Celanese Corp - Series A (CE) — Q3 2018 Earnings Call Transcript

Thank you, Anita. Welcome to the Celanese Corporation third quarter 2018 earnings conference call. My name is Surabhi Varshney, Vice President of Investor Relations. With me today are Mark Rohr, Chairman and Chief Executive Officer; Scott Richardson, Chief Financial Officer; and Scott Sutton, Chief Operating Officer. Today’s presentation includes statements about expectations for future results and plans that are forward-looking statements. Actual results might differ materially from such statements. Additional information concerning factors that could cause actual results to materially differ can be found in the posted materials. We will also discuss non-GAAP measures today. You can find information related to these non-GAAP measures and reconciliations to their comparable GAAP measures on our website in the Investor Relations section. Form 8-K reports containing all these materials are available on the SEC’s EDGAR system. Celanese Corporation distributed its third quarter 2018 earnings release and posted slides and remarks about the quarter in the Investor Relations section of our website after market close. Since we published our comments yesterday, we will now open the lines for your questions.

Yes, hi.

Good morning, P.J.

Every week I get some kind of price increase announcement from Celanese in acetyls. So my question is, how are your paint coatings and polyester fiber customers taking these price increases? And I guess, you've been leading the market in acetyls; if there is new capacity that comes in, would that upset the discipline?

Hi, P.J. This is Mark. Thanks. Let me back up a little bit. Over the years, people have kind of made fun of our price increases, but we did that for a specific reason. When you deal with customers, my personal experience is customers don't mind pricing; they just don't want to be disadvantaged or surprised. We go to great lengths to very openly share what's going on in the market and how we're responding to that, and we work closely with individual customers to help them manage those price increases. Broadly speaking, that's why you see us do what we do. Because of that, we have found that our customers respond well to our efforts. Sometimes it's tough, but they always respond positively. We've not seen any unusual pushback or anything else from pricing. If you look at the level of inflation we’re seeing, P.J., you've seen many cycles of inflation over the years; it's not that severe. There are different areas where it's hitting us, but it's not unusual nor is it anything we didn't see a few years ago on a routine basis with multi-hundred million dollar year-over-year raw material inflation numbers. So, I know there's a lot of worry about that, but I can't quite quantify it and I don’t know why people are so concerned about it. We work hard to stay ahead, and we do. We work closely with our customers, but we haven't seen any particular issues. Regarding polyester, there is no big issue, no significant concern there.

Yeah, don't get me wrong. We appreciate your price increases and admire that you are able to raise pricing and recover raw materials.

Yeah. No, I didn't take it that way. I just want to make sure that people understand that we do this intentionally and for a reason—it's to help our customers.

Right. And then just Mark, good question on your guidance for 2019. You mentioned that gains in EM engineered materials would be offset by winter seasonality. I was wondering if you can explain what you mean by winter seasonality? Thank you.

Well it’s—thank you, PJ. Those of you that have followed the coating businesses in China for a while understand that you go through these seasonal periods. Classically in our business segments, we would have weaker winter seasons or fourth quarters and weaker first quarters. This varies between coatings businesses in Europe, Chinese New Year seasonality, and auto builds. Many factors roll into that generically and it's not a big deal. It is just a natural occurrence similar to weak sales in Europe in August. It is something that happens. What we saw last year, however, was a bit unique as we didn't see that seasonal effect; we powered through the first and fourth and there were several subtle reasons why that happened. We believe that we're returning to that kind of normal movement, so again, it's not a big deal other than the fact that we didn't observe it as we started the year. Fundamentally, we see our—over the next several years, we would have stronger mid-cycle earnings year than at the end cycle, beginning at the end of the year. That's all it means, P.J.

Okay. Great. Thank you.

Thanks very much.

Good morning, Jeff.

Hi, good morning. I noticed in your AI business that your volumes were lower sequentially and if I recall correctly, you had all kinds of outages in the second quarter. So, why were your volumes sequentially weaker?

Yeah. So, hi Jeff, this is Scott Sutton. Look, we don't worry too much about sequential volumes. As you know, we run a model where we activate our network. Sometimes we're stronger in certain derivatives, and sometimes we're not. You really have to think about the entire year for the health of the business. For the whole year, we anticipate that even volumes in that business will increase.

No, you will—it's a very tight market. You had a remarkable year-over-year pricing and you had very good sequential pricing. Were you attempting to maximize the profitability of the model in the third quarter?

We always try to budget every minute of the day, and we’re in the market with several hundred thousand tons per year in terms of bio-resell in that process. It wasn't necessarily unusual this quarter, that activity may have been a little bit more unusual. But yeah, we always try to make good decisions to maximize profits for our shareholders.

Yeah. And Jeff, I mean I would really encourage you to think about the whole variability of change from a volume standpoint, not just what's shown as the AI segment, and think about that on an annual basis as well.

Okay. Great. Thank you so much.

Thank you.

Good morning.

Good morning.

I don’t know if this is for you, Surabhi, or Scott, but I thought the comprehensive review you guys put out was excellent and it helps answer a ton of questions ahead of time. I really appreciate limiting your formal conference call remarks so we can ask questions. I wish all companies would approach it the same way. Let me ask my two questions if I could. First, for Scott Sutton, on the EM model, do you all feel it's more about product expertise or process expertise? Can you start going down the pyramid to more commoditized or less specialized plastics and apply the same process for the same success, or do you think it's limited by the types of products that you sell through EM?

Well, Bob, I mean really the real intellectual property in that business is the model. How that manifests itself is by being able to match our broadest solution set to the largest number of customer needs. We do well where there's a little bit more sophistication needed by customers, but that also applies to mid and lower range products as well—it’s not exclusive to only those super sophisticated products.

Got you. Okay. And then I thought you had a very interesting point about your auto demand relative to auto builds. Can you give us any insight into how we can predict and calibrate your growth in that market when it seems to be so detached from OEM build rates?

Yeah. Yeah. I mean, Bob, you know even across all markets, we’re not necessarily dependent on absolute growth of driver volumes in this business. You've got to be able to think about sophisticated solutions, and sometimes when volumes are declining, like they did in auto in the third quarter, there's actually a bigger drop for unique solutions for cost savings from the customer. So I can't provide a way to connect to that. What I will say is that we grew every single market segment, and that’s the plan moving forward as well.

Great. Thanks very much.

Okay. Thanks, Bob.

Yeah. Good morning. Thanks for taking my question. Look, there's been a lot of movement in gas prices in the middle of the year. We get that you guys don't naturally trade on spot. But I guess, how are you thinking about how pricing moves as we get into the fourth quarter and into 2019? As far as 2019 goes, when you think about year-over-year, can it be up or flat? How are you thinking about it?

Not a lot, but that’s what I would say, John. We work in that market to try to mark the net value back to our corporation. Classically, you would expect to see a drift down in pricing a bit and pull off a bit in the first, and we certainly started seeing a little bit of that, but there have been announcements by local Chinese companies actually driving pricing back higher in China, which is a bit unusual. So we stop thinking about it too much. We think more about normal seasonality, and normal seasonality would say there would be a little bit off in the fourth and a little bit off in the first, stronger in the middle quarter. That’s how we’re looking at this normalized view year-over-year rather than in absolute dollar per term price. So Scott, do you have any further thoughts on that?

Yeah, Mark. I mean, I would just add that the way pricing comes about is by the number of activations we’re able to do to our network. You’ve seen us increase that metal increase next year. Underlying all of that, fundamentals are still okay; effective utilization is still okay. So if you combine those two factors, I think it’s a manageable situation.

Got it. Thanks very much. And then just a quick follow-up. You indicated in your outlook for 2019 that there were potential costs associated with several large planned outages. How should we consider the delta between 2019 and 2018?

About $50 million. We have a huge internal turnaround, where we’re expanding and rebuilding for efficiency, one of our POM assets in Ibn Sina. That's a very significant turnaround, and those can be quite expensive.

Great. Thanks very much.

Sure.

Yes. Good morning. Regarding Engineered Materials, you’ve put forth a goal of having 5,000 projects in 2020. Can you speak to two aspects? First, how do you expect the average project size to trend between now and then? And then second, what sort of level of acquisition activity do you anticipate to achieve that level?

Yeah. Go ahead.

So, Kevin, this is Scott Sutton. In terms of average project size, that will trend where it has been trending over the last couple of years. We are going to increase the number of projects we close or get purchase orders for, targeting 5,000 by 2020. We do anticipate some small bolt-on acquisitions between now and then that help add to that pipeline, but most of it comes through organic growth.

Okay. And second question if I may on capital deployment. You raised your 2020 earnings goal to $12, up from I think $11 at the time of your Investor Day in May. Can you update us on what amount of capital deployment is embedded there? My recollection is it was excluding repurchases but inclusive of some bolt-on acquisitions—and related to that, your press release indicates an ability to accelerate repurchases. Obviously, the market has been somewhat volatile. What are your latest thoughts on that subject?

Yeah. Kevin, this is Scott Richardson. So, what we said at Investor Day was that we expected CapEx to be in the $350 million range for the next three years. We’re going to probably come in around $330 million this year just with the timing of how it flows through. But we made the announcement on the POM expansion; we have several other attractive productivity and growth-driven projects we’re examining. We expect that as we reach the end of that three-year window, CapEx will actually increase beyond that $350 million level. We anticipate being in that range, maybe plus or minus a little bit next year but should be at higher levels beginning in 2020 and beyond. That should translate to continued earnings growth through productivity and top-line growth going forward. Regarding repurchases, our cash flow has been very strong this year. We stated this quarter that we expect to approach $1.2 billion of free cash flow. We have the opportunity, given where the market has been, to accelerate those repurchases that we originally stated to be $1 billion over the three-year period from 2018 to 2020.

Thank you very much.

Kevin, this is Mark. Just real quick on two of those topics, it's a bit of an add-on to what Scott said. We haven't fully communicated the opportunities we have to incrementally expand our assets. In most cases, we can achieve phenomenal returns without needing incremental volume. We have enough productivity opportunities in front of us; that’s a little difficult to conceptualize. When you have a global network of assets and are engaged in various fields related to raw material values across energy costs, logistics costs today which increased by over $60 million over a two-year period for a company like ours, there’s tremendous value out there. We have numerous projects that we are evaluating. You've seen some of those announcements yielding returns from 25% to 45%, largely independent of material volume. Expect more capital investments to go into that. We haven't provided a number yet, but predominantly may be in January. For near-term cash, we have reported this ability to generate roughly around $1.2 billion this year and expect that figure to increase over the next few years. We’ve targeted $3.6 million, and we’re working hard to surpass that. We believe even with constant earnings we will generate more cash. We will seek efficient ways to invest that cash into attractive opportunities. While we are monitoring bolt-on acquisitions, we believe we can manage those pretty well with cash flow.

I appreciate the additional color.

Anita, could you do that again, please?

Great. Thank you. Could you update us on any progress in replacing your filter tow deal with Blackstone with an alternative transaction?

We're still working on that, John. There are not many options out there. We haven't found one yet. I remain convinced, as do Scott and Scott, that there are opportunities for us to do things, possibly more structurally based on our manufacturing, but we're working hard to find opportunities.

Is there any risk for a second inventory correction in filter tow given the general weakness in China? Or do you think inventories are low enough that we don't have that risk right now?

We're pretty comfortable with inventory levels. We don't see that as being a risk. We've been active in trying to drop pricing globally. We've gained some traction, which is good, and we need that to offset some of the natural volume declines, not dramatically, but about 2% per year.

Okay. Thank you.

Thank you.

Thank you. Good morning.

Good morning, David.

Just on China, are you observing signs of slowing or softening in the economy? Regarding these winter shutdowns, I think in your prepared comments you suggested that they might be more severe this year. However, they could be less severe than last year due to the need to stimulate the economy. Can you provide comments on that?

Well, I think all three of us here would have slightly different perspectives. I'll give my spin, and then Scott and Scott can follow. Reading publications, China is reporting slightly lower numbers. For those of us who have made a living in China for a long time, we never believed the previous numbers anyway. So, I don’t know what to make of the 6.5% growth or 7.5% growth myself. From my point of view, we don’t see any dramatic slowing in China.

Yeah. I mean our project pipeline is increasing nicely in China.

In fact, a good portion of our growth has stemmed from increasing activity, even in the last quarter in China. We’ve been able to close a lot more deals and activations as well, indicating quite an active environment. If a slowdown is occurring, I think it's happening in a controlled manner that actually enhances commerce without detracting from it. The demand for quality and improvement is extremely high. Absolute dollar sales may have declined, but the need to dramatically enhance quality has become paramount. We just don’t quite feel it, is what I would say.

Got it. And Mark, just regarding your M&A pipeline, I know you acquired Next Polymers. How's the rest of the M&A pipeline looking for this year and next year?

Scott, you want to address that?

Yeah. David, I would say that we still have a healthy pipeline, particularly in Engineered Materials, with good opportunities for meaningful bolt-ons next year.

Thank you very much.

Yeah.

Hey, good morning. Nice quarter there.

Thanks, Mike.

Mark, in terms of automotive, I’m curious how much potential there is for converting parts to plastics. What are you currently converting and what do you perceive as opportunities in the next couple of years?

Yeah, it’s infinite. I mean, you can only imagine the thousands of connections and discrete parts that go into automobiles, each playing an intrinsic role in the quality, aesthetics, and fuel efficiency of the vehicle. Manufacturers continually strategize to balance those value equations, considering the fluctuating prices of materials like steel and aluminum. So, the possibilities for refinement are very exciting, and we see opportunities in areas like lithium energy packets and their housing, connectors, and the design of new consoles, all contributing to reduced weight and expanded applications for reinforced plastics and structural parts. While there may be a limit, I can’t foresee what it is.

Okay. Great. When considering the 2020 outlook for segments, the Acetyl Chain seems to be on track; can you discuss the potential upside and downside in the coming years?

The upside potential for that business primarily lies in volume. The industry is operating at mid-80% capacity utilization and typically loses three production assets per year on average. Think about 1.5 million tons out of a 16 million to 18 million ton market. Last year, we were probably 2.2 million to 2.3 million tons, which was unusually high for that period. The historical frequency of those '100-year storms' occurs every three to five years. So we believe we are entering a phase where the business will be tight. We expect the loose monetary policy from China that has led to negative cycles is gone and that we will be solidly into an upcycle that will last a long time. For us, that entails strong pricing and incremental volume growth—it’s all looking positive.

Great. Thank you.

Sure.

Hey, guys, good morning.

Hey, Ghansham.

Hey, Mark. Just to expand on that last point, you noted Acetyl capacity utilization was in the mid-80s globally in 2018. Do you expect that to rise in 2019 or remain around the same level? It appeared to be tighter in 2018 given certain industry disruptions and force majeures. What are your thoughts on 2019?

When we analyze these scenarios, we operate based on realistic expectations rather than fringe factors. We anticipate it will remain similar to this year. Demand may increase slightly, but we are conducting some minor incremental expansions while others may slightly reduce volumes. Our assessment is that utilization will remain mid-80s, with perhaps a slight rise.

Okay. And regarding the EM segment, operating margins improve year-over-year for Q3 after several quarters of declines due to high raw material costs and initial dilution from acquisitions. Looking back to 2016, margins were around mid-30s for that segment. When do you anticipate returning to those levels, or has the business mix changed since then?

Yeah. This is Scott Sutton. I believe we are operating at a healthy level for that business currently. We can grow at that margin level, and we can add bolt-on acquisitions to increase their margins significantly, adding value to the company. I find our current margin level to be healthy.

Got it. Thank you.

Thanks.

Good morning.

Good morning.

I'd like to understand the raw materials situation. There has been some increase recently in some of the feedstocks. Would that impact you going forward considering your ethylene purchases?

On ethylene specifically? Okay, I'll answer more broadly. If you examine the third quarter, every single business saw energy and raw material prices increase, but we’ve managed to cover that with pricing. We could feel some effects from that, but I believe we are structured to completely bracket those costs.

And in terms of a three-year outlook on profit generation, what type of cash deployment do you anticipate, and how would that be split between buybacks and acquisitions?

We’ve earmarked $1 billion for buybacks at this time. We will prioritize deploying cash back into the business through organic investment. We’ve estimated $1 billion for acquisitions over the same period. We haven’t acted on this regularly, but as Scott mentioned, we see attractive opportunities emerging next year.

Is there capacity to increase those given the over $3 billion that you could generate over three years?

Absolutely. We're going to be opportunistic with what's in front of us.

Hi there. Two quick ones. On EM, you normally don’t discuss trends on a regional basis. As you contemplate the evolving project pipeline, if large customers start restructuring their global supply chains over the next two or three years, would you see any disruptions in that pattern, or how might you adapt to that? Secondly, Mark, regarding productivity and capitalizing on more opportunities across the system, some companies discuss this in terms of spreads while others discuss it in terms of utilizing volatility. A few years ago, you mentioned approximately $100 million in hidden headwinds that you'd seek to offset; is the issue one of spreads or volatility, or is it simply fewer adverse areas of concern compared to the last few years?

Scott, why don’t you take the first question regarding changes in global supply chains and the potential impacts?

Sure. Laurence, in our EM business, we are growing in every region. Yes, there are brief periods where one area may be slower than another, but we’re sufficiently positioned globally to provide solutions that flex our supply chain as needed. We don’t see any issue with restructuring customer supply chains impacting that business.

You posed various challenges, Laurence, in terms of productivity. Some may recall that in 2012, 2013, and 2014, we faced substantial headwinds—roughly $500 million due to methanol and southern contract losses, compounded by significant foreign exchange impacts. We navigated these through productivity initiatives and adjusted business models to maintain double-digit earnings during that period. Since then, we've doubled our profitability in three years by refining our business models to manage complexities. While we’ve reduced our productivity contributions over the past few years, there remain significant opportunities for improvement. Our recent models are well refined, and I believe we haven’t fully realized our potential. Moving into a new productivity frontier, we aspire to leverage volume growth opportunities alongside identifying inefficiencies in various regions and assets. I suggest looking at our current profitability level as a robust foundation from which we can grow.

Yeah. Perfect. Thank you.

Thanks.

Yeah. Good morning, fellows.

Good morning, Duffy.

Quick question. A couple of years ago, your Singapore plant was relatively uncompetitive in low oil conditions, but you revamped your carbon monoxide contract with Linde, making it competitive again. Should we be concerned that with rising oil prices, that plant might become uncompetitive once more?

It is very dependent on oil, particularly concerning bunker fuel, which has seen volatility related to the transition to low sulfur options. While that unit may become less competitive in a high oil environment, we have alternative strategies to address that issue. We're not particularly worried.

We implemented some changes a few years ago that provide us more flexibility in a high oil environment. We do remain exposed, but not nearly as vulnerable as we were previously.

Thanks for the details there.

Thank you!

Thank you. I recall your prepared comments mentioned 4% organic volume growth in EM. I assume the growth came at the expense of some pricing—did customers reduce their purchases from you, buy more from competitors, or did you experience demand diversion without shifting customer shares?

The primary driver was that we successfully secured price increases to counter raw material inflation while still managing to grow volume. Therefore, I don’t interpret this as indicative of a fundamental demand shift.

As a follow-up regarding your goal of closing 5,000 projects, do you have the necessary intellectual resources and physical R&D infrastructure to reach this goal, or will it require additional investments in personnel and facilities?

We continue to invest in human capital. We have a competent team that is consistently growing in capabilities. We’re also expanding our R&D within various sites, as evidenced by several recent announcements. There will certainly be more of those.

Okay. Understood. Thank you very much.

Thank you.

Thanks. In the engineered materials, you referenced a deceleration in organic growth attributed to higher raw material pricing. It seems you performed well in automotive—can you specify what end market faced demand destruction? Was it medical, industrial, or another segment? What instils confidence in regaining high single-digit growth soon?

I would recommend looking at this not through the lens of individual markets. We discussed at our April session that our embedded growth strategy drives our approach across our applications. Each application is developed uniquely, regardless of overall market trends. Therefore, we don’t structure our focus based on market conditions. We instead aim to foster application differentiation to create comprehensive programs.

Thank you.

Okay.

Good morning. Thank you. Is POM operating at a high rate at this point in the industry?

Yes, the answer is yes. We maintain numerous differentiated products, while still managing some standard offerings as well, and the industry is currently operating at a high capacity.

Understood. Thank you. With regards to your 2019 guidance, do you incorporate any buyback or M&A assumptions?

Not really. Relative to earnings, the projected buybacks are of minimal impact, and we struggle to forecast movements realistically within the 10% to 20% range—therefore, no such assumptions were made.

I understand. Thank you.

Let’s take one more question, and it will be the last for the call.

Hey, good morning. Thanks for taking my question. The release mentioned project wins in EM were up 58% year-over-year. Could you provide a breakout regarding how much of this growth comes from existing customers versus new clients, and where do you see the most opportunities going forward?

Yes, that's correct. Comparing Q3 of this year to Q3 of last year, we closed 925 projects. The coming growth stems from a mix of both existing customers and new clients. Our broad solutions portfolio is increasingly being utilized across a larger spectrum of their needs.

Great. We noticed reports of considerable planned and unplanned maintenance in Singapore and Q3, yet your results were impressive. Were there opportunities left untapped in Q3? And if so, what was that magnitude?

No, we didn’t leave any notable opportunities on the table. We were proactive and capitalizing on every potential we could.

Sounds good. Thanks.

Sure.

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