DuPont de Nemours Inc (DD) — Q3 2021 Earnings Call Transcript

Good morning, and thank you for joining us for DuPont's third quarter 2021 earnings conference call. On today's call, we will also discuss two strategic transactions that we announced this morning. We're making this call available to investors and media via webcast. We will extend today's call to approximately 90 minutes to allow for Q&A related to both earnings and the strategic announcements. We have prepared slides to supplement our comments during this conference call. These slides are posted on the Investor Relations' section of DuPont's website and through the link to our webcast. Joining me on the call today are Ed Breen, Chief Executive Officer; and Lori Koch, Chief Financial Officer. Jon Kemp, President of Electronics and Industrial, will also join for the Q&A session. Please read the forward-looking statement disclaimer contained in the slides. During our call, we will make forward-looking statements regarding our expectations or predictions about the future. Because these statements are based on current assumptions and factors that involve risks and uncertainties, our actual performance and results may differ materially from our forward-looking statements. Our 2020 Form 10-K, as updated by our current and periodic reports, includes detailed discussions of principal risks and uncertainties which may cause such differences. Unless otherwise specified, all historical financial measures presented today exclude significant items. We will also refer to other non-GAAP measures. A reconciliation to the most directly comparable GAAP financial measure is included in our press release and posted to the investor page of our website. I'll now turn the call over to Ed.

Thanks, Pat. And good morning, everyone. And thank you for joining us. In addition to our excellent quarterly results, I am pleased to talk about two significant strategic moves we are making to further strengthen our portfolio and deliver long-term value for our shareholders. I will provide a brief overview of these announcements before Lori walks you through earnings. Our team has delivered outstanding results in the third quarter above the high end of our guidance ranges for sales, operating EBITDA, and adjusted EPS, highlighted by the actions we took to implement price increases to stay ahead of raw material inflation. In the quarter, we delivered a neutral price cost impact for the Company, which is a proof point of effectively managing the levers within our control to deliver strong results. Market demand in nearly every one of our end markets was strong and our supply chain organization executed well in a challenging environment to deliver for our customers. Organic growth was up high single to double digits in every segment in the quarter. I am pleased by the quick actions our teams took to position us to continue managing the supply chain challenges and raw material cost pressures effectively as we head into the fourth quarter. As Lori will cover in a few minutes, we expect to fully offset raw material price headwinds again in the fourth quarter. As I mentioned, we also announced two strategic transactions this morning. The acquisition of Rogers Corporation and our attempt to divest a substantial portion of our Mobility and Materials segment will significantly strengthen DuPont's position in our core high-growth, high-margin markets with a focus on electronics, water, and technologies, and next-generation automotive. In addition to focusing the portfolio, these strategic actions will accelerate our top-line growth, operating EBITDA margins, and significantly improve our earnings stability. The combined transaction will allow us to benchmark extremely well against best-in-class multi-industrial peers, resulting in long-term value creation. I will cover the details of the Rogers and M&M transactions shortly, but first, let me turn it over to Lori to discuss the quarter, as well as our outlook for the remainder of the year.

Thanks, Ed. And good morning, everyone. As Ed mentioned, customer demand across almost all of our end markets remained strong in the third quarter. We saw continued improvement in many of the industrial end markets adversely impacted by the COVID-19 pandemic, as global economies continue their recovery. Organic growth in the quarter was up 16% versus 2020. We delivered net sales, operating EBITDA, and adjusted EPS above the high end of our third quarter guidance. In addition, we had strong cash flow generation and returned $657 million of capital to shareholders during the quarter, which included $500 million in share repurchases and $157 million in dividends. We now have $875 million in share repurchases remaining under our existing authorization, which expires next June. We expect to complete the full year 2021 with about $2 billion in share repurchases, which is at the high end of the range we provided earlier this year. Net sales of $4.3 billion were up 18% versus the third quarter of 2020, up 16% on an organic basis. Organic sales growth consists of 10% volume improvement and 6% pricing gains, reflecting the actions we are taking to offset inflationary pressure. Excluding the impact of metals, price was up about 5% during the quarter. Overall sales growth was broad-based and reflects high single to low double-digit volume growth in all three of our reporting segments. Double-digit organic growth within Asia Pacific, Europe, and North America reflects continued strong demand in our key end market. From an earnings perspective, we delivered operating EBITDA of $1.09 billion and adjusted EPS of $1.15 per share, up 20% and about 90%, respectively, versus the year-ago period. The earnings improvement was driven by strong volumes across all three reporting segments and earnings uplift from the Laird Performance Materials acquisition. The swift pricing actions we implemented earlier this year, in the face of raw material inflation, continue to benefit our operating result. For the total Company, our selling price increases during the quarter again offset raw material inflation. Gross margin was up about 160 basis points versus last year, reflecting increases in both M&M and E&I. Operating EBITDA margin of 25.5% was in line with our third quarter guidance expectations and reflects 50 basis points of margin expansion versus the prior year. However, if you exclude the impact of price and costs, our operating EBITDA margin for the quarter would have been nearly 27% and incremental margin would have been over 40%, reflecting very strong underlying operating performance. I have also mentioned previously that we track our operating performance for our core results on an underlying basis versus 2019, given the unique nature of 2020 and certain discrete items that impacted our operating results in the prior year. In comparing our third quarter results to pre-pandemic levels, sales for our core businesses were up 15% versus 2019 with operating EBITDA leverage at 1.4 times on an underlying basis despite the global challenges around supply chain pressures and raw material inflation. From a segment earnings perspective, E&I delivered a 13% operating EBITDA improvement on strong volume and better-than-expected results from Laird as we continue to integrate this business with our current electronics offerings. M&M delivered a 75% improvement in operating EBITDA or about 2.5 times operating leverage compared to the year-ago period. For the quarter, cash flow from operating activities was $842 million and capital expenditures of $208 million resulted in free cash flow of $634 million. Free cash flow conversion of 112% was up significantly compared to the second quarter.

Thanks, Lori. I'm excited to share with you more detail on the two significant strategic moves we announced this morning, which will further strengthen our portfolio and deliver long-term value for our shareholders. The announcements of an agreement to acquire Rogers Corporation and our intent to divest a significant portion of our M&M segment are substantial moves, advancing our strategy to shift the portfolio towards higher-growth and higher-margin businesses, while significantly enhancing the earnings stability of the Company. The acquisition of Rogers will build on the Laird Performance Materials acquisition that we closed on July 1st, adding another high-quality business that expands our leading market position across highly attractive end markets. Rogers is a market leader in each of their primary product categories and brings a world-class organization with differentiated technology, innovation capabilities, technical expertise, and deep customer relationships. The same value proposition that differentiates our DuPont businesses. Rogers operates in end markets where we have already established leading positions, such as consumer and mobile electronics and others that are adjacent to our businesses, such as 5G infrastructure and electric vehicles, enabling us to offer an even more attractive total value proposition to a broader base of customers. While M&M has been the market leader in high-performance thermoplastics serving automotive, electronics, industrial, and consumer markets, we believe DuPont is no longer the best owner for this asset. By separating M&M from the rest of the portfolio, we are better positioning the business to expand on its leadership position in these markets and continue to tackle some of the industry's most critical challenges, such as vehicle safety and fuel efficiency. We will leverage existing tax attributes to complete a highly efficient cash sale of the M&M business, providing ample funding to finance the Rogers acquisition, as well as further M&A and share repurchases while maintaining a strong investment-grade credit rating. We have a few key targets that would be excellent additions to our portfolio. Following the completion of the intended Rogers acquisition and the planned divestiture of M&M, DuPont will focus on key emerging technologies and enhance top-line growth. Our participation in the auto markets going forward is much more connected to the high-margin advanced technologies, enabling long-term secular trends like hybrid and electric vehicles, as well as advanced driver assistance systems (ADAS). A large portion of our order exposure will be aligned with EVs and ADAS, both of which are growing at a significant pace. This improved balance in our end markets will drive further consistency in our results and allow us to deliver best-in-class results among our multi-industrial peers. Strengthening our position in clean energy and electric vehicles, combined with our existing positions in water, safety, and production technologies, will continue to advance our customer sustainability priorities. The M&M and Rogers transactions will deliver an additional 140 basis points of margin improvement, floating us well above our top multi-industrial peers. We have taken several actions to drive top quartile EBITDA margins at DuPont. Getting DuPont to this point has been a multi-year journey with decisive news aligned with our value-creation levers of active portfolio management, a best-in-class operating model, and disciplined capital allocation.

Thanks, Ed. Before we move to the Q&A portion of our call, I would like to remind you that our forward-looking statements apply to both our prepared remarks and the following Q&A. We will allow for one question and one follow-up question per person. Operator, please provide the Q&A instructions.

Good morning.

Good morning.

Good morning, Lori and Jon.

Good morning.

Sounds like you guys have been busy. Kind of asking you a technical question here. I mean, the process that you're going to run on mobility, if it doesn't come out as you like, would you consider spinning the business? Is that one of the options that's in play here?

We are very confident that there will be a sale of this asset. There's considerable interest, and we've received numerous inquiries recently. We will begin the sale process in the next few days. One of the advantages of this sale is that it is very tax-efficient for us, which makes it appealing. The tax implications will be in the mid to high single digits, which is quite impressive. I am confident it will sell, and we are aiming to close the deal around October of next year. Additionally, it's noteworthy that M&M has the lowest multiple among DuPont's assets, yet we expect to achieve a sale price higher than DuPont's current trading multiple. When comparing to DSMs entering the market, analysts anticipate at least an 11 times multiple. Our asset is superior in terms of growth, margins, and is larger and more global. Therefore, I am confident it will sell for even more than what the company is currently valued at.

Good. And then Ed, as a follow-on, can you talk through the synergies with Rogers? Is this standard kind of G&A stuff or is there something kind of more there that you can talk us through?

Yes, it's pretty similar to our other deals. And by the way, it's a very achievable number for us. As we said in our prepared remarks, we took ICS, which is one of our divisions; this will be in the E&I segment. We used ICS. We use Laird and the Rogers deal. Adding in the Laird synergies, by the way, it's 6% of revenue. So we're highly confident. We've been scoping this out for a long time. One of the nice things here, I suppose, is it's a public company. So all those costs go away, which are pretty significant, obviously. And that just happens. Then a big chunk of it is G&A and functional costs, streamlining it into our structure. We get some procurement savings also. And then we've got some facility consolidations. We've got sales offices all overlapping each other globally as an example. So we've scoped it out in a lot of detail. Obviously, we'll get more detail once we can sit down even more with the team. And I would also add, we had just closed on the Laird deal July 1, and we had announced $60 million of synergies with Laird. The team is now at $63 million. And that's literally line-by-line, who's doing it? When are we getting it? What's the payback? So we have line of sight. Hopefully, we're being conservative here on the combo at $115 million of synergies for Rogers.

Hey, guys. Good morning.

Good morning.

So just quickly on the results. It sounds like kind of the majority of the 4Q cut is really kind of auto production-related. Then, I have a follow-up on the strategic stuff.

Yes. Look, Steve, it's all auto, centered on the semiconductor. We did not see it in the third quarter as you could tell by Lori's prepared remarks; we had a very robust third quarter. Looking forward, we expect some deceleration in order patterns, primarily in automotive end markets where IHS estimates for the second half have been cut by 17%. This is purely a result of the global semiconductor shortage, which is impacting our customers’ ability to produce and thereby pushing up demand. We're expecting it to carry through the rest of the quarter. By the way, our supply issues with force majeures have cleaned up substantially, so we're not dealing with that. We're really dealing with just the semi-thing, and of course, everyone's dealing with logistics and shipping and all that.

Right. And then just lastly, with the cash you're bringing in, clearly, a couple of billion of cash generation, some divestitures bringing in some cash here in the fourth quarter.

I think the only thing you're off on is the timing of the receipt of the cash from the divestiture. So we ended the third quarter with about $1.7 billion in cash. We generated $600 million in free cash flow in the third quarter, and we'll expect a similar posting in the fourth quarter. We also plan to be active in the market with our share repurchases, likely about $500 million incremental in the fourth quarter. That would put you just shy of $2 billion at the end of the year. There will also be cash from the Clean Tech divestiture, which should be about $470 million after tax. That will be incremental to the approximately $2 billion mentioned earlier.

At the end of the day if you go to the end of 2022, your numbers are clearly in the zip code there. And as we highlighted in our remarks, there are a couple of M&A targets that we love and have been looking at for two to three years. We will continue to be very balanced with share repurchase. But we don't need to make any of those decisions now. We won't get the cash for the M&M business until about October first of next year. And we'll see where things are at that point in time.

Good morning, everyone.

Good morning, John.

Wanted to know if we can keep that train of thought going. You talked about wanting to maintain a healthy balance sheet. A lot of stuff going on, moving parts, several companies also reporting today. Can you just help us? What's the zip code you think you'll have your net leverage at when you pro forma for all the divestitures and the acquisitions?

Yes. The reasonable target could be around 2.75 times by the close of the completion of both the divestiture of the M&M business and payment for the acquisition of Rogers, ideally around mid to end of 2023.

Got you. Thank you. And then maybe just another question around capacity, just the organizational capacity to continue to do M&A. Do you have the bandwidth to kind of do all this at the same time? Or should we think that any kind of larger addition is post the M&M divestiture?

If there is anything of this size, it would be around the time or after the proceeds for M&M. So we're going to put this pre-payable debt in place just in the interim period. We can pay that off when we get the proceeds, as Lori said. The team is very capable. It's a separate team that's doing a lot of the work on the separation of M&M.

Yes, thank you. Can you speak to the competitive landscape in terms of the businesses and how the growth rate for the business has been over the last three to five years versus the broader market? Has it outpaced it? Are you gaining share in that area? Can you give us a little bit of color on that?

When you look at it, it's different based on the individual product lines and the different divisions of the business. Rogers is really well-positioned in continuing to grow. You've got mid-single-digit growth rates in key markets. They're winning in the market. They've got a great pipeline of opportunities, especially on the automotive and advanced mobility side with electric vehicles and advanced driver assistance systems. So we feel very good about a high-single-digit growth rate going forward.

Thank you. I have two questions. Your 2022 Rogers EBITDA estimate is 10% above consensus. Is there any significant new product or development that you uncovered in your due diligence?

Yes. The largest incremental growth really is just coming from the top line due to their strength in the pipeline that Jon had highlighted earlier. So we've got around 30% of their revenue in advanced mobility, which is growing mid-teens, and we're confident that’s driven by their project pipeline.

Thanks, Ed. Thanks everyone for joining our call. For your reference, the copy of our transcript will be posted on DuPont's website. This concludes our call.