CHS Inc. — Q3 FY2016 Form 10-Q
Reporting period: Quarter and nine months ended May 31, 2016. Unaudited results; dollars below are in millions unless stated otherwise. CHS is a diversified farmer-owned cooperative with Energy, Ag and Nitrogen Production segments.
Financial performance
| Metric | Three months 2016 | Three months 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $7,796.6 | $8,740.9 | $22,164.7 | $26,596.1 |
| Gross profit | $317.5 | $311.9 | $818.3 | $1,149.6 |
| Operating earnings | $148.1 | $146.5 | $316.1 | $651.5 |
| Net income attributable to CHS | $190.3 | $178.1 | $425.8 | $649.6 |
| Gross margin | 4.1% | 3.6% | 3.7% | 4.3% |
| Operating margin | 1.9% | 1.7% | 1.4% | 2.5% |
For the quarter, income before taxes rose 14% to $194.5 million, while revenue fell 11%; CHS-attributable net income increased 7%. For the nine months, revenue declined 16%, pretax income fell 41% to $407.9 million, and attributable net income declined 34%. Lower commodity prices reduced reported sales, while weaker margins drove lower year-to-date earnings.
- Segment results: Q3 pretax income was $109.4 million in Energy (up 31%), $24.2 million in Ag (down 61%), $25.0 million in Nitrogen Production, and $36.0 million in Corporate and Other (up 41%). For nine months, Energy pretax income fell 36% to $239.2 million and Ag fell 76% to $62.4 million; Nitrogen contributed $26.3 million, with no prior-year segment comparison.
- Cash flow: Nine-month operating cash flow was $262.4 million, versus cash used of $26.5 million a year earlier. Investing used $3,604.4 million, principally reflecting the $2.8 billion CF Nitrogen investment; financing provided $2,740.6 million. Cash declined to $346.4 million from $953.8 million at August 31, 2015.
- Liquidity: Working capital was $825.5 million and the current ratio 1.1, versus $2.8 billion and 1.5 at August 31, 2015. Management said operating cash generation and available revolving capacity should support operations for the next 12 months.
- Debt and capital: At May 31, notes payable were $3,336.9 million and current plus long-term debt was $2,625.3 million, approximately $5,962.2 million combined. Total equities were $7,866.6 million. CHS was in compliance with debt covenants. Net interest expense for the quarter increased to $26.7 million from $10.8 million; for nine months it increased to $49.4 million from $43.5 million.
Material changes and unusual items
- CHS invested $2.8 billion in CF Nitrogen on February 1, 2016, obtaining an 11.4% membership interest and an 80-year supply agreement. The investment generated $53.1 million in nine-month equity income. The investment increased assets and borrowing needs.
- Q3 Energy results included an $80.2 million noncash recovery of lower-of-cost-or-market energy inventory write-downs recorded earlier in fiscal 2016. CHS cautioned that further energy-price declines could cause significant inventory charges.
- Ag results were pressured by the downturn and lower margins; Q3 processing and food ingredients included a customer-specific bad-debt charge, and nine-month results also reflected asset disposal and receivable charges.
- Nine-month tax benefit of $17.8 million, compared with tax expense of $47.6 million in 2015, primarily reflected an IRS settlement. Effective tax rates were unusually low and differ with patronage and nonpatronage earnings.
- Prior-year comparative figures were revised for immaterial lease-accounting and cash-flow presentation errors. CHS stated the revisions did not materially affect prior periods.
Outlook, risks and contingencies
- Management described Ag and Energy as being in a down cycle, with reduced commodity prices and lower global margins; duration and severity were uncertain. CHS expected revenue, margins and cash flows to remain under pressure and planned to hold overhead costs flat and reduce capital investment through fiscal 2017 and into fiscal 2018.
- Fiscal 2016 capital expenditures were expected to total approximately $836.5 million, including $384.9 million for refinery property, equipment and major repairs. Major refinery projects included the completed McPherson coker replacement and an expansion expected to finish in early fiscal 2017.
- Key exposures include commodity-price volatility, weather and crop conditions, seasonality, customer credit, and volatile renewable identification number (RIN) costs under the Renewable Fuels Standard. CHS said the latest RIN mandate price increase had not materially affected results.
- Guarantees for related nonconsolidated entities totaled $114.4 million outstanding under a $1.0 billion permitted maximum; management did not expect a payout. The MDEQ proposed a $90,000 penalty concerning sulfur dioxide emissions at the Laurel refinery; CHS accepted the revised proposal in April 2016.
- Disclosure controls were considered effective. A new ERP system was being implemented over several years and requires significant resources; management was adding controls as implementation proceeds.
Important facts for investors to verify
- Whether operating cash flow and credit availability can sustain liquidity as cash balances have fallen and short-term borrowing increased.
- Debt levels, interest costs, covenant headroom and refinancing needs after financing the CF Nitrogen investment.
- Whether Energy inventory reserve recoveries, refining margins and commodity prices materially affect future earnings.
- Whether Ag margins, customer receivable exposures and the identified bad-debt items improve or deteriorate.
- CF Nitrogen distributions, equity earnings and supply-agreement economics, including the long-term nature of the arrangement.
- Actual fiscal 2016 capital spending and progress on refinery projects, alongside management’s stated investment reductions.