third quarter is not a significant quarter for seed sales. And a dip in gross profit was primarily due to timing of vendor programs. This quarter's potash and nitrogen performance was exceptional and demonstrated our significant leverage to improving market fundamentals. Potash adjusted EBITDA was 64% higher than the third quarter of last year, as we benefited from higher prices, record volumes and much lower costs. Sales volumes were almost 4 million tonnes this quarter, which was an all-time record as we were able to capture incremental sales in a tight global market.Price increases were most pronounced in offshore markets with our average realized price increasing 25% compared to the third quarter of 2017. This reflects a significant increase in spot market prices and the settlement of new contracts with India and China at higher prices.Also our potash cash cost of product manufactured declined by 22% to $56 per tonne in the quarter. A result of higher production volumes, merger synergies and a greater proportion of supply from our lowest cost mines. We surpassed our previous third quarter production record by nearly 600,000 tonnes, including increased production from Rocanville, which had cash cost of $40 per tonne in the quarter. This places us among the best and lowest-cost producers in the world.Following a strategic review of our potash portfolio. We decided to permanently close our New Brunswick potash facility and took a $1.8 billion noncash impairment in the third quarter. The decision to invest in the operation was approved back in 2007 and the facility has been in care and maintenance mode for almost 3 years now. We remain positive on the long-term fundamentals for potash and can increase production in Saskatchewan at a significantly lower cost than resuming production in New Brunswick.Nitrogen EBITDA more than doubled in the third quarter as we benefited from higher prices, increased sales volumes, merger synergies as well as low-cost gas in North America. The gas price spread between North America and major nitrogen-producing regions such as Europe and Asia has widened, providing a significant margin advantage for our well-positioned assets. We also reduced our urea controllable cash cost to product manufactured in the quarter by 16% compared to last year. Our nitrogen plants have operated very well in 2018 with utilization rates of 93%, up 7% from last year.We also recently signed a new gas contract in Trinidad where operating rates have been higher year-over-year. Phosphate and sulfate EBITDA increased to $88 million this quarter, driven by higher realized prices, in particular for fertilizer products. Our phosphate team remains focused on minimizing cost and optimizing our product mix. This includes expanding production of our U.S. phosphate sites and completing the transition of our Redwater facility to ammonium sulfate, which is expected to be completed in the third quarter of 2019. With strong results across all business units, Nutrien's adjusted net earnings for the quarter was $0.47 per share. Adjusted EBITDA totaled $839 million in the quarter, up nearly 80% from the comparable period in 2017.Now turning to the outlook. We are nearing completion of another strong harvest in North America. Record yields removed significant crop nutrients from the soil that will need to be replenished. While the higher yield in trade tariffs have impacted crop prices, in particular for soybeans, the underlying market fundamentals remain supportive. Global grain stocks are projected to tighten during the 2018-'19 crop year, especially for corn. Lower corn stocks along with higher cash margins relative to soybeans will support a significant increase in corn acreage both in North and South America in 2019. As a result, we expect a strong fall application season in North America, despite weather challenges experienced earlier this fall.Turning to the potash markets. We increased the low end of our 2018 global shipment guidance and now expect demand in the range of 66 to 67 million tonnes. Canpotex is positioned for a record year and is fully committed to January 2019. Prices in all major spot markets continue to firm, and the settlement of contracts with China and India at $60 and $50 per tonne increases will support offshore netbacks.We anticipate healthy demand in the domestic market and recently announced a $25 per short tonne price increase. Importantly, we continue to see strong underlying consumption trends in limited distributor inventory that should support solid customer engagement well into 2019. We have responded to this market opportunity and increased potash sales volumes by 1 million tonnes in 2018. We also have at least 5 million tonnes of incremental operational capacity in Saskatchewan that we can bring online as global demand grows and have the capability to add further brownfield expansions in Saskatchewan that are much lower cost than greenfield expansions. The nitrogen markets improve faster than many predicted, and we see positive fundamentals for the remainder of 2018 and into 2019. We expect favorable demand conditions, limited new supply next year and anticipate relatively stable Chinese urea exports going forward. And importantly, for our nitrogen margins we expect the North American natural gas advantage to remain very wide relative to other key producing regions globally. Based on these market conditions, our 2018 annual earnings guidance is now $2.60 to $2.80 per share, and the midpoint of our adjusted EBITDA guidance increased to almost $4 billion. The midpoint of our EBITDA range represents a more than 35% increase over 2017 combined adjusted EBITDA, which demonstrates the strength of Nutrien's integrated business, the realization of merger synergies and our leverage to improving market conditions.Nutrien has made significant progress on its strategic priorities and delivered strong financial performance over the first 3 quarters. Looking ahead, we expect to generate stable and growing free cash flow and have a balance sheet that is second to none in our industry. We expect to generate between $6 billion and $8 billion in cash over the next 3 years. That will be allocated to growing the business and returning cash to shareholders.In terms of growth, we remain focused on expanding our retail footprint in North America and Australia and have very strong pipeline of acquisition opportunities. So far this year we have acquired 50 locations with expected EBITDA close to$30 million. And we will close more before the year ends.We continue to actively evaluate opportunities in Brazil and expect to develop a strong footprint in this growing agriculture market over the next 3 to 5 years. We are also evaluating opportunities to grow our Loveland product business which provides significant margin enhancement across our retail portfolio and value to our customers.In the third quarter we launched our retail digital platform and have already signed up customers representing an estimated 30% of our North American retail revenue base. Combining this digital capability with our industry-leading distribution system, local agronomist network and proprietary products offering will provide a significant competitive advantage in delivering value to growers. And we expect it to deliver significant value to Nutrien by improving customer retention, share of total spend while generating operational efficiencies across our network.Furthermore, yesterday we announced a 7.5% increase to our dividend, taking our annual dividend to $1.72 per share. This increase reflects our confidence in our improving operational cash flow, continuous growth in retail earnings and greater synergy expectations. Our objective is to provide a steady and growing dividend that is closely tied to growth in retail earnings and have targeted a range of 40% to 60% of free cash flow after sustaining capital through the cycle.Finally, I would like to acknowledge the retirement of Wayne Brownlee at the end of October. Many of you knew Wayne during his many years as CFO. Wayne made significant contributions toward the creation and financial strength of Nutrien and we would like to thank him for his leadership and wish him well in his retirement.We are making good progress on selecting a new CFO, and expect to make an announcement by the end of the year. I have our Interim CFO, [ Fred Tune ], on the call with us today to help answer any financial questions. Fred has held senior financial roles at Nutrien and predecessor companies for the past 14 years.This is an exciting time for Nutrien. We have accomplished a lot in the first 9 months and look forward to delivering on the significant opportunities that lie ahead. Thanks for listening. And we would now be happy to take your questions.

[Operator]

[Operator Instructions] Our first question comes from the line of Ben Isaacson with Scotiabank.

[Oliver S. Rowe, Associate]

It's Oliver Rowe on for Ben. What gas and urea price environment do you need to see in the North American nitrogen market in order to invest in building new capacity? And I guess, what do you think the incentive price is in North America for greenfields in general?

[Charles Victor Magro, President, CEO & Director]

Yes, good morning, Oliver. Look, we've been doing a lot of thinking about our nitrogen business. And you can see that we've got lower cost, higher sales volumes through the network. And we're really focused right now primarily on driving through the rest of the synergy capture. But when we look at North America and the strong fundamentals that we're seeing around the world when it comes to nitrogen, we think we're still a long ways away when it comes to prices that are needed to justify Greenfield economics. And look, when we think about greenfields, it's not just about our market price that's needed, it's also about risk management. Specifically when you look at North America, right now in North America getting a lump sum turnkey type project to build a greenfield project is almost impossible. And so when we look at the risk versus return and even when we have a quite a bullish view of long-term pricing when it comes to nitrogen, it would not warrant in our opinion greenfield economics. We're nowhere near that. Now when it comes to brownfields. Certainly brownfields could make sense. Nutrien is looking at several brownfields through our network, primarily in North America. But it's a little too early for us to talk specifically about that. Most of the brownfields we're looking at actually will drive either cost efficiencies or product mix optimization. And I think there is going to be a lot of value that we can generate simply by looking at our network. We will most likely have some brownfield expansions. But right now we're primarily focused on delivering our synergies.

[Operator]

And our next question is coming from the line of Jacob Bout with CIBC.

[Jacob Jonathan Bout]

So clearly potash market is are very tight. I think I read that Canpotex is sold out to the start of 2019. Can you talk a bit about what you’re looking for 2019 given the ramp of capacity, greenfield capacity by competitors. And maybe talk a bit about what's driving the strong potash demand in North America.

[Charles Victor Magro, President, CEO & Director]

Sure, good questions, Jacob. I'll have Jason Newton, our Head of Market Research, give you a kind of a view of how we see the fundamentals and then I'll provide some higher level overlay. Go ahead, Jason.

[Jason Newton, Director of Market Research]

Hey, good morning, Jacob. Yes, as we look out into 2019, as you mentioned, most producers are relatively heavily sold into early 2019. And as we look at the year,we think that I mean given where South American soybean planting is today we expect to see a significant increase in second crop corn as well. And so we expect demand in South America to remain strong. We also expect that given, I guess just to touch on the second part of your question, given the record yields that we've seen in North America we expect to see very strong North American demand. And with the way harvest has come off over the past couple of weeks, I think the fall application season looks good. And how that progresses will drive demand in the North American market in the first half of next year. I guess overall when you look at the supply-demand balance and the capacity ramp-ups that we expect to see in 2019, we expect a relatively balanced supply demand balance of past utilization rate in 2019 to what we saw this year. And we know and we continue to see that the supply, I mean even if projects ramp up that the supply coming to market tends to be lower than what the capacity ramp-ups are. And we've seen that this year, and we expect that to continue again next year. And we also have closures coming into the market again next year. So we know that there's a German mine shutting down at the end of the next year, that will take some capacity offline. So overall, we expect to see a relatively stable capacity utilization rate in 2019, but expect the tight supply-demand balance that we're seeing today to persist at least through the first half next year.

[Charles Victor Magro, President, CEO & Director]

Yes, Jacob, just looking a little further ahead then. So look, we've had a strong year. And it's a function of supply demand, solid demand fundamentals over the last several years. So demand has been growing. Even this year where we've seen what I would call normalized potash demand globally the market is very, very tight. We expect that that tightness will continue in the next year or 2. And then once the new supply comes online from Canada and from Russia, we expect then that there would be quite a pricing momentum beyond that. So when we start thinking about 2021, 2022, so a little bit more mid-term, we see very tight supply-demand fundamentals. And we see that we would almost start to be entering peak-type conditions where we have a strong and sustainable cycle because after the new capacity that's been well-documented and discussed, there's nothing behind it to speak of. So once we get out to 2021, 2022, we think that this could have quite a sustained recovery.

[Operator]

And our next question is coming from the line of Don Carson with Susquehanna.

[Unknown Analyst]

Hi, this is Jake, on for Don. On the retail side has Nutrien been named as a defendant in any of the glyphosate suite given your leading distribution position there? Or are plaintiffs just going after the manufacturers?

[Charles Victor Magro, President, CEO & Director]

No, we have not.

[Operator]

And our next question is coming from the line of Andrew Wong with RBC.

[Andrew D. Wong, Associate Analyst]

So just regarding the SQM sale, do you anticipate any more hurdles that could potentially come up or is that deal now pretty much in the clear? And then just following the deal, what do you plan to do with the cash?

[Charles Victor Magro, President, CEO & Director]

Yes, good morning, Andrew. So we have now -- if you step back and you look at what we have to accomplish beginning of the year, so we've now completed all the transactions except for the SQM A shares. Specific to that deal with Tianqi, we have all the necessary approvals that we need. So as we've communicated this morning and we've -- I think we've been pretty consistent in our communication, we do expect that we will now complete that transaction and close the deal by the end of the year. Once that deal is closed, we do expect that we will have approximately $5 billion of net proceeds after tax. And that's really the focus. So the use for capital then when you start thinking about that as a -- from a capital allocation perspective, if you use that number as a starting point of $5 billion after-tax plus the organization, the company itself is generating very substantial free cash flow. Even after you remove sustaining capital and the dividend, we do expect that we will have somewhere between $6 billion and $8 billion after the dividend, after sustaining capital to allocate in the next 3 years. So our priorities for growth really haven't changed. We think where we are right now in the cycle there's a huge strategic opportunity to continue to grow our retail business and that's what we plan to do. We plan to continue to look for consolidation opportunities in North America, we are looking aggressively at Brazil. And we've been quite patient in Brazil but we think there's a real opportunity to replicate our retail model in Brazil as well as backward integrating into our Loveland products portfolio which that business has been just operating so superbly and we see more opportunities there. Beyond that though, we also think that there will be an opportunity to return more capital to shareholders. But until we actually have completed and closed all the transactions it's a little too early to get more specific than that.

[Operator]

And our next question is coming from the line of Mark Connelly was Stephens.

[K. Tong, Research Associate]

It's actually Joan Tong for Mark Connelly. Sticking with Brazil, I'm just wondering like with the shift in politics change, just wondering if your view on Brazil in terms of relative attractiveness in expanding to that market, has it changed? Like as compared to like maybe other geographic regions. And how is the hurdle rate that you applied potential for your investment different what you used in weighing the U.S. and Canadian investment?

[Charles Victor Magro, President, CEO & Director]

Thank you very much for the question. So to answer it directly, we -- it really hasn't changed, our view of Brazil is one of being a long-term investor. We see the agricultural market in Brazil as having very significant opportunities long term. I think there's going to be more agricultural land put into production. We think that our products and services, our technology, our digital capability can add significant yields to Brazilian farmers. And I think we can also make some money doing it. So when I look at Brazil, the new government we consider to be pro-business, we consider that government to be pro-agriculture. So if anything, it's another step forward in terms of being more positive. And when we look at the hurdle rates specifically, obviously the hurdle rates in Brazil will need to be higher than in North America when we look at investing capital because the risk profile is different. But I do want to make sure that I just communicate really clearly. The first series of acquisitions probably will not meet those hurdle rates because there's no synergies. So longer term we will absolutely get there. We firmly believe that Brazil over the long term will become a very, very significant part of our retail portfolio. We actually think that it could become the second largest part of our retail portfolio over many years. And we will deliver the hurdle rates that Brazil needs. But the first several acquisitions, I just want to make sure that we're clear, will most likely have less of a return because there won't be synergies.

[Operator]

Our next question is coming from line of Chris Parkinson with Credit Suisse.

[Graeme Marc Welds, Research Associate]

This is Graeme Welds on for Chris. I just had a question about the breakdown of retail results. And obviously there was some pressure on crop protection and the [ courts have just gone wild ]. Nutrients are quite strong. I'm curious what your outlook is for the different subsegments in retail heading into next spring where we're expecting the shift from some soybean acres over to corn in the U.S. and the impact that that might have.

[Charles Victor Magro, President, CEO & Director]

Yes. Thank you very much for your question. Mike Frank, our President of Retail can take those.

[Michael J. Frank, Executive VP & President of Retail]

Good morning, Graham. So as you know, our Q3 is not a significant quarter for retail, but we did see some impact on our crop protection business. The year started out especially in the U.S. cold and wet and then summer got hot and dry. And so the need for both insecticides and fungicides was a little bit lower this summer than it was last summer. And so that had a bit of a negative impact on volumes of crop protection. And then of course we have a good quarter from a -- [ from a ] larger standpoint. Looking into next year, so we're at a point where we're now obviously selling fall fertilizer. Harvest progress is similar to what it was this time last year. We had a good October. And so counting on normal weather conditions, we believe that our fertilizer business will be very strong in Q4. And looking at early next year both seed and CP, we have a lot of momentum. And so we gain pretty significant market share in the U.S. in crop protection in 2018. Our results are up about 6% versus the market up about 1.7%. We also gained share in seeds. And while seed margins were flat we actually expanded margins in crop protection largely because of the benefit of our proprietary products. And so we believe that momentum will drive us into next year. And obviously our farmer customer margins are compressed and so the value that we bring as a trusted advisor has never been more important. And so we're expecting more of the same and another year of growth looking at 2019.

[Operator]

And our next question is coming from the line of Duffy Fischer with Barclays.

[Patrick Duffy Fischer, Director & Senior Chemical Analyst]

Couple of questions, maybe 3 around retail. First is just with the consolidation of several of the very large suppliers into your retail business is there anything different over the next year? And what I would think of is did Monsanto pay out its volume program in the third quarter but Bayer in the fourth quarter, so now that's going to change to one or the other. So is there anything lumpy from that? The second is just what metrics will you give us around your retail digital customers and how should we grade you on that over the next several years? And then the last one is just around the Brazil retail acquisitions, are those generally done in real where the move in real actually might have just made some of those more expensive or like a lot of bag down, there is that kind of a dollarized purchase price?

[Charles Victor Magro, President, CEO & Director]

Good morning, Duffy. Mike Frank can take your questions.

[Michael J. Frank, Executive VP & President of Retail]

Yes, so Duffy, first on the consolidation of suppliers, I would say at this point in time there's has been really no impact on programs or the timing of programs. And so I wouldn't expect to see any impact in FY '18 or even next year because of that. We're working with all of our suppliers. Specifically you asked about Bayer Monsanto. With them just getting their deal closed here recently a lot of the programs even for this upcoming year are really the same as the programs that they've had in the past as independent companies. And so we're not seeing any change on that at this point in time. Your second question with respect to digital. So we're off to a great start. We launched our integrated digital platform back in July, our first version. And we continue to make updates to the version. We already have about a third of our customers that have already signed up and are now engaging with us on our new digital tools. So we're very excited about where this is going. We think we have a unique opportunity because of our relationship with the growers, our extensive supply chain to really bring an integrated digital platform both from an account management, a retail and a digital agronomy perspective. And so we're putting that all together. It's an open architecture. So we'll also have third-party apps that will be on our platform as well and it will be a single-stop shop for our customers that are looking for digital solutions and digital tools. Yes, so finally your third question in terms of Brazil acquisitions. We would expect most of them to be in reais. Now again we haven't announced anything here. Recently we closed a deal of a company called Agrichem early in the year. And so we're obviously aware and watching where the real moves, and, you know, typically we'll pay a multiple on real EBITDA. So I think that in some way hedges our cost against the dollar move with the real. But we would expect to pay reais for most of the transactions if not all of them.

[Operator]

Our next question comes from the line of Josh Spector with UBS.

[Joshua David Spector, Equity Research Associate]

Yes. Hey guys, just a question around free cash flow, specifically looking at working capital. I guess it's been a pretty big use for the past 3 quarters. And if I assume a normal giveback in fourth quarter I still get cash use of around a few hundred million or 0.5 billion for the full year. Just wondering if that's consistent with the way you're thinking about working capital for the year? Or some other assumptions that I should consider?

[Charles Victor Magro, President, CEO & Director]

Yes, good morning, Josh. We'll have Fred Tune answer that question for you.

[Unknown Executive]

Hi, Josh, it's Fred here. You are correct, our working capital, as it has done in the past, tends to be an outflow for the first 3 quarters of the year. What you do see in the fourth quarter as we begin to collect all the harvest-based receivables in our retail business and then additionally we begin to get a very large customer prepaid balance come in toward the end of the year. What's a bit different this year versus last year is 2 things. One is that our retail business is bigger, so we are expecting growth in some of our fourth quarter receipts. And then the second thing is that we are moving up in the commodity cycle. So there may be a bit of an offset there just as fertilizer prices rise and we begin to restock.

[Operator]

Our next question comes from the line of Stephen Byrne with Bank of America.

[Unknown Analyst]

This is [ Ian ] on for Steve. The impairment charge that was taken for New Brunswick, could you elaborate a little bit more on why the account is deemed it was necessary to take that charge today? And operationally, is there anything at all that changes as a result of that?

[Charles Victor Magro, President, CEO & Director]

Yes, so I'll talk to you both the decision that was made and then operationally I can have Susan Jones, our president, talk about that. So look, as we said early in the year, we were doing a full portfolio review of all the company's assets and businesses and operations. And so we went through -- this is a -- it's been a many-month process, but we went through the strategic review with the Board of Directors very, very recently and just yesterday actually took a final recommendation to them. But this is really -- has to do with just where do we think that the market is best positioned. We looked at our network now. When you look at having the six mines in Saskatchewan, what we think we can deliver from the mine from a nameplate capacity where the best use of capital is to expand it, and so the decision is pretty obvious when you look at we have 5 million tonnes in Saskatchewan of excess capacity today. And if we invest a little bit of capital into the 6 facilities in Saskatchewan, we can even go much higher than our operational capacity that's stated at 18 million tonnes for very economic expansion. And the cost -- the cash cost of production in New Brunswick is just so much higher than Saskatchewan, so it's the best use of cash. So that's the analysis that took some time to work through. It's -- we needed to make sure that we did all the engineering and the analysis, financial modeling behind it. And then the recommendation was simply taken to the board just recently. Operationally, Susan?

[Susan C. Jones, Executive VP & President of Phosphate]

Yes, good morning, Ian. I -- Chuck has reiterated that the capital and the operating cost to run New Brunswick is significantly higher than Saskatchewan. I did want to just reaffirm that our outlook for potash markets has not changed and that we do believe that we can continue to bring on Saskatchewan production quickly at a much lower cost. And you will have seen this year we brought on 1 million tonnes and we do expect that to continue to increase next year. So I think the way you should just look at it is this portfolio review is completed. And we believe that this is going to ultimately drive our cost of product manufacture down while continuing to meet market demand in the future.

[Operator]

Our next question comes from the line of Joel Jackson with BMO.

[Joel Jackson, Director of Fertilizer Research]

I actually want to follow up on that line of questioning. So how do we account for the New Brunswick mine now coming off care maintenance and shutting down? Is that a good share of the $75 million of increased production optimization synergies? Or is there another cost impact that we'll get from New Brunswick? And just on -- I appreciate the rationale for shutting down New Brunswick. Is there also a concern about, I know when it came on there was a crack in the shaft issues, is some of that still lingering?

[Charles Victor Magro, President, CEO & Director]

Susan, go ahead and answer the first question.

[Susan C. Jones, Executive VP & President of Phosphate]

Good morning, Joel. So in terms of synergies, no, the synergies are not related to New Brunswick shutting down. Just I'll address the cost of New Brunswick first. So New Brunswick is costing about $25 million a year to keep in care maintenance. We'll expect to see shutdown costs over the course of the next 1 to 2 years and then that will be depleted. And after that, we are fully provided for in terms of our remediation costs. In terms of synergies themselves, our synergies are driving from 2 main buckets, the first is sustaining capital savings that we're achieving at our Vanscoy facility. And you will recall that we announced earlier in the year taking Vanscoy from 2.7 million to 2.1 million tonnes and actually shifting that production to our lower-cost mine. So we are able to pull Vanscoy into the network, reduce sustaining capital. And we also in the same token are reducing our cost of product manufactured by shifting it to lower-cost mines, that's where the synergies are coming from.

[Charles Victor Magro, President, CEO & Director]

Yes, Joel, it's Chuck. So the New Brunswick shutdown has nothing to do with the $600 million of synergies that we announced today. So I just want to make that clear that the cost savings will actually be post 2019. And of course our synergy target will be delivered by the end of '19. And then to your second question. All I will say today is that when we look at the New Brunswick versus our network in Saskatchewan, dollar for dollar you put it into Saskatchewan because we can get a bigger bank for our buck. And so it's simply a strategic shift to go from relatively high-cost production to low-cost production. And having the capability now that we've had a really good look at our network in Saskatchewan, we have the capability to bring on pre-economic brownfield capacity expansion in that network at a fraction of the cost it would take to bring up, say, a greenfield plant.

[Operator]

And our next question comes from Adam Samuelson with Goldman Sachs.

[Adam L. Samuelson, Equity Analyst]

Maybe continuing on the change in the synergy outlook, I just want to be clear, the $600 million run rate target that you've now outlined, that's all operating expenses or is there sustaining capital benefits embedded in that that doesn't actually hit the P&L, per se, or EBITDA? And then just a little bit more detail on what has changed in the areas where you're seeing better synergy realizations? And if you can provide any buckets by business that will be helpful.

[Charles Victor Magro, President, CEO & Director]

Yes, sure. So we'll have Steve Douglas, our Chief Integration Officer, kind of walk through those questions for you.

[Steven James Douglas, Executive VP & Chief Integration Officer]

Sure thing. The $600 million does include some component of reduced capital spend. But I'd say the lion's share of this number is related to operating costs that will make the way to the P&L. Now, ultimately the reduction in capital spend means less capitalization which means lower depreciation in the future, so that also will ultimately hit EPS, but it does take a little bit longer obviously.

[Operator]

Our next question comes from the line of Michael Piken with Cleveland Research.

[Michael Leith Piken, Equity Analyst]

I just want to talk a little bit more on the retail side in terms of how you're thinking about sourcing raw materials in the face of some of the tariffs and what the inventory situation looks like for crop protection at the end of the season.

[Charles Victor Magro, President, CEO & Director]

Yes, Michael, I'll have Mike Frank just -- we have made some strategic purchasing to kind of work our way through the tariffs issue that we're seeing between the U.S. and China, and Mike can walk you through that.

[Michael J. Frank, Executive VP & President of Retail]

Yes, good morning, Michael. So firstly, there will be an impact on crop protection, prices and costs going into 2019. You know, there's a number of products that are being sourced from China from various suppliers that are going to get impacted with the 10% tariff. And so, we're already seeing that. And with the rumors of a 25% percent tariff coming in the new year, you could have even more impact. So as Chuck mentioned, we did make a decision several months ago that we were going to strategically build up some of our crop protection inventory, and so we're sitting with about $300 million more of inventory this time than we were at this time last year in anticipation of that. That being said, one of the other hedges that we have against this is our proprietary business. And so we are looking at a diverse supplier base for our proprietary products. There's a few of our products that will get impacted by the tariffs. But we're going to be largely unaffected in our propitiatory business, which should give us a competitive advantage. And so this is going to be very dynamic as it plays out over the course of this next season. Depending on what happens to the tariffs, if they go away or if they get increased the market will react to that. So we're being very cautious in terms of the amount of products that we're bringing in at this point in time that have a tariff impact.

[Operator]

Our next question is from the line of Steven Hansen with Raymond James.

[Steven P. Hansen, Senior Vice President]

Just a quick one on the M&A front for the retail domestically here. I think you described your M&A pipeline as pretty full. I think you've also got some brownfield efforts that are progressing. But if you were to contemplate next year growth in that -- in the domestic location-based, how would you expect that to change relative to what you've done this year? I think you described 50 thus far with a few more to go. Trying to understand what the cadence of M&A growth domestically.

[Charles Victor Magro, President, CEO & Director]

Yes, hi, Steve. Mike Frank can take your questions.

[Michael J. Frank, Executive VP & President of Retail]

Yes, Steve. So as Chuck has already mentioned. Our pipeline is significantly fuller now than it was at this time last year. And so not only have we had a record year already in terms of the number of tuck-ins that we've done. We expect to do some more between now and the end of this year. I would say geographically you know we're looking for opportunities across the U.S. I think the fact that grower margins continue to be compressed, and as we just talked about on the previous question with the tariff impact on crop protection products, I would expect another very challenging year for the retail market in general. And that gives us an opportunity to continue to aggressively drive our consolidation and professionalization strategy. And so we would expect an even higher rate of tuck-ins both in terms of numbers and especially in terms of dollars going into next year in the U.S. And as Chuck mentioned earlier, we would expect that at some point in the next 12 months to 18 months to make some significant moves in Brazil as well.

[Operator]

Our next questions are from the line of Jonas Oxgaard with Bernstein.

[Jackson Kulas]

This is Jackson Kulas on for Jonas. You said that you expect peak potash tightness in '21 to '22. Can you talk about how you think about the upper bound for potash pricing in that environment and what you guys are going to do to manage your production?

[Charles Victor Magro, President, CEO & Director]

Yes, thank you for the question. So see, if demand grows at a normal pace over the last 10-year rate, so let's say, 2.5% to 3% per year, with the new capacity coming into the market certainly when we look at the overall supply demand by 2021, 2022, the supply demand is very, very tight. And in that situation what you have is you have really Nutrien sitting there with the only material incremental capacity to put into the market. So our strategy has always been just to meet our demand with our production. And so it's a little early for us to talk to you about what we will do in 2021. But you can imagine that with being the only company that will have any real incremental capacity left at that period of time our view is one of we will meet the market, and that's an important guideline. If you look at this year alone, we're up 1 million tonnes. And global demand is up somewhere between 1.5 maybe to 2 million tonnes. So we did increase our capacity and our sales quite -- quite aggressively because the market needed the tonnes. And we saw an opportunity to create shareholder value. So it's not -- it's not anything more complicated than that. It's -- we'll have to assess the situation at the time. But given the supply demand, I think where this thing is going to end up is that Nutrien will have -- will be really one of the only companies that have any real capacity to put in the market at that time.

[Operator]

Our next questions are from the line of Vincent Andrews with Morgan Stanley.

[Neel Kumar, Equity Analyst]

This is Neel calling in for Vincent. What type of impact do you expect the Chinese urea production during the winter heating season? And do you think there will be significant restrictions to gas and coal feedstock usage for urea producers like last year?

[Charles Victor Magro, President, CEO & Director]

I'll have Jason Newton answer that question.

[Jason Newton, Director of Market Research]

Good morning, Neel. I'd say looking through the winter months we definitely did see as we got into late in 2017, early 2018 that production rates declined. And we expect that given the current natural gas supply-demand situation that the natural gas availability will tighten as we go through the winter months. And that will lead to lower production. As an offset that we are definitely at higher prices today than we were a year ago and the rates of production have been relatively strong of late. And so I think as we look toward the next few months and into early 2019, we wouldn't see a significant difference early in the year in terms of Chinese exportable capability than what we saw this year.

[Operator]

And our next question comes from line of Alex Falcao with HSBC.

[Alexandre Pfrimer Falcao, Senior Vice President]

I have 2 questions. One, regarding phosphates. When you guys did the integration does -- where are you right now when you first idealized where you're going to be in phosphates? And if there was to be a divestment here, do you think there would be any buyers for the U.S. assets? That's question number one. Question number two on Brazil. Are there any plans other than to buy small distribution companies in Brazil? We know that some of the traders are struggling and their distribution arms could be up for sale. So is that something that you guys would explore? Any of the logistics that are up for sales in Brazil as well?

[Charles Victor Magro, President, CEO & Director]

Thank you for your question. I have Raef Sully, our President of Nitrogen and Phosphate take your first question and I can answer your Brazil question.

[Raef Sully]

So Alex, just on the synergy development, we're on track as planned. We will be ramping up production at White Springs in the first quarter of '19. We will be closing down our Redwater facility in the first quarter of '19 and then changing over to ammonium sulfate by the third quarter of '19. All that is on track. The 3 projects associated with that are on schedule and on budget.

[Charles Victor Magro, President, CEO & Director]

And for your Brazil question. So look, our model for retail is very different than just being a pure distributor. We have of course fertilizer chemistry seed. We provide agronomic knowledge and advice, services and digital technology. And of course, our proprietary product portfolio. So that's how we think that the model will create a lot of value for Brazilian farmers. Now, we have -- and one of our first acquisitions in Brazil was buying a distributor that we then converted to what I would call a full-service retailer. And so it is a potential for us to enter the market through a distribution-type acquisition. And then over time we would add the rest of our products and services to make it a more full service offering than you're used to seeing in our other geographies. So it is an option.

[Operator]

And our next questions are from the line of John Chu with Laurentian Bank.

[John Chu, VP of Research & Diversified Agriculture Analyst]

Just on the higher synergy targets. I'm just curious, regarding the distribution and on the procurement side, those targets were not revised higher for 2019. So on the distribution side, you're about 80% towards your target. Is there any more room to improve there or is it safe assume there is a much more upside? And then similarly on the procurement side, just curious, if there's any more potential for revised higher targets somewhere in the first half of next year?

[Charles Victor Magro, President, CEO & Director]

Hi, John. I'll have Steve Douglas take the question.

[Steven James Douglas, Executive VP & Chief Integration Officer]

Yes, there -- I think Susan laid out some of the changes to the numbers for next year, some of that was also administratively-related to some costs associated with benefits and some cost associated with insurance. We are constantly looking for new sources of synergies. But that said, I mean we have to target the ones that we think are the most realistic, the one easy -- the ones that are easily achievable relative to the others and the most bank for your buck. So while we'll constantly look for new synergies -- in everyone of these particular areas, we've raised the number predicated and what we think is most eminently achievable and again delivers the fastest return. That said, we are constantly looking. And I think we did spend -- when you look at the fact that the deal closed somewhat later than we anticipated, we spent a lot of time to the extent we could from an antitrust perspective making sure that we found the most -- a lot of the synergies ahead of time. So while we haven't raised those targets, doesn't mean we're not looking, but we are -- we only really raise it when we're, A, competent, and, B, think it's the most advantageous for us to achieve.

[Charles Victor Magro, President, CEO & Director]

And John, just want one last thought on synergies. So we've set the target of being the end of '19. We do have other savings and you could even say synergies that will most likely take us well beyond 2019, into 2020. But we're most likely not going to call those a synergy, we're going to probably come out some time next year with a set of operational efficiency targets for all of our businesses and the corporate organization. That will have some of this thinking and analysis built into it. But 3 years after a merger we can't sit here in good faith and say it was all because of the merger.

[Richard Downey, Vice President of Investor & Corporate Relations]

And that's all the questions we have this morning. The IR team is available to answer any other follow-up questions. Thank you for joining us.

[Operator]

Okay. Thank you. And this concludes today's teleconference. You may disconnect your lines at this time. Thank you for participation.