Albemarle Corp (ALB) — Q1 2018 Earnings Call Transcript

Thank you, Jasmine, and welcome everyone to Albemarle's first quarter 2018 earnings conference call. Our earnings were released after the close of the market yesterday, and you'll find our press release, earnings presentation, and non-GAAP reconciliations posted on our website under the Investors section at www.albermarle.com. Joining me on the call today are Luke Kissam, Chairman and Chief Executive Officer; Scott Tozier, Chief Financial Officer; Raphael Crawford, President, Bromine Specialties; Silvio Ghyoot, President, Catalysts; and John Mitchell, President, Lithium. As a reminder, some of the statements made during this conference call about the future actions or performance of the company as well as lithium demand may constitute forward-looking statements within the meaning of federal security laws. Please note, the cautionary language about forward-looking statements contained in our press release; that same language applies to this call. Please also note that our comments today regarding our financial results exclude non-operating, non-recurring, and other unusual items. GAAP financial measures and reconciliation from those to the adjusted numbers discussed today may be found in our press release and the appendix of our earnings presentation, both of which are posted on our website. Finally, as announced during the third quarter 2017 earnings conference call, we are now reporting segment revenues and earnings in a new format. Performance Catalyst, which previously had been consolidated with Lithium, is now consolidated with Refining Solutions in a segment titled Catalysts. Please refer to our 8-K filing of March 12, 2018 for the restatement of segment revenue and earnings in prior periods under this new reporting format. Also note that most external databases that provide consensus earnings estimates have not yet updated their estimates for this new segmentation format. Now I'll turn the call over to Luke.

Thanks, Eric, and good morning, everyone. I'm very pleased with our start to 2018, which highlights the growth of our Lithium business, the strong cash generation of our portfolio, the strength of our balance sheet, and our ability to successfully execute our capital expansions in Lithium. First quarter net sales grew by 14% and adjusted EBITDA grew by 18% over the prior year. Lithium delivered double-digit adjusted EBITDA growth of 31%, and both Bromine and Catalysts delivered solid results with strong cash flow. Our adjusted diluted earnings per share grew by 24% compared to the prior year. Consistent with our efforts to manage the portfolio and maintain a strong balance sheet, we closed on the sale of our polyolefin catalysts and components business to W.R. Grace for a sum of $416 million on April 3. Our lithium capital projects remain on track at planned spending of between $550 million and $675 million for 2018. Page 6 of the earnings presentation deck outlines the progression and timing of expansion plans for carbonate and hydroxide conversion capacity. Let me provide a brief update on that project. We were in the construction phase for the Xinyu II lithium hydroxide expansion in China and plan to commission the plant in early 2019. During the second half of 2018, we expect to make electrical tie-ins in La Negra relating to the expansion. La Negra II is on track to reach nameplate run rates in 2019, and we have moved from engineering to construction for the La Negra III and IV lithium carbonate expansion. We still expect to commission La Negra III in 2020. In the Salar de Atacama, by the end of the fourth quarter 2018, we expect to reach the full pumping rate of 442 liters per second, which is the rate needed to supply the additional capacity in 2020. Engineering activities have commenced in Kemerton, Australia for a new lithium hydroxide plant, with expectations to commission the first 40,000 metric tons in 2021. During the past quarter, we received approval from CORFO to increase our lithium production quota in Chile to as much as 145,000 metric tons of lithium carbonate equivalent. In parallel, we progressed the engineering for our prime yield enhancement project in the Atacama and began feasibility work for additional lithium carbonate conversion capacity in Chile. Now let's look at lithium demand. During the past quarter, we outlined the assumptions behind our view of electric vehicle and lithium growth that we expect to result in a global market of over 800,000 metric tons on an LCE basis by 2025. Those assumptions are on page 7 of our earnings presentation deck. We continue to see validation of these demand assumptions. During the past few months, for example, both Volkswagen and Volvo made commitments to significant electrification of their vehicle fleet by 2025. These recent announcements are good indicators of not only the size of the investments along the value chain but also of the timing. Commitments throughout the supply chain are now being made for 2025 supply. I'd like to use Volkswagen's announcement as an illustration of what's happening in the supply chain. To reach their targeted sales of 2 million to 3 million electric vehicles by 2025, Volkswagen announced that they expect to invest about $25 billion. Volkswagen will convert 9 production lines to electric vehicles by 2020 and another 7 lines by 2022, for a total of 16 electric vehicle production lines. Volkswagen plans to contract for approximately 150 gigawatt hours of battery capacity per year to supply those lines. They have already awarded about $25 billion in battery contracts and expect to award additional supply contracts soon. Battery cell producers are expected to invest between $9 billion and $12 billion to meet this 150-gigawatt-per-year supply commitment for Volkswagen. To put this in perspective, Tesla's Nevada factory is targeted for 35 gigawatts of capacity at full rates. Using our assumptions for lithium intensity shown on page 7 of the earnings presentation deck, 150 gigawatt hours equates to roughly 140,000 metric tons of new lithium capacity. That's equivalent to about two-thirds of the 2017 global demand of about 220,000 metric tons. And this is for an OEM which had about 11% of the global auto market share in 2017. Now, Volkswagen may or may not hit their 2025 electric vehicle target, but the point of this illustration is that companies in the supply chain need to lock up commitments for each critical raw material to meet this type of targeted growth. This dynamic should benefit lithium producers for years to come. Albemarle has a track record of being able to build and operate large-scale production facilities that provide a reliable supply of high-purity derivative products. That track record, combined with our technical expertise and our ability to fund growth, makes us an ideal partner for the OEM supply chain. Others have tried to enter this supply chain in the past. To date, only the majors have consistently demonstrated an ability to supply the volume and the quality of electric vehicle-grade lithium required by the global OEM supply chain. Before I turn the call over to Scott, I'd like to emphasize that our lithium expansion plans are not about market share gain. In fact, we expect this full implementation of our capacity expansions will result in Albemarle only maintaining its market share. Our strategy is to build up capacity to meet long-term commitments to our customers with floor price economics that provide a strong return to our shareholders.

Thanks, Luke, and good morning, everyone. In the first quarter, we reported adjusted diluted earnings per share of $1.30, an increase of 24% compared to the first quarter of 2017. The increase was driven by an adjusted EBITDA increase of $31 million or about $0.21 per share from our Lithium business. Lower corporate costs and favorable foreign exchange contributed about $0.08 per share. We continue to expect our 2018 effective tax rate, excluding special items, non-operating pension, and OPEB items, to trend toward the lower end of the previously provided range of 23% to 24%. Operating working capital ended the quarter at 26.3% of sales, an increase from the fourth quarter of 2017. Capital expenditures during the first quarter were $132 million and will continue to ramp during 2018, reflecting growth capital deployment in our Lithium business. We continue to expect full-year CapEx to range between $800 million and $900 million. Net cash from operations was $122 million, which was about 50% ahead of the first quarter 2017, and we still expect to end 2018 between $660 million and $730 million, more than double our 2017 results. And finally, currency exchange rates compared to 2017 were a tailwind to adjusted EBITDA of about $6 million in the first quarter. Our 2017 average rate was just over $1.12 per euro and Q1 2018 averaged about $1.22. Now, moving on to our business performance. Lithium sales increased by 38% compared to the first quarter of 2017 and adjusted EBITDA increased by 31%, with adjusted EBITDA margins of 44%. Volume growth for the first quarter was 19%, with pricing improving by 14%, driven by the increasing demand from our contracted customers. All of our conversion facilities are operating at maximum rates, as we work to bring additional capacity online. In Bromine, first quarter sales of $226 million and adjusted EBITDA of $70 million were up 3% and 2%, respectively compared to the first quarter of 2017. Adjusted EBITDA margins were strong at 31%. Sales growth was driven by moderate price increases, partially offset by freight and raw material costs and by lower volumes caused by constraints in elemental bromine, which we expect to continue through Q2. The market for flame retardants, primarily in electronics, automotive, and construction, remained solid. Catalysts reported first quarter net sales of $261 million and adjusted EBITDA of $68 million, resulting in adjusted EBITDA margins of 26%. Year-on-year adjusted EBITDA was negatively impacted due to a shortage of raw materials used in curatives and lower volumes in hydroprocessing catalysts, or HPC catalysts. The decline was partially offset by gains in volume and price for fluid catalytic cracking, or FCC catalysts, which were both up about 2%. And just as a reminder, Q1 included around $11 million from the polyolefin catalysts and components business that won't continue in future quarters. Now, I'll turn the call back over to Luke.

Hey. Thanks, Scott. As we look to the rest of 2018, Lithium remains on an aggressive path to deliver at least 20% adjusted EBITDA growth during 2018. We expect second quarter Lithium second quarter EBITDA to be sequentially stronger than Q1. Further, we anticipate the second half of 2018 that is fairly equal to the first half of Lithium, with Q3 possibly weaker than Q4 due to downtime needed for the La Negra tie-ins. In Catalysts, we continue to expect good EBITDA growth in our Refining Solutions business. However, curatives is expected to face pressure as a result of raw material challenges, which could unfavorably impact EBITDA by as much as $10 million for the full year. As a result, we expect full-year adjusted EBITDA growth for the Catalysts segment to moderate to the mid-single digits. The favorable market trends in flame retardants are anticipated to continue in Bromine Specialties. And with the exception of the first half capacity constraints for elemental bromine and some derivatives, our plants continue to run very well. Pricing and operational efficiencies are currently expected to offset higher costs for raw materials, freight, and distribution. We now expect full-year adjusted EBITDA growth in the low- to mid-single digits on a percentage basis. The upside in Bromine Specialties is expected to offset the headwinds in the curative portion of Catalysts. From a longer-term perspective, we believe that Albemarle stock is currently undervalued. Hence, subject to market conditions, we intend to buy back $250 million of stock via an accelerated share repurchase program that was recently approved by our board. After completion of that program, approximately 10 million shares would remain under our current authorization, leaving ample headroom should we deem additional action to be warranted. The strength of our balance sheet, combined with the operating cash flow from our businesses, gives us the confidence that we can take this action, execute our capital projects, maintain our long-term debt-to-EBITDA ratios, and still have plenty of firepower leftover. In fact, absent any further corporate actions such as M&A or additional stock buybacks, we would expect to end 2018 at a net debt-to-EBITDA ratio of around 1 times. Given all of this, for the full-year 2018, we now expect adjusted EPS to be between $5.10 and $5.40. I am confident that Albemarle is well-positioned to maximize shareholder value in the short-, medium-, and long-term. We have a clear and straightforward strategy, grow our Lithium franchise, leverage our strong cash flow from Bromine and Catalysts, and deliver strong margins and returns on our capital growth investments. We believe we have the people, the balance sheet flexibility, and the focus on execution to drive strong and profitable growth over the foreseeable future.

Jasmine, that concludes our prepared remarks. We're now ready for Q&A.

Hi. Good morning. This is Dylan Campbell on for Bob. Could you help bridge us to this two-half 2018 Lithium EBITDA being flat relative to first-half 2018, I guess, taking into account what I would presume to be higher volume levels in 2018? And I guess, what would especially offset those higher volumes in the second half of the year?

Yeah. Hi, Dylan. This is John Mitchell. Yes. So, for the second half of the year, I mean, we have baked into the second half what we think we have in terms of production. And also, on the pricing side, our guidance hasn't changed with regard to full-year price effect of the high-single-digit pricing. As we see more capacity coming online, we can adjust our expectations and guidance going forward.

Got it. Thank you. And then, I guess, after completing the sale part of the PCS business in April, can you update us on, I guess, your strategic or your long-term strategic plans for the Catalysts and Bromine businesses, and how they fit into your long-term strategic plans of the consolidated business?

Sure. This is Luke. As we've talked about how each piece of this puzzle fits together, we need the free cash flows from the Bromine and Catalysts business to be able to fund the capital that we see in the growth of Lithium. Lithium today doesn't free cash flow in and of itself with the investments that we have. So we look at it and all those pieces fit together. Now, there'll be a point in time in the future where we'll continually assess that portfolio to determine if that is the best path to drive shareholder value. We've not hesitated to make portfolio adjustments when we thought we could drive higher shareholder value by doing so, and we would continue that assessment on an ongoing basis.

Hi. This is Scott Goldstein on for P.J. Good morning. I'm looking for more color on within pricing. It just seemed a little more modest than what your competitors realized. Can you maybe break out how much of the growth was from a change in mix and how do you expect that mix to change for the remainder of 2018 and perhaps 2019?

Hi. This is John. So, in terms of the product mix, most of our incremental additional volume is on the carbonate side. But I think the difference in pricing philosophy between the different lithium companies is really what's driving differences in pricing guidance. Again, our focus on long-term contracts, we have certainly clear visibility in terms of the value of the products that we're selling to customers. We want to make sure we're taking a fair and balanced approach with our customers, who are the leading cathode and battery producers of the world. And we are fixated on making sure that we have an excellent risk-adjusted return on our investments. And so our pricing guidance is essentially what's baked into our long-term agreements. So, we have good visibility in terms of our approach to pricing. The other benefit in terms of our approach is that we don't see risk in terms of pricing going down. So we have good visibility in terms of stability of the pricing. And we do not expect our prices to be volatile in terms of going down versus others in the lithium space have a different approach in terms of maybe trying to play spot market pricing and other ways to look at pricing in the market.

Okay. Thank you. And maybe just a follow-up. So I think a little more than 80% of your lithium volumes are committed through long-term contracts. Can you just remind us how that trend has changed maybe over the past year? And are you seeing more demand for longer-term contracts in your negotiations currently?

Yeah. Great question. In 2018, I'd say actually almost 100% of our volume is under long-term contract. We had moved our customer base to three- to five-year agreements and now we see a strong pull from the leading providers of batteries and cathodes to go to as long as 10-year agreements. And the rationale for that is really around security of supply. And not just security of supply of any type of molecule, but security supply of an EV grade that meets their specification for a battery that they can make a 10-year warranty on. So I think we have selected a really great basket of leading providers in the cathode and battery space, and we're working together to plan the investments in lithium capacity for EV-grade batteries and they're planning to produce more cells for the OEMs. So we see our long-term agreements getting longer toward 10 years.

Hey, this is David Huang here for David. I guess, first on Lithium. Can you talk about maybe your updated views on lithium hydroxide versus carbonate? I guess, you previously said you wanted to be in both, but is there an increasing preference for one with the other? And also, if you have any views on vertical integration and further consolidation in the sector?

Okay. I will let John take the first and then I'll talk about consolidation.

Thanks, Luke. So, with regard to preference on carbonate and hydroxide, again, the largest battery and cathode producers, depending on the type of battery that they're producing for the specific application, they have a demand for both carbonate and hydroxide and they're able to forecast for both types of molecules. Of course, in terms of increasing energy density, there are many battery producers that are going to hydroxide in order to go to the high nickel-based or high metal-based cathode materials. So we do see, on a percentage basis, higher growth in hydroxide. But our long-term agreements have both carbonate and hydroxide in them, and we don't see a decrease in demand for carbonate. We just see an acceleration of demand for hydroxide.

Yeah. And if you look at consolidation, I think that there's a lot of noise out there in the marketplace about consolidations up and down the value chain. And I think that just gives a signal to how tight it is and how people are scrambling to get the supply that they need in order to make their commitments throughout the chain. So we're consistently looking, and we believe we sit on the best resources in the world in Salar de Atacama and in our site in Western Australia. We have untapped resources in Kings Mountain, North Carolina as well as an option for resources in Argentina. We feel great about where we are from the geographic diversity as well as the brine and rock balance, where we can go carbonate or hydroxide as the market dictates. So I think you're going to see continual discussion out there in the marketplace about suppliers lining up with our customers and their raw material suppliers. But we love the spot we're in with our resources and with our customer contacts. So we feel like we're partnered in the right area. And if those decisions should change and there would be an opportunity, as I've said before, our balance sheet gives us plenty of firepower to take actions that could strengthen even further our portfolio in the Lithium business.

Okay. Good morning. This is Silvio. Thanks for the question. As you know, the price increase for FCC is an ongoing exercise. It's never finishing. But I can confirm that right now we're getting traction. One hand, it's still based on the philosophy that we are trying to get the right price for the value we are providing to the refiner; and on the other hand, the efforts to offset the inflationary pressure that we are facing. But the prices are holding.

Thank you and good morning, everyone. Just a clarifying question and maybe it relates to the 3Q La Negra costs. I don't know if you can size those for us at all. And I assume the answer is yes, but do you still expect Lithium margins for the full year to be up 40%? I just ask because it came out of this quarter's slide versus last quarter's.

Yeah. From a Lithium margin standpoint, we still believe that full year will be above 40% from a margin standpoint. We've not laid out what the costs are in that third quarter, but we have an opportunity to come in and make tie-ins for that site overall that we're going to need to do at some point in time. As I said in my prepared remarks, we're going to be able to pump at full rates in the fourth quarter. We think it makes sense for us to go ahead and make this tie-in now, so that whenever that brine we start pumping at full rates, those ponds get filled up, we won't have to do it later during 2019 or 2020 when we'll have the full brine. So we believe it's prudent to do that. It's just a movement between quarters. It's not going to impact the year in any way, but it could make third quarter weaker than the fourth quarter. So, that's why we brought it up and let you guys know about it, Vincent.

All right. Very helpful. And just a follow-up on the now longer tenure contracts that you have, is there anything different about – and I know this is sensitive, but anything different about the terms versus the existing contracts? And I guess, in particular, is there any sort of take-or-pay component to these longer contracts or anything different about your ability to adjust price or anything like that that you can share?

Yeah. Philosophically, we've kept the same approach that we have on contracts; the bigger difference is, it's a whole lot more volume.

Hi, guys. This is Dan Rizzo on for Laurence. How are you?

Well.

Okay. Are you referring to the gasoline standards?

Yes. Correct. The marine...

Okay.

Marine.

Oh, the marine fuel. Well, I'll try to stay brief on that one. There is a large amount of fuel oil that could not be used anymore in 2020 when those standards are coming on and there are different tracks to address this. One could be that you have scrubbers in the boats which you cannot install overnight. So there will be a requirement of an additional amount of diesel or hydrotreated mid-distillates that is being added to this pool of marine fuel, so to dilute the specs and to have for the next couple of years the boat sailing on not necessarily pure heavy fuel but on blended fuels. That's one of the ways to get there. Like I said, the other one is a big infrastructure to clean the fuels on the boat. The future will tell us which direction it will ultimately be, but we can be firm that there will be an additional amount of diesel required around the 2019-2020 period and maybe the year thereafter to address that sudden change in specification.

So, Silvio gave you the detailed answer. At a high level, any time there’s a regulation that tightens up the specifications from a diesel standpoint, it benefits the hydrotreating part of our business. So we would expect that to be positive news for our HPC business and clean fuels.

Thanks. Good morning. Maybe you can just give us an update on – appreciate the update on demand and maybe you can just give us an update on what you're seeing on the supply side as well. There were some issues with weather earlier this year in Latin America and Chile and Argentina. Was that effective negative for you guys or not? And then, secondarily, maybe just update on your projects as well as what you're seeing from competitors. Thanks.

Okay. Thanks. This is John. With regard to the weather comment, no impact on Albemarle operations with regard to weather so far in 2018. We've also taken some added steps as mitigation in the event there are any rain events, particularly in the Atacama. So I think we're well-prepared. With regard to the overall supply dynamic in the marketplace, in 2018, it's as expected, as we track all the projects around the world. Going forward, beyond 2018, nothing new that changes our supply-demand outlook. As we look at the materials that are required for our customers, which are EV grade, performance materials, carbonate and hydroxide, we feel that the market remains in balance through 2021 and don't see any increase in supply that gives us any concerns in terms of oversupply dynamic, et cetera. Even if there were issues with regard to oversupply, we have long-term agreements that do not affect Albemarle in terms of its own supply-demand dynamic, as we are contracted with the market leaders going forward. So you're not going to see any impact regarding supply-demand dynamic in Albemarle's pricing.

Great. Thanks. And as a follow-up, there has been recently some plateauing it looks like in carbonate pricing. So, I guess, the right read is we shouldn't assume that impacts you. And even so, maybe just describe what you think that resulted from between carbonate and hydroxide pricing? Thanks.

In terms of the marketplace and the differences between carbonate and hydroxide, hydroxide has always been sold at a higher price, given the cost build-up of hydroxide versus carbonate. Certainly, around the world, as different producers are going into new resources, the cost structure of their products will change. Because every natural resource around the world is different, the cost to mine, the cost to extract, the cost to refine and the cost to make a specialty product is going to vary. So, looking back in terms of historical norms is a little bit faulty as we go forward and we're bringing on more and more capacity. I don't think that there's going to be any kind of – I don't know if you're alluding to the contraction in terms of hydroxide and carbonate price. We certainly don't see it. And again, our pricing models are based on pricing to value, and also pricing to the specific terms and conditions in terms of our long-term agreements.

Thank you. Good morning, everyone. I think during the fourth quarter earnings call, you were talking about high-single-digit lithium price increase expectations for 2018. Has this changed in any way?

No. It's not changed. What you're seeing, we're higher in the first quarter, but as you go through the year, it'll be lower on a year-over-year comparison. So we'll end the year about where we thought we would.

Thank you, Luke. And Xinyu II 20-Kt hydroxide commissioning in 2019, is there a qualification period or a ramp period? So, in practical terms, how should we think about EBITDA contribution at a full rate? Is it by the middle of 2019, by the end of 2019?

Yeah. This is John. Yeah. You should think that there is a qualification period for Xinyu II. So as we start commissioning and producing product at quality, then we have to shift quantities to our customers and they're going to have to qualify that production facility. And so I think you should look at mid-2019 in terms of getting the full rates.

Thanks so much. What are you seeing in terms of the number of potential customers for lithium versus a quarter ago or two quarters ago? Are you seeing an increase, decrease, kind of flattish, just in terms of volume of customers?

Yeah. It's about the same number of customers from a material standpoint; there have been definitely new entrants into that cathode production. We're dealing with the big players and it hasn't changed over the last 12 months.

Okay. And then, in terms of moving volumes around and customers taking all the volumes, are you seeing any movement from one customer to another customer or folks not taking volumes or asking for incremental volumes versus their contracts on a regular basis?

Yeah. It's all of the math. As a general rule, we haven't seen a customer who's not saying we don't want what we've committed. All our customers are saying we want more.

Hi. Good morning. One of your bromine competitors talked about today that they've been signing one-year contracts for the derivatives and for elemental bromine at double digits.

We have lost.

I think we lost, Jasmine. I don't know whether or not you may want to go into the next question. Maybe just add him.

Good morning. This is Pete Osterland on for Jim. What is the raw material involved in the shortage for curatives? And, broadly speaking, who are the main buyers of the impacted products?

Good morning. This is Silvio. If you see that our curatives are all based on toluene diamine, so it's pretty easy to figure out what the shortage is. It has to do – there are a handful of major producers of this material in the world and the shortage is caused by the major turnaround and changes in the upstream manufacturing facilities. So it's something that is temporary. And like we have in our earnings call, we are expecting that it will have an effect of $10 million-ish on a yearly basis.

Jasmine, is that all we have in the queue?

Okay. Thank you, everyone. We appreciate the questions and look forward to visiting with many of you over the coming quarter. Jasmine, we can end the call now.