Celanese Corp - Series A (CE) — Q1 2018 Earnings Call Transcript

Thank you, Steven. Welcome to the Celanese Corporation First Quarter 2018 Earnings Conference Call. My name is Surabhi Varshney, Vice President, Investor Relations. With me today are Mark Rohr, Chairman and Chief Executive Officer; Scott Sutton, Chief Operating Officer; and Scott Richardson, Chief Financial Officer. Celanese Corporation's first quarter 2018 earnings release was distributed via Business Wire yesterday after market close. Slides and prepared remarks for the quarter were also posted on our website in the Investor Relations section. As a reminder, some of the matters discussed today and included in our presentation may include forward-looking statements concerning, for example, our future objectives and plans. Please note the cautionary language contained in the posted slides. Also, some of the matters discussed and presented include references to non-GAAP financial measures. Explanations of these measures and reconciliations to the comparable GAAP measures are included with the press release and on our website in the Investor Relations section under Financial Information. The earnings release and non-GAAP reconciliations have been submitted to the SEC on Form 8-K. The slides and prepared comments have also been submitted to the SEC on a separate Form 8-K. This morning, we'll begin with introductory remarks from Mark Rohr and then open up for your questions. I'd like to turn the call over to Mark now.

Thanks, Surabhi, and welcome to everyone listening in today. I’ll begin with just a few highlights before opening the call for your questions. For the quarter, net sales rose 26% year-over-year and 16% sequentially to $1.85 billion. With strong pricing and volume support, we are pleased to announce GAAP earnings of $2.68 per share and adjusted earnings of $2.79 per share. Engineered Materials, Acetate Tow and the Acetyl Chain, as well as our affiliates, all reported strong results, continuing the trend that’s been underway for some time. Adjusted EBIT margins expanded by 300 basis points, achieving record operating EBITDA of $553 million and EBITDA margins of 30%. Engineered Materials reported net sales of $655 million, supporting record segment income of $118 million, driven by projects, acquisitions, and higher sales in Asia. Volume increased 19% year-over-year and adjusted EBIT margins for Engineered Materials came in at 27%. Affiliate earnings grew 26% year-over-year to $54 million. We saw strong growth in Asia and we commercialized over seven reported new projects this quarter. The Acetate Tow segment income in the first quarter was $78 million, which declined a bit year-over-year as unique carryovers in the first quarter of 2017 could not repeat themselves. The Acetyl Chain grew 32% year-over-year and 18% sequentially, reporting net sales of $1 billion for the quarter and record income of $253 million. Modest but consistent demand growth and high regional supply dynamics helped lift pricing and generate the significant growth in earnings. Margins expanded to 24%, more than 400 basis points sequentially, with strong asset and derivative pricing in all markets. For the rest of this year, we expect Engineered Materials to build on this success with more than 3,000 project wins, additional bolt-on acquisitions, and continued growth in Asia. Earnings in Acetate Tow should step down slightly next quarter and remain at that level through the year. Consistent demand growth and business fundamentals through the Acetyl Chain should support earnings growth through ’19 and ’20. Given the strong performance in all these businesses, we increased our expected guidance for adjusted earnings per share to the 20% to 25% range over 2017. With that, I’ll now turn it back to Surabhi.

Thank you, Mark. Steven, please open the lines for Q&A now.

Regarding the contribution from acquisitions to Engineered Materials, I understand that it wasn't broken out specifically and is included in the overall volumes. A few quarters back, you mentioned that you expect acquisitions to increase over time as they provide more to achieve your goals. Can you provide some insight into how much additional capacity you have in Engineered Materials or what kind of investment cycle is needed to support the growth in volume you're experiencing?

Along with those acquisitions, did come the ability to easily expand capacity without much capital, and we’re in the process of doing that and we still have some available. However, at the same time, we have a number of investments going on in both compounding and at least one polymer expansion that are underway this year and we expect more in the future. So we’re doing both organic expansion and extending the capacity that we acquired through acquisitions.

And that fits Laurence within the $300 million to $350 million of capital that we projected for the next several years in previous calls.

And then secondly, can you update us on your thinking on the Chinese environmental tightening and the related shutdowns, in particular how you’re considering the tailwind from ’18 into ’19 and ’20? Do you see it subsiding, or what do you see as the longer-term trend for the Acetyl’s business?

So I think if you think about the Acetyl’s business, you have to take a long-term view and think of slow rates of change. We have a business that is growing 2% or 3% per year, maybe accelerating a little bit, so maybe 3% or 4% right now with that kind of percentages per year. If you look back at the cycle, we probably peaked out with shelf capacity somewhere around 2011. There was a big build-up in China around 2008, '09, '10 when money was free, and we wanted to convert coal as well, which is easy for China. Since then, capacity has been relatively flat and we’ve seen creeping capacity utilization build. Imagine at a 2% or 3% decline in that capacity over time; that’s the available capacity. Currently, we’re operating around 80% on average, and a short-term increase may happen, potentially to 83%, 84%, or 85%, which is achievable. Long term, we think a 5% capacity reduction is possible as the regulations run their course over the next three to four years.

Are you implying that you need to add capacity, I mean just as a clarification?

I think we are adding incremental capacity. From my point of view, as we move into the next decade, we will see capacity addition, but it’s a long way out. Today, I think what I’m seeing is incremental capacity as a way to go. You can also look for ways to bring more into the market. The tightness is going to be with us for a while.

Mark, in Acetyls following to Laurence’s question. What is the normalized earnings rate here absent the Q1 beneficial from the outages? And I think you said did you say you expect to see rates increase 10% in the industry going forward? So based on that, how should we think about normalized earnings power in Acetyls over the next two to three years?

We're going to go into a lot of detail on it in a few weeks, and I don’t want to steal the thunder of that. We don’t have a normalized earnings overview of that business; that earnings should grow and should continue to grow for a good while. A lot of people view this business as cyclical, but it's had only one cycle in the last 18 years by my math, and demand has been pretty consistent. We think we’re moving back to a high capacity utilization scenario. But we have to be very cautious about projecting this business as there’ll be subtle movements in pricing and incremental volumes, and that will moderate as we progress through the year.

And just on Acetate Tow, Mark. Is there a plan B now, post the JV not going through?

Yes, we have a plan B, too. We have plan B, C, D we’re working on. We said it’d be flat; we’re putting forth plans to keep it flat through this next planning cycle through 2020. We will share that when we get to the next meeting in a few weeks.

Just to follow up on the Acetyls and the question about normalized results, do you have any insight on the impact of the tight market conditions in Acetyls during Q1? Congratulations on your new role, Mr. Richardson. What do you estimate the benefit was from the strong market conditions? There’s $231 million that surpassed previous estimates; would you attribute $50 million, $60 million, or $70 million to the short-term gain during the quarter?

I don’t know if we’ve looked at that. I am looking at Scott. I mean, the machine produced that number, and without the flexibility, adaptability, and a long-term contract with cost-plus basis, I’m not sure what it would have been. It would have been significantly less.

Frank, I would just add that what’s going on here is you do see the fundamentals improving, and like Mark said, those fundamentals are going to continue to improve over the next few years.

It’s interesting that you’re expecting Acetyl up in 2019 after setting up a very difficult comp for the first quarter. Obviously, there isn’t a great expectation for you that that will continue to improve on an operating basis. And if I could, free cash flow obviously was on the light side here in the first quarter. How should we think about the cadence of free cash flow to get to that over $900 million for 2018?

We expect that to catch up through the year. What we saw in the first quarter was really just the timing of collection; about 40% of our Q1 sales occurred in March. So just from a timing standpoint, a lot of that collection pushes into April. Mark talked about the strength we saw in Asia, and we have slightly longer terms there, which plays a role. Additionally, we had a little bit of increase in CapEx to support the growth in the businesses. Those are really the reasons for where the free cash flow number came in Q1, and we expect to catch that up as we move through the year.

I just want to go back to Acetyls one more time. I think you mentioned that you were hinting that this business should continue to grow into 2019. But in your prepared remarks here, you’re saying that margins were 24% and you expect 20% margins for the year. That implies some giveback in the second half. Can you just talk about that?

We had a 24% margin in the quarter, and that was up 400 basis points over the prior quarter at 20%. We’re trying to range by this. Normalized margins for us might be between 24% and 20%. As we transition, we have a little bit of volume pullback getting through the year. We have planned turnarounds, which is a $30 million hit, and these fluctuations can occur. So those things do happen but over long-term stability, they don't significantly impact the overall numbers.

And now that the tow unit's call off, one of your competitors is taking tow into other products like fibers. I was wondering if you can talk a little bit about that. Are there any plans to shut down any capacity?

We’ve gone over this previously. There are some competitive actions but we’re not planning to move into that space. We focus on other applications and innovations that push more towards the polymer side and film sides, which have a lot of exciting developments. We have strong performance in the China market and expect to maintain stable earnings through the years ahead.

When you guys contemplated Strategy 3.0 for the EM business, do you anticipate you can continue to achieve those high single-digit organic volume growth rates? What more do you need in that toolkit, either from a product or geographic standpoint? And can you talk about the staffing needs as you continue to grow that business so aggressively?

Over the last three years, we’ve grown earnings year-over-year by a significant amount. Our focus is on growth, as you’ll see more in the future. We believe in our project model and have strong plans to improve efficiency. Our growth metrics show that this business has a solid trajectory, and we will continue to innovate and expand.

We’re optimistic about the growth potential, and we have the right resources in place. The number of projects we get wins on is key to our growth. We’re looking to expand our solutions set, which will include opportunities for bolt-on acquisitions.

The focus on efficiency will enable us to grow without proportionate resource addition. We’re just scratching the surface of our capacity to optimally increase our competitive positioning.

Mark, could you touch on the overall macro? You called China as a driver for both Engineered Material and Acetyl. What about the other regions? How would you characterize global growth as we see it today?

From a high level, the entire world is doing well. We have strong business in the Americas and are improving our footprint across the region. Europe is doing exceptionally well with great innovation and connectivity to OEMs driving growth. Japan is stronger, and the engagement with OEMs there is translating to business success. China, in particular, is improving considerably with our initiatives.

And just a second question, last quarter you pointed toward the legacy consumer specialty segment being flat on an EPS basis for 2018. Do you still think that will be the case in the context of re-segmentation of food?

We’ve been managing the Acetate Tow business carefully and intend to keep it flat. The market scenario indicates proficiency in managing earnings, despite gradual declines. We will look to maintain this stability with a precise medium-term outlook.

Mark, considering Engineered Materials, you’ve doubled the business since the last downturn, and you think about the pace of acquisitions potential. What do you see as the potential to grow this business over the next three to five years?

We have a very broad pipeline with many acquisition candidates. We’re engaged with a considerable number annually, and we’ve been successful in aligning with our strategic goals. We will focus on polymer-based initiatives for future growth.

The opportunities for growth are immense. We see significant room for acquisitions and expansions. Our priorities will remain with efficiency and optimality, enabling sustainable growth without the need to drastically increase resources.

Could you provide more details on Ibn Sina, which started up early this year? How will that develop throughout this year, and what is the timeline for the plan to be fully implemented? Additionally, could you clarify the increase in ownership versus the increase in operating rates this year? Will this trend continue into the first half of next year?

We’ve started up that plan expansion and have been withdrawing volume from it considerably. It’s expected to take until the end of this year to reach capacity. The earnings will be steady and not dramatically shift due to scheduled turnarounds.

And if you could just comment on Slide 9, you talked a little bit about free cash flow from that slide. Can you talk about just cash flow from operations, the big step down each of the last two years from that base of high 200s, and what’s in a way of that cash flow?

Duffy, it’s really just timing for us. We’re targeting greater than $900 million for the year. We’re poised to collect that in the coming quarters. Strength in the core business leads us into the second half of the year, and we expect positive progression in cash flow.

With the benefit from trading activity and acetyls above normal in the quarter, Eastman didn’t come back until the start of the quarter. So I would imagine opportunities for trading were high at the start of the quarter.

I think our activity in the early year was more price-oriented than volume-focused. We did trade some, we did move third-party volume in that period. Expect to see some pricing continue into this quarter.

And then you mentioned there may still be opportunities to extract further value. The Blackstone deal had operational synergies, but do you think you could still find a path to deconsolidate without some merger deal?

It’s harder to navigate the EU landscape for deconsolidation. The implications of overlapping activities hinder some opportunities, so we’ll need to find alternative routes forward.

I understand the first quarter free cash flow dynamics, but I just want to make sure I am clear that you raised guidance, but the full year free cash flow you’re still calling for above $900 million. Is that just a continuation of the issue? Higher prices in AI, obviously higher working capital from an inventory and receivables perspective?

That’s a good way to consider it. There’s really nothing fundamental going on as an issue. We talked about the rise in inventory from M&A integration that we will continue to see, and we expect to collect that over time.

We’ve had a little more capital flowing into growth activities, and that has impacted the first quarter but provides a good outlook into the future despite these motions.

And just as a follow-up, I can’t help noticing that oil is around $75 again. Where would TCX be coming, where would you get that going again? Is it much higher than current levels?

We’re not really focused on that at the moment, though it remains viable for the future. We’re keeping an eye on it; we’ll keep you posted.

Just a follow-up on the guidance here. The 20% to 25% EPS growth, could you characterize how much is persistent acetyls upside or the acquisition contribution, or is it EM performing better than expected?

It’s hard to get too specific. Broadly, we're having a very good strong year in materials, and we expect that trajectory to sustain. The changes in pricing will moderate, but we’ll still see substantial growth.

The business strategies we have are producing results. All three business segments show strong fundamental underpinnings, which supports our confidence moving forward.

Steven, we will now conclude the call. Thank you for your questions and for listening in this morning. We’re available after the call to address any further questions you may have. Steven, please close the call.