The Mosaic Company (NYSE:MOS) Q2 2020 Earnings Conference Call August 4, 2020 11:00 AM ET

Company Participants

Laura Gagnon – Vice President of Investor Relations

Joc O’Rourke – President & Chief Executive Officer

Clint Freeland – Senior Vice President & Chief Financial Officer

Conference Call Participants

Adam Samuelson – Goldman Sachs

Chris Parkinson – Credit Suisse

Michael Piken – Cleveland Research

John Roberts – UBS

Jonas Oxgaard – Bernstein

Ben Isaacson – Scotia

PJ Juvekar – Citi

Mark Connelly – Stephens

Joel Jackson – BMO

Steve Byrne – Bank of America-Merrill Lynch

Vincent Andrews – Morgan Stanley

Operator

Good morning, ladies and gentlemen and welcome to The Mosaic Company’s Second Quarter 2020 Earnings Fireside Chat. At this time, all participants have been placed in a listen-only mode. After the company completes their prepared remarks, the lines will be open to take your questions.

Your host for today’s call is Laura Gagnon, Vice President, Investor Relations of The Mosaic Company. Ms. Gagnon, you may begin.

Laura Gagnon

Thank you and welcome to our second quarter and 2020 earnings call. Presenting today will be Joc O’Rourke, President and Chief Executive Officer; Clint Freeland, Senior Vice President and Chief Financial Officer; and Rick McLellan, Senior Vice President, Commercial. We will host a prepared question-and-answer session addressing the questions received last night, followed by a short live Q&A session, time permitting. All of our earnings materials released yesterday after market close are available on our website at mosaicco.com.

We will be making forward-looking statements during this conference call. The statements include, but are not limited to statements about future financial and operating results. They are based on management’s beliefs and expectations as of today’s date and are subject to significant risks and uncertainties. Actual results may differ materially from projected results. Factors that could cause actual results to differ materially from those in the forward-looking statements are included in our press release issued yesterday and in our reports filed with the Securities and Exchange Commission.

We will also be presenting certain non-GAAP financial measures. Our second quarter press release and performance data attached as exhibits to yesterday’s Form 8-K filing, as well as our commentary on the quarter posted to our website also contain information important on these non-GAAP measures.

Now, I’d like to turn the call over to Joc.

Joc O’Rourke

Good morning. Thank you for joining us today. I’ll start with very brief comments, then we’ll get straight on to your questions. This was a very good quarter for Mosaic and our momentum is increasing. The key points about our performance are, our cash flow generation this quarter is the result of the past five years of work by our team to transform our cost structure and strengthen our franchise; we’re succeeding even earlier than we expected; we’ve already achieved five of our seven 2021 cost targets.

Even with realized potash prices down $20 per tonne from the first quarter and realized phosphate prices up just $13 per tonne in the quarter, we generated over $800 million in cash from operations. We delivered adjusted EBITDA 25% higher than consensus expectations, even before our adjusted EBITDA definition change.

We paid down $500 million in short-term debt and structured payables in the quarter, while retaining cash on the balance sheet above $1 billion. In potash, we continue to invest in the accelerated K3 project, hitting a major milestone of connecting the K3 shafts to the K1 mill. We continue to reduce our brine management costs and we achieved the lowest cash cost per tonne of production in over a decade.

Mosaic Fertilizantes had an excellent quarter, hitting both real-based cost targets and achieving further cost benefits from the weakening real, as well as realizing over 80% of our targeted full year transformation benefits. Phosphates drove the cash cost of rock below the target and lower than last year, despite increasing distances from mining to beneficiation.

And with all of these efforts, we’ve reaffirmed our commitment to you, to our shareholders, our employees, our customers and our communities to act responsibly. We announced new aggressive broad-based environmental, social and governance targets and we will use these targets to drive performance across the business.

We are continuing to transform. The quarter’s accelerating earnings and cash flow clearly reflect our efforts to date and we are driving additional future savings. We expect to deliver another $700 million in savings above the 2019 base, as we continue to execute our strategy. Mosaic is more competitive than ever before and with fertilizer markets improving, we have significant earnings leverage to the future.

Now, we’ll take your questions.

Question-and-Answer Session

A – Laura Gagnon

Joc, I’m going to start with some questions we received on cost. Adam Samuelson from Goldman Sachs asked.

Adam Samuelson

In the second quarter Mosaic was ahead of its 2021 target on a number of its key cost KPIs. How much incremental opportunities do you see on each key metric to further reduce costs? And, if so, what level of incremental capital spend would be necessary to achieve those outcomes?

Joc O’Rourke

Thanks for your question, Adam. As we’ve said earlier, we have new targets that include $700 million of additional improvements across the company, $200 million of those coming from our Brazil operation and $500 million coming from our North American and administrative.

Some of the areas where we believe we can make big gains as we go forward obviously are in Brazil, where we continue to improve that business; in North America, where automation is allowing us to drive efficiencies in both phosphates and potash. And then of course, our K3 operation which as we ramp it up, we’ll eliminate a lot of cost and improve our brine management cost. So, as we look forward, we see a lot of opportunities still. And importantly, in September when we bring our — all of this to our Analyst Day, we expect to be able to give you more color and detail on what that’s going to look like.

Laura Gagnon

Joc, Chris Parkinson from Credit Suisse asked.

Chris Parkinson

You’re clearly comfortably ahead on numerous cost initiatives including your K3 shaft brine inflow, phosphate rock costs in the U.S. and Brazil and Fertilizantes platform. But would you take a step back, how are you thinking about your structural cost base in a normalized environment? And how much more could actually be done especially in phosphate?

Joc O’Rourke

Yes. Thank you, Chris. It’s important to keep in mind that these cost improvements certainly are somewhat driven by high utilization. We’ve had a good quarter where we’re able to use our assets fully and we’ve had some benefits from exchange rate, particularly in Brazil, but also in Canada. Over the long term though, the real differences have been structural and those are going to stay with us and those are going to continue and we’re going to continue to improve those. So, if we look at our major projects which include Esterhazy K3, next-gen mining and the Brazil transformation, those are not temporary differences. Those are true structural changes that we’ll be delivering value for the long term.

Laura Gagnon

Joc, Michael Piken from Cleveland Research asked.

Michael Piken

You mentioned that you are on track to exceed your $225 million in non-market growth in 2020. Which segments are exceeding your expectations and how higher can this number go for 2020?

Joc O’Rourke

Hello Michael. Let me clarify. Our $225 million were actual items that we spent in 2019, but we did not expect to repeat in 2020. And so on those some of the key items, the Plant City idling that’s happened and now is outside of our cost structure. Our Brazilian dams, we’ve completed the work now and that $80 million of cost is now behind us. Equally, the ramp-up of Esterhazy, which has gotten better than we expected, we now are delivering one million tonnes a year from the K3 project.

So, that benefit has already flowed through to us. And then of our $50 million of transformation in Brazil that were part of that $225 million, we’re already at over $40 million. So, we see that as pretty much complete and ongoing savings will be above and beyond that original $225 million we talked about.

Laura Gagnon

Joc, a large number of questions seeks a better understanding of our countervailing duty petition. Seth Goldstein from Morningstar, Chris Parkinson from Credit Suisse asked for an update on potential regulation changes of the U.S. import duties on Morocco and Russian supply. And if the outcome is successful in our favor, what should they expect in changes to their landed U.S. costs? In other words, what are the potential outcomes in terms of leveling the playing field?

Joc O’Rourke

Thank you, gentlemen. Let me start by saying, we believe in free and fair trade. However, the reason we filed this petition in the first place was to address imbalances associated with unfair government subsidies on imports and to highlight unequal requirements on environmental standards. We believe, our competitors benefit from access to artificially low rock costs and energy while not having to meet adequate and proper environmental standards. We also will say that what we have done is put this forward to the Department of Commerce and the International Trade Commission. They will judge on the merits and as such, determine what level of duties if any, need to be put in place to create a fair trade situation. And Clint, do you have anything to add to that?

Clint Freeland

Yes. No, Joc. I think you’re right. We certainly are ahead of schedule on the realization of the $225 million in non-market benefit this year. Keep in mind that the $80 million that we spent on dam remediation last year was spread really through the second to fourth quarter. So we realized about $36 million in benefit in the second quarter and should realize the balance throughout the rest of the year.

Laura Gagnon

Joc, John Roberts from UBS would like to know.

Q – John Roberts

Can you review the basis for your phosphates countervailing duty to position? And have you had any response from customers or competitors?

Joc O’Rourke

Thank you, John. Our basis for the petition is clearly laid out in the public documents. And I would ask that you go to those. Also the comments from any of our competitors or customers or the other concerned groups is clearly laid out in those public documents. So I would suggest you go there.

Our position is clearly that the Department of Commerce and the International Trade Commission really are the ones that will decide what are the merits of this case. Now clearly, as we talk to our customers, some are concerned mostly about how they’re going to get their supply. We believe that this has opened up new opportunities for outside competitors to come in and make up some of that supply. But in the end I think all people understand why we’d put it forward. And we’ll have to wait to see what the ITC says in terms of its merit.

Laura Gagnon

Joc, we received several questions asking about trade flows and implications to other markets. Specifically, Adam Samuelson and seven others asked: over the next six to 12 months, how do we think about the net impact of potential trade flow impacts of potential U.S. countervailing duties on Morocco and Russian phosphate? Do you see risk of market share competition rising in other major import markets, notably Brazil?

Joc O’Rourke

Thanks, Mike and Joel. Let’s answer the last question first. No, we don’t think this will impact global supply and demand. All we will do is probably change trade flow. The current market and resulting pricing is reflective of a tight market. And if anything the countervailing duties only highlighted to people that this market was tight. So what’s causing the tight market? Favorable farm economics and lower supply, which began to take shape well before we filed the petition.

However, it is reasonable to assume that the trade flows will be altered and some product will be shifted to other jurisdictions including new suppliers coming into the U.S. and the Moroccan and Russian suppliers focusing on other markets which could be Brazil or wherever.

Laura Gagnon

Jonas Oxgaard from Bernstein asked two more technical questions with respect to the petition namely.

Jonas Oxgaard

If the Mosaic trade complaint is upheld, will there be a retroactive benefit to Mosaic? And what is the time line for final decision on the complaint?

Joc O’Rourke

So look, thank you, Jonas. Let me first clarify. Whether duties are applied retroactively will depend upon the level of imports from these two countries from the filing of the case until the DOC preliminary ruling. We expect the case to be finalized in Q1 2021. And at that point if there has been excessive imports they will look at assessing a retroactive duty.

Laura Gagnon

Joc, I’m now going to move on to questions about phosphate operations. Ben Isaacson from Scotia asked.

Q – Ben Isaacson

On the cash cost of mine rock in Florida falling to $36 per tonne from $40 year-over-year how much of that was due to transformational efforts versus favorable geology? And how much more wiggle room is there to bring that down? And how sustainable are these cost improvements?

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Joc O’Rourke

Thank you, Ben. Clearly our cost improvements are a combination of several factors. We’ve certainly been running our assets at elevated utilization rates and that’s helped. But our efforts to centralize mining operations, streamline processes and automate have also helped reduce our cost. As previously mentioned, the establishment of a central control center for our mining and collapsing all of our mining operations basically into one large operation, which should be — begin operation by the end of the year will really further enhance cost savings. And as we introduce new management structures, incorporate automation for certain mining functions and accelerate savings from adjustments to transportation we start to see real long-term improvements in our cost structure.

Laura Gagnon

Joc, PJ Juvekar from Citi also asked.

PJ Juvekar

With the recent rise of over $50 per tonne in DAP pricing, have you ramped up your production at the mine? And what could be the benefit of better cost absorption from higher tonnes in the third quarter?

Joc O’Rourke

Thanks for the question, PJ. High utilization rates have a beneficial impact, but that’s really only part of the story as we’ve mentioned. But I will say that as we look at Q3 going forward, we can expect those tonnage — high tonnage and higher utilization rates to continue. So we do expect to see better costs throughout the rest of the year both structurally and because of high utilization.

Laura Gagnon

Joc, we also have a question from Adam Samuelson from Goldman Sachs.

Adam Samuelson

With specialty percentage rose to 48% of shipments and marked a new quarterly high in phosphate coincident with MicroEssentials shipments to Fertilizantes being substantially above recent quarters, is this sustainable? Why or why not?

Joc O’Rourke

Thank you, Adam. The sales of MicroEssentials and Aspire hit record highs and K-Mag came in close to the record in quarter two 2020. Among these growth MicroEssentials’ shipments to Brazil has been a major driver. Now we believe the growth of MicroEssentials will continue over the next quarter driven by Mosaic Fertilizantes and also North America.

I have to reemphasize the value that MicroEssentials brings to the growers is showing positive returns for them on their investments. So these are bringing real value to the growers and to our customers the distributors so we do believe that as more people start using MicroEssentials this is very sustainable and they’re going to see the benefit and they’re going to keep using that product.

Laura Gagnon

Joc, three analysts submitted multipart questions related to our potash operations. So first Chris Parkinson asked.

Chris Parkinson

The demand environment in potash appears to be modestly improving while spot prices are well off their first half lows. Can you talk about your thought process for the second half of 2021 operating rate assumptions and how that may drive changes in your mine mix?

Joc O’Rourke

Thanks, Chris. As you know we’ve accelerated the development of K3 and this has an obvious impact on costs both now with declining brine management spending and in the future as the mine ramps up. Beyond K3, we continue to see strong results from Belle Plaine, which recorded its lowest cost position in more than a decade.

As we move forward, we’re going to take advantage of owning two of only seven mines in the world with annual production capacity of over 3 million tonnes and with some of the lowest costs in the industry. So as we look to the future, we intend to optimize the production coming from K3 and from our Belle Plaine operation and only see running higher cost mines like Colonsay if the market really requires it in the future.

Laura Gagnon

Joc, another question comes to you from Jonas Oxgaard of Bernstein.

Jonas Oxgaard

In potash you lowered your cost per tonne a fair bit but how much of that was simply spreading fixed costs over a 20% larger volume? On a fixed volume basis what would your cost reduction be?

Joc O’Rourke

Good question, Jonas. There is no question that the larger volume helps spread out our costs. However, we believe there are structural changes that are fundamentally changing our costs over the long-term. We think one area of clear savings is the accelerated reduction of brine management costs as we shift to K3.

K1 underground mining will be completed this year. Brine management accounted for $8 a tonne in Q2 and that will continue to decline as we move into 2021 and will be eliminated completely by 2022. So as you can see a lot of our cost reduction is actually structural and should be with us for the long-term.

Laura Gagnon

Joc, PJ Juvekar from Citi asked.

PJ Juvekar

What kind of savings do you expect from sending K3 potash ore to the K1 mill? And what is the updated time line now to shut down K1 and K2?

Joc O’Rourke

Thank you, PJ. We expect to be sending potash to K1 and actually be shutting down our K1 shafts from a production perspective early in 2021. That will start meaning, we’re only going to be operating two shafts and then by the end of 2022 only operating the one big K3 shaft. At that point, the project will be complete, we’ll eliminate brine inflow and that really will be the end of our K1 and K2 plant mines from a production perspective.

Laura Gagnon

Joc, Vincent Andrews is interested in how he should think about our potash shipments in the second half of this year given how strong shipments were in second quarter? Also, can we remind him of the accounting for the Chinese contract shipments that were already in a bonded warehouse prior to contract agreements?

Joc O’Rourke

Thank you, Vincent. Yes we did have strong shipments in quarter one. And if I referred to our discussions with Canpotex, I think they have a fairly full order book for Q3 and even going well into Q4. So I believe the shipments internationally will be strong in the second half. And domestically, we’re expecting a good fall in North America. So we’re expecting strong shipments there as well. So from our perspective, our second half is looking pretty strong from a potash perspective.

In terms of the shipments in the first half, I’d just like to throw it over to Clint to explain a little bit about our China shipments to bonded warehouse that we rev recced in the first half of the year. Clint, can you discuss that?

Clint Freeland

Sure, Joc. Good morning, Vincent. So to start with on a consolidated basis, we don’t recognize revenue until that product is sold to a third party. However, we do – on a segment level basis, we do recognize a revenue when Canpotex sells product to our distribution business in China. And when they sent that product to our distribution business in China, the segment recognized revenue but that was based on an estimate of pricing since the contract had not been completed.

Once the contract was completed and the price for that transaction was set that gave rise to the adjustment. But again that’s an adjustment on the Potash segment only, because we won’t recognize revenue on that product on a consolidated basis until it’s finally sold to a third party.

Joc O’Rourke

Thanks for that clarification, Clint.

Laura Gagnon

Joc, I’m now going to move on to questions about Mosaic Fertilizantes. We have four analysts including John Roberts from UBS and Mark Connelly from Stephens asked similar questions about the timing of volumes in Brazil.

John Roberts

Brazilian farmers are having an outstanding year so far, and have been widely reported to be buying inputs well ahead of last year’s schedule. How much, do you think has been borrowed from the third quarter? And are we likely to see an offsetting reduction in third quarter margin to reflect those lower volumes next quarter? And specifically, within the quarter April and May were significantly higher than the prior year month, while June appeared to be much closer to a year ago. Is that just timing? Or are the trends decelerating into July?

Joc O’Rourke

Great question. The strong volumes in the first half of the year did reflect some forward input purchases, as a result of generally favorable farm economics. But year-over-year demand is expected to be up slightly to 37 million tonnes. And in that figure, we believe we are beginning to take market share as farmers gravitate towards higher analysis products and high-value products such as our MicroEssentials.

Laura Gagnon

Joc, Mark Connelly at Stephens asked.

Mark Connelly

How did the dramatic improvement in costs in Brazil break out between volume-driven cost improvement and operational structural cost change that should repeat with normal volumes?

Joc O’Rourke

Thank you, Mark. Let me start by saying last year our operations were negatively impacted by the change in regulations that required us to shut down a couple of operations for down improvements. That reduced volume and impact of our raw materials access. This year, we’re benefiting from running at full operations rate. And this also has allowed us to have more access to our own rock supply. So overall that has helped a little bit. So about a-third of what those costs are probably volume related. The others are improvements to our freight, our inventory management, our overall planning and of course structural changes to our cost structures.

I think overall though we’re seeing long-term changes to how the Brazil business is running and we’re starting to see full benefit of the $330 million or so of integration benefit that we announced at the end of last year.

Laura Gagnon

Joc, PJ Juvekar has a question about currency.

PJ Juvekar

The Brazilian real versus the U.S. dollar was down significantly year-over-year in the second quarter of 2020. How did that volatility impact you? And what specifically was the impact in the quarter on Mosaic Fertilizantes?

Joc O’Rourke

Thanks PJ. I’d like to talk about two aspects of the Brazilian real that really has changed things. And the first of those of course is the impact on farmer economics. I think that is actually the bigger improvement their ability to buy fertilizers and the continuous growth of the Brazilian agriculture segment is largely driven by great economics for the farmer. And so that’s the first place we want to talk about where the Brazilian real has helped us.

In terms of our cost performance you will see that we tend to put our targets in real based so that allows us to understand what’s the real underlying improvement. Obviously, there was some positive impact. I think we saw definite improvements in our overall cost because of the real. But I would say we focus more on what is the real-based cost because that tells us whether we’re really improving the business or just taking advantage of currency.

Though in the back you’ll notice — sorry PJ I’d also like to point out that if you look at the back of our stuff you’ll see basically our sensitivities and a $0.10 move in the real amounts to about $20 million a year unhedged. So if we think about us as being about 50% hedged it’s fairly easy to do the reconciliation to last year’s real costs.

Laura Gagnon

Joc, we have another question from Ben Isaacson with respect to Mosaic Fertilizantes.

Ben Isaacson

Mosaic Fertilizantes sales volumes have been notably higher year-over-year. Can you walk through the strategic strength of this business and how it relates to your mix between commodity and MicroEssentials tonnes?

Joc O’Rourke

Thanks Ben. Again I’ve said this before, but I’ll repeat. The volume growth really was a result of improvement in farm economics in Brazil. The strengthening of the U.S. dollar versus the real excellent barter ratios and anticipation of a strong summer crop demand. So, both commodity and performance products have shown robust increases in quarter two of 2020 versus a year ago.

Laura Gagnon

Joc, Chris Parkinson’s asked for a COVID-19 update. His question is.

Q – Chris Parkinson

Brazil is in the midst of a fairly complex COVID-19 outbreak which has periodically been affecting the ports and logistics system. Can you give us an update on the demand environment as well as any logistical headwinds you foresee during the peak fertilizer application season?

Joc O’Rourke

Thanks Chris. Look let’s start from our own operations in Brazil. And although we’ve had a number of cases because of the high level of community transmission we have not been impacted on our operations to this point and we’ve instituted a number of procedures to make sure we mitigate the spread.

Sorry and then from an overall country logistics perspective we believe that in general we have been unaffected by COVID. Now, obviously, there’s going to be local places where that impacts us.

But in general we’ve been able to work around that and kept the product moving to the end customer. And from a demand perspective despite COVID, we’ve continued to see strong demand again driven by favorable foreign economics and we have got our product to our customers with relatively little impact.

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Laura Gagnon

The last question we received on Mosaic Fertilizantes comes from Joel Jackson.

Joel Jackson

Fertilizantes’ second quarter gross margin was more than double the results from the prior two years. How much of that gain was market conditions versus foreign exchange tailwinds versus share gain in the market versus a pull-forward of Q3 because of COVID-related logistics concerns?

Joc O’Rourke

Thanks, Joel. I would summarize our results in the second quarter in Brazil, as a couple of factors. First of all, if we looked at the exchange rate, it’s probably offset almost perfectly the change in pricing. So what we see in actual results is, almost solely the result of our own actions, and the reversal of some of the down costs that we saw, last year.

Laura Gagnon

Joc, we received a handful of questions on the balance sheet, primarily focused on uses of free cash flow. John Roberts asked, ‘what are the capital allocation priorities moving forward? And can you please discuss your gross, debt level, dividend and potential share repurchases?

And PJ Juvekar asked, ‘Beyond paying down some debt what could be uses of cash, especially with improved free cash flow in the second half of 2020? Would buyback be approved use of cash over the countervailing duty decision prevents you from buying back stock? Joc, can you talk about capital priorities, to address both of these questions?

Joc O’Rourke

Yeah, thank you, gentlemen. Our capital priorities are unchanged. And they continue to be what we’ve said in the past. Our first priority is to maintain the business. Next priority maintains investment-grade metrics. And to do that, we have to continue our normal capital plan, as we’ve had.

We expect to lower debt by about $1 billion over the next few years, doing so, when our bonds come due, in the next couple of years. And then continue some of the key projects like the Esterhazy acceleration, K3 acceleration. And then, what we have after that, returning capital to shareholders. All three of these are depending on future cash flow generation. And capital allocation will not be impacted, in any way by the countervailing duties.

Laura Gagnon

We’ve also had a couple of questions from a buy-side analyst and they include, can you describe what’s included in the $610 million of short-term debt, that you indicated will be paid in 2020? And does Mosaic still plan to keep about $1 billion cash balance and pay down its 2021 maturity?

Joc O’Rourke

Thanks for the question. At the start of this year we did increase our cash balance to $1 billion, by first of all taking out some money from our revolver and executing on some of our inventory financing debt. Since that time we paid down the revolver. And we will continue to pay down the rest of the $600 million in short-term debt, throughout the rest of this year.

Laura Gagnon

Before we move on to market-related questions, Ben Isaacson asked about our tax rate outlook.

Ben Isaacson

Why is your effective tax rate expected to be in the mid-to-high 50s? And how should we think about this rate under a Trump or Biden presidency?

Joc O’Rourke

Thank you, Ben. Let me start by saying the first part of this is — and the reason for the tax rate being higher is our income mix between our three jurisdictions Canada, Brazil and the U.S. The details of that, I’m going to actually hand it over to Clint, to explain why the negative earnings in the U.S. will create a higher tax rate overall.

Clint Freeland

Yeah. Thanks, Joc. And Ben that’s right, it really comes down to an earnings mix phenomenon for us. If you recall, the tax rate is based on GAAP results by jurisdiction. And when you look at the United States not only is, our Phosphates business incorporated into that, but also our corporate G&A our interest expense and so forth.

So, there are times when that pre-tax income in the U.S. turns negative. And that can begin to skew the rate. When you then start to factor in things like, some of the foreign currency moves that we’ve seen, and how it affects our mark-to-market, and some of the notable items that we have on our schedule, that begins to skew it.

And then, as you’ve seen Brazil improve this year, that’s our highest rate tax jurisdiction. So that begins to influence that rate as well, so really the combination of all of those things that’s resulting in an unusually high tax rate for this year. And then, I’d add two things. One, on a longer-term basis, we would expect that effective tax rate to be somewhere in mid to high 20s. But then I would also call your attention that our cash tax rates and payments are much different than that. As a matter of fact this year, we expect to end up with a small cash tax refund so very different than the effective tax rate in our financial statements.

Laura Gagnon

Now let’s move on to market related questions. Mike Piken asked.

Michael Piken

If you could comment on our summer fill programs in the U.S. and where we see downstream inventories in the U.S. at this point?

Joc O’Rourke

Thank you, Michael. I think we’ve had fairly successful fill programs in both phosphates and potash here in the U.S. In recent discussions that we’ve had with our customers suggest that they’re probably in the range of 60% full for the fall season. So there will be increased buying towards the fall season. But for the most part, our customers are in reasonably healthy shape going into that fall.

Laura Gagnon

Steve Byrne is looking for insight into future volumes.

Steve Byrne

How are you trending in each of the segments through the month of July on a year-over-year basis? Do you see volumes higher in the third quarter? And any expectation for volumes for the rest of the year?

Joc O’Rourke

Thanks, Steve. I would characterize Q3 as largely having our order books full for both phosphate and potash. And so it will be a matter of delivery and revenue recognition that will determine where we are for quarter three. But we expect a reasonably good fall in the U.S. and global markets are running well. So for both phosphates and potash, we expect relatively normal Q3 volumes in both. And then for the rest of the year, we should also see a good stable volume.

Laura Gagnon

Joc, Mark Connelly would like insight into grain and oilseed price implications.

Mark Connelly

How important to Mosaic’s earnings outlook are higher grain and oilseed prices? If the current price of corn is sustained through 2020 and soybeans stay at/or near their current prices, do you think there is any material room for higher P&K prices in the market?

Joc O’Rourke

Thank you, Mark. Clearly oilseed and grain prices do have implications for us. But in general, the farmers tend to work a lot more on their needs to plant. So what’s a lot more important to us is planting intentions, number of acres planted. And remember also the grain and oilseeds are just a few of the products that we fertilize. So it really depends on what does the whole global market look like and what is the demand for P&K and what supply balance there as opposed to something on the grain and oilseed. It has an indirect impact, but I would say no direct impact on our pricing.

Laura Gagnon

Vincent Andrews from Morgan Stanley wants to know about our market forecast.

Vincent Andrews

Given that the last 10 years of P&K shipments show some pattern lumpiness, potash more than phosphate, why not forecast lumpiness going forward rather than just CAGRs?

Joc O’Rourke

Thanks, Vincent. We tend to forecast on annual growth simply because some of the other factors that go into the lumpiness of our business are impossible to forecast. And those are really inventory movements globally and of course weather. You saw in 2019, the weather impacts in the U.S. made a fundamental difference to the growth rate of both phosphates and potash on a global scale. So we really have to look at it on averages, but recognize that there will be lumpiness as we go forward.

Laura Gagnon

I’m going to move on to some questions on phosphates. This one is from Ben Isaacson.

Ben Isaacson

The benchmark MAP selling price fell by $16 to $314 per tonne yet Mosaic’s average finished product selling price fell by almost three times that amount or by $44 to $308 from $352. Why? How could we think this — so how should we think about this relationship going forward?

Joc O’Rourke

Thanks Ben. The answer here is simply that the average selling price in Fertilizantes is based on all the components we sell, including urea and potash in the blends, both of which are down significantly. So when you look at that relationship going forward, you have to take into account all three products that could be in our blends that we sell.

Laura Gagnon

Ben also asked.

Ben Isaacson

DAP stripping margins have started to improve in July after remaining largely flat throughout the second quarter. Are you seeing this flow through to the Phosphates segment margin?

Joc O’Rourke

Thank you, Ben, again. DAP stripping margin is — we track that, because that really is what do we get after the cost of raw materials and transport as revenue. So, of course, this flows directly into our margins. An improvement in stripping margin really is almost directly related to our overall profitability.

Laura Gagnon

Adam Samuelson would like to know.

Adam Samuelson

What does Mosaic see as the equilibrium prices of U.S. NOLA, DAP and MAP versus key offshore benchmarks?

Joc O’Rourke

Thank you, Adam. All I can really say there is, if you look at it historically other than the last say three years where there’s been a real increase in imports, we have seen NOLA prices being similar to other global prices. And I would expect that under a more fair trade market that’s what you would see is, you would see the NOLA price being equal to what the prices in other markets adjusted for the transport cost. And that’s exactly what we expect will happen after a countervailing duty case, if they readjust that market.

Laura Gagnon

Joc, Steve Byrne would like more insight into our global phosphate demand outlook, and its relationship to inventory swings.

Steve Byrne

Specifically, what is your estimate of underlying global consumption of phosphate in 2019? And was it below the shipments of 71 million tonnes? Did it reflect channel inventory builds?

Joc O’Rourke

Thank you, Steve. If we look at 2019, there was no question that there was a buildup of global inventory, particularly in the U.S. I mean in the U.S., there was a poor season and the imports in particular kept coming in. We shut down our Louisiana operation for a number of months last year. And still the inventory build in the U.S. was very high.

Likewise, the Brazilian inventory was probably slightly above normal coming into this year, for maybe some of the same reasons. But what I will say is, in the first and second quarter of this year, we have largely cleared out all of that inventory and probably have moved from an area of high inventory to a very low inventory in phosphates as we move into the third quarter of this year.

Laura Gagnon

Joc, in a related question he also asked.

Steve Byrne

Are normalized inventory level is the reason for the increased phosphate shipment forecast in 2021?

Joc O’Rourke

Thanks, Steve. Yeah. In terms of 2021, what we really see is the inventory levels should be pretty much leveled off, and we expect normal growth in the market as per any other year, so that 2% type annual growth in 2021.

Laura Gagnon

Vincent Andrews would like our opinion on farmer economics.

Vincent Andrews

He asked given the recent run-up in DAP prices are you all concerned about U.S. farmers deferring fall applications?

Joc O’Rourke

Thanks, Vincent. Look, our experience has been — and if you look even at the spring with the COVID uncertainty, that farmers will put fertilizer on their fields according to their needs. And frankly today with precision agriculture, they’re more likely to put the right amount of fertilizers on every year. So and phosphate prices, frankly, also are a very small piece of the overall cost of running a farm.

So, I don’t believe that most farmers will look at phosphate pricing and have it change their application.

But I’d also highlight that phosphate prices are still very affordable when you look at where grain and oilseed prices are. So as with most fall seasons, we would expect that weather will be the main arbitrator of demand. And with expecting an early crop maturity this year, we expect we should have a good fall.

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Laura Gagnon

Joc, we have three questions related to China and phosphate. First Vincent Andrews asked.

Vincent Andrews

What do you anticipate will be the Chinese DAP exports in the second half of 2020? And what second half 2020 DAP price does that assume? If DAP prices are higher or lower than your assumption what would happen to Chinese exports?

Joc O’Rourke

Thanks, Vincent. Chinese exports over the first half of the year were lower by about 800,000 tonnes from last year. Now, the base forecast calls for Chinese exports to end the year about 600,000 tonnes lower. In other words, we expect that international pricing is a little higher. We’ll incent a few extra tonnes coming out of China in the second half.

And if prices are higher than our expectations, there might be a little bit more upside but we don’t see significant upside. And part of the reason for this is domestic demand is coming in fairly strong as we move into fall. And I think the big issue there will be export availability limitations. Now, obviously, if our prices are lower than expectations, the volumes could be even lower than what they are now.

Laura Gagnon

Joc, Seth Goldstein and Steve Byrne both asked about production. Specifically, what is the status and outlook for reduced phosphate production at specific facilities in China and Tunisia? And do you expect the lower exports over the next several years?

Joc O’Rourke

Well, let me hit China first. There’s been a well-known shift towards shutting down some of the higher polluting plants, particularly along the Yangtze River and we’ve seen some, that have resulted in production declines in the first half of the year. In terms of Chinese export volume over the next years, we maintain that Chinese exports will trend lower and we’ll establish a new normal. I mean we’ve now seen what we think is the bottoming of Chinese domestic demand and we’re seeing a lowering of production. So with that will have to come a lowering of exports as they meet domestic demand.

For Tunisia, it would appear that expectations for a plant resurgence of production in 2020 were somewhat overstated. But it’s also important to put Tunisia in context. They have produced an average of about 750,000 tonnes of DAP and TSP over the last five years. Current protest will certainly lead to shuttering of the rock production. This has plugged them for over a decade, so which means we would expect them to stay about the same run rate as we go forward as well.

Laura Gagnon

Joc the last section of questions relates to potash global markets. Steve Byrne and Seth Goldstein asked about the impact of palm oil demand on potash. What is the typical lag between movements in palm oil prices and changes in potash demand in Southeast Asia? And has the rebound in palm oil pricing resulted in increased potash demand in Southeast Asia?

Joc O’Rourke

Thank you, gentlemen. The palm oil demand is important for potash. And what we have seen recently is, an improvement in palm oil prices. And we know that for production reasons they will be adding potash to their palm oil plantations. So we see that as a fairly direct relationship.

I wouldn’t say we see increased demand, but we see demand that is getting back to its normal levels. In terms of a longer term export demand and domestic demand for biofuels is helping in terms of optimism for recovery. So all of these things mean that we should see a better demand for potash in the Southeast Asia region, particularly Malaysia and Indonesia.

Laura Gagnon

Joel Jackson and Ben Isaacson would both like to understand where global potash inventories stand in the various regions particularly in China.

Joc O’Rourke

Thank you, gentlemen. If we look at China there’s sort of a bifurcation of inventory. We know there’s about 3.5 million tonnes at the port. But we believe there’s relatively low inventories as we move inland. And so as we’re now seeing a strong demand for NPKs in the domestic market, we do expect that the movements out of the port to those NPK plants will start bringing down inventory levels assuming that the arrivals are about normal levels compared to last year.

Laura Gagnon

Mark Connelly and Steve Byrne are both interested in potash demand growth. What is driving the acceleration in potash demand in your forecast and other specific geographies?

Joc O’Rourke

Thanks. I wouldn’t say we’re actually forecasting an acceleration of potash demand. Our potash demand growth from a long-term trend is staying fairly steady at what we believe to be around 3%. And if you take 2019 out of it, I think we still stay just on that trend.

Laura Gagnon

In a related question if demand ends up toward the high end of your range, do you see increased supply balance in the market? Or would you expect the market to tighten?

Joc O’Rourke

Well I guess this requires two things. One the success of production ramp-ups on the new projects particularly I guess EuroChem’s, Volgakaliy and Usolskiy. But given the delays we’ve seen in recent years on these ramp-ups it would seem that the market should tighten actually if demand comes in at the high end of our expectation.

Laura Gagnon

And the last related question also what is the bull case for potash pricing over a three to five year period?

Joc O’Rourke

Thanks. There’s a number of factors that could create a bull run in potash prices. And the first, I’ve already mentioned which is slower ramp-up of the projects particularly the ones in Russia and Belorussia. But what we would really expect is probably a higher utilization rate of the North American assets over the next say three to five years and a more modest rise in prices. That would suggest prices appreciate slightly to where they were maybe in 2018 and utilization of assets goes up at the same time.

Laura Gagnon

Another potash related question from Adam Samuelson and Ben Isaacson. They’re both asking about the disconnect between pricing trends between Brazilian MLP that rallied off-loads in the second quarter versus U.S. and Southeast Asian MLP prices that have continued to be lower. Are strong Brazilian economics enough to offset this weakness in other regions?

Joc O’Rourke

Thanks. Brazilian farm economics are really outstanding at present which is certainly helping to underpin pricing in that market and we expect that to continue. For the U.S. and Southeast Asian markets, I think it’s important that remember that this is a seasonally slow period for potash demand and that will impact prices. I’d also like to highlight that our summer fill program was extremely well received. And it is typical of commodity markets to necessarily see first a rebound in demand and then prices following after that. We have now completed our pre-submitted questions.

And so now I would like to do is open it up to the audience for live Q&A. Operator?

Operator

[Operator Instructions] First question comes from the line of Adam Samuelson from Goldman Sachs. Your line is open.

Adam Samuelson

Yes. Thanks. Good morning, everyone. So I guess I wanted to just follow up on the affordability question Joc on phosphates. And on your own kind of affordability metric that you published were now above long-term average. And just trying to think about where you would see an upper limit to that? And especially, if you think about next year and farmer income risks from government support programs in the U.S. or lack thereof given kind of the big farmer support payments that have been experienced both this year and last?

Joc O’Rourke

Thanks Adam and welcome. There’s certainly a relationship between crop prices and how people feel about the imports. But as you say support payments from governments and whatnot have done a lot to keep farmer incomes at least stable. And yes, while we’re pushing phosphate and potash prices — probably not potash so much, but certainly phosphates a little bit closer to that ratio, two things on this I’d say is, first of all, you’ve got to look at December 2021 prices.

And if you look at December 2021 prices I think we — I think, we’d be looking at what $3.60 for corn and $9 for bean. So they’re going to see some reasonable prices on there if they sold forward into that market. So they’d be incented to get a good crop and use the fertilizer. But in terms of the direct relationship between the two, I’d say you could easily go a standard deviation above that ratio and not have it materially affect demand.

Operator

Thank you. Next question comes from the line of Steve Byrne from Bank of America. Your line is open.

Steve Byrne

Yes. I just wanted to hear whether or not you saw any impact on phosphate imports during the month of July following the countervailing duty petitions. And just ask for an update on your gypsum sales out of your gypstacks in Brazil. Any update on that?

Joc O’Rourke

Sure. Thanks Steve. First of all, yes, in July I believe the imports were low in July. I have to get an exact number and get somebody to get back to you on how much that was down. But our understanding — and we did talk to a lot of customers and our understanding is certainly the importers, who are importing either the OCP or the Russian products definitely took a step back to understand what the risks might be in terms of them picking up some sort of countervailing duty risk.

So we did see a step back in July. Whether they will come back into the market in the next couple of months I don’t know. What we have seen however is new products coming in from places like Egypt and Australia and Mexico. So it does say, there is some change. I got to ask somebody to give me what was the second part of your question there, Steve I missed in my writing.

Operator

Thank you. The next question comes from the line of Chris Parkinson of Credit Suisse. Your line is open.

Chris Parkinson

Great. Thank you very much. So you already mentioned you expect Chinese DAP exports should be down, I guess, 600,000 tonnes or so and that you don’t really expect a much on a year-on-year basis in terms of Tunisian availability, which is fair. But there have been a few mines over the last couple of years that were kind of in the process or the tail ends of the ramps in Morocco obviously Saudi even Turkey and Egypt. Do you believe that the phosphate market has really felt — has already felt the full effects of these previous ramps. And now we can just kind of isolate our thought process in terms of new supply on just the Moroccans and Saudis. Just what’s your kind of aggregate assessment of the SD over the next let’s say two to three years? Thank you very much.

Joc O’Rourke

Yes. Thanks, Chris. I think materially, it is all about what’s left of the Saudi ramp-up. And assuming, they reach their I think 2.7 million tonnes was their target for 2020 and there is some debottlenecking and other projects that OCP is expecting to do. I mean those are still yet to come but — and maybe a little bit of extra coming out. I saw PhosAgro has been exporting or has been producing a little higher number. So there could be some new tonnes coming out of PhosAgro. But for the rest of the world I would say basically the closures are more than offsetting any small ramp-ups that we’ve seen. And overall, it really is now coming down to small increases from the Saudis and then whatever Morocco brings in in the next couple of years with a little bit of addition from possibly from PhosAgro.

Operator

Thank you. No further question at this time.

Joc O’Rourke

Well if there are no other questions I’d like to first of all say thank you for the questions you brought in. We had a very good set of pre-submitted questions, which I thought was very healthy. But to conclude our call, I’d like to just reiterate our key themes here. Mosaic generated strong results despite low realized prices for our products. Our long-term transformation efforts are really starting to deliver substantial, structural cost savings and we expect to drive additional savings in the years ahead. Our balance sheet continues to strengthen as we paid down debt and generated strong cash flows. Fertilizer markets continue to improve and prices are rising. We are navigating the COVID-19 situation successfully with minimal impacts to our business

So in summary, Mosaic is more resilient and competitive than it has ever been and we have built significant earnings leverage for a rising price environment. So we are looking forward to continued improvement and continued success on our journey towards being a very competitive company. So thank you for joining the call. Have a great day, and we hope to talk to you in person soon.

Operator

Ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect. Have a great day.



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