DuPont de Nemours Inc (DD) — Q3 2022 Earnings Call Transcript

Good morning, and thank you for joining us for DuPont's Third Quarter 2022 Financial Results Conference Call. Joining me today are Ed Breen, Chief Executive Officer; and Lori Koch, Chief Financial Officer. We have prepared slides to supplement our remarks which are posted on DuPont's website under the Investor Relations tab through the webcast link. Please read the forward-looking statement disclaimer contained in the slides. During this 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 or results may differ materially from our forward-looking statements. Our 2021 Form 10-K, as updated by our current and periodic reports, includes detailed discussion 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 also posted to DuPont's Investor Relations website. I'll now turn the call over to Ed.

Good morning, and thank you for joining our third quarter financial review. We posted strong quarterly results, above our previously communicated guidance, in an extremely challenging environment due to uneven macro conditions and persistent inflation globally. Our revenue growth of 4% versus the year ago period included solid organic growth of 11%. Customer demand remains strong across most of our key end markets during the period, highlighted by double-digit volume increases in select areas, including Kalrez, Vespel, Laird, Semi, Water, and Auto Adhesives. To combat persistent inflationary headwinds in raw materials, logistics, and energy, we continue to implement necessary pricing actions, which have fully offset such headwinds to date. Given continued energy cost inflation, we now expect full year 2022 inflation of about $800 million year-over-year, which we anticipate will be fully offset by pricing actions. Our third quarter results also demonstrated year-over-year operating EBITDA growth and margin improvement, reflecting DuPont's unique business mix, innovative solutions and highly diverse end markets, as well as strong operational execution during the period. We are pleased to have reported strong performance during each of the first three quarters of 2022, and we remain firmly committed to continued strong execution in the coming periods. Turning to Slide 4, I will comment on the details of our transformation progress. First, last week's announcement that we completed the sale of the majority of our M&M segment to Celanese marks the completion of our last contemplated large-scale divestiture for which we received $11 billion in gross cash. The M&M business is an excellent set of assets that we know will prosper, and we are confident that Celanese is the right owner going forward. We are excited by the prospect of proving to the market that our multiyear transformation has brought DuPont to a truly different place. After the Dow merger, followed by the spins that created the new DuPont, we have further transformed our business with large-scale deals, including the N&B split-off and now the M&M transaction. We further sold 8 smaller businesses over the last three years, with proceeds totaling over $2 billion. We are starting the next phase of our growth from a position of strength, leveraging highly profitable businesses with strong and leading market positions centered in growing markets as well as a healthy balance sheet. These assets include some of the best intellectual property in their respective industry verticals with globally recognized brands familiar to us all, as well as the thousands of long-time B2B industrial customers. For DuPont, we are confident that our remaining mix of businesses offers a different dynamic with significantly lower volatility and higher expected long-term growth given our revenue mix. This is driven by a focus on secular tailwinds, including the 5G build-out and other electronics drivers, global clean water infrastructure development, continued demand for safety and personal protection solutions, secular growth across multiple industrial technology verticals that we serve, and from next-generation automotive growth. We believe we have built a portfolio that can perform alongside the best diversified industrial companies. Our businesses are aligned with secular growth trends, we deliver top-tier levels of profitability, and we should clearly benefit from dampened business volatility compared to our portfolio from just a few years ago. These advantages are clear and will help us to generate superior shareholder value over time. Regarding the Delrin divestiture process, we continue to advance our internal work required to divest that business. We are being diligent with our overall marketing process to ensure we maximize value in proper market conditions and expect to have completed a sale in 2023. Before I move on, I'd like to briefly address the intended Rogers acquisition. We terminated this deal on November 1, which was the outside date of the transaction agreement originally signed a year ago. This was an unfortunate outcome in that the potential strategic fit of Rogers with our business was strong, and we saw a lot of opportunity, but we were unable to secure regulatory approval for the transaction. We wish the Rogers team well. For DuPont, the inability to close the acquisition has no material impact on our ongoing business outside of the obvious loss of opportunity. We remain confident in the quality of our portfolio and its growth potential, and we'll look to be opportunistic with select and targeted M&A moving forward. Shifting to capital allocation on Slide 5. With the receipt of the proceeds from the M&M sale, we are now able to accelerate our capital return options and further strengthen our balance sheet while maintaining flexibility to continue to grow the business through disciplined and targeted M&A. Today, we announced that our Board has authorized a new $5 billion share repurchase program which expires June 30, 2024. We intend to act immediately and enter an accelerated share repurchase agreement for $3.25 billion of common stock, which includes the remaining $250 million under the previous authorization. We anticipate completing this ASR within about nine months, with 80% of the shares retired upfront during the fourth quarter. We currently expect to complete the full $5 billion of repurchases within the authorization period. In addition, we will retire $2.5 billion of our senior notes due 2023 in the fourth quarter. The prepayment reduces refinancing risk in a rising rate environment while generating pretax annualized savings of over $100 million. Further, we plan to reduce our commercial paper balance to zero by year-end, of which we had $1.3 billion outstanding at the end of the third quarter. In combination, the significant share repurchase authorization and our deleveraging plan demonstrate our continued commitment to returning capital to shareholders while maintaining a strong balance sheet. Our approach remains balanced and in line with our overall capital allocation strategy. We expect to finish the year with a leverage ratio significantly below our longer-term target, maintaining balance sheet capacity to further allocate excess capital through a combination of bolt-on M&A and potential share repurchases over time. Our M&A focus remains on targets that fit within our growth pillars and are aligned with key secular growth trends. With that, let me turn it over to Lori to discuss third quarter details as well as our financial outlook.

Thanks, Ed, and good morning. As mentioned, we saw continued strong demand during the quarter in most of our end markets, with organic growth better than our expectations coming into the quarter. The global economy remains challenged in some respects, but our team's focus on disciplined pricing and operational execution contributed to operating EBITDA margin expansion on a year-over-year basis. Turning to our financial highlights for the quarter on Slide 6. Net sales of $3.3 billion increased 4% as reported and increased 11% on an organic basis versus the prior year quarter. Global currencies remained highly dynamic as we saw a 4% headwind resulting from U.S. dollar strength against key currencies, including the euro, yen, and yuan. The 3% portfolio headwind reflects the impact of non-core divestitures. Breaking down organic sales growth, we saw 8% pricing gains and 3% higher volume. Volume growth reflects continued strong demand, most notably in semiconductors, water, and general industrial, reduced somewhat by lower volumes for protective garments within Safety Solutions and ongoing softness in smartphone and personal computing markets globally within Interconnect Solutions. On a segment basis, third quarter organic growth was 15% for W&T, 7% for E&I, and I'll highlight 25% organic growth for the retained businesses that we report in Corporate, representing the adhesive portfolio from the former M&M segment. On a regional basis, we delivered organic sales growth in all four regions, led by volume increases in North America and Asia Pacific. From an earnings perspective, operating EBITDA of $856 million increased 5% versus the year ago period, and adjusted EPS of $0.82 per share increased 4%. These increases were driven primarily by volume gains as pricing actions were offset by higher inflationary cost pressure. Adjusted EPS in the quarter included a higher-than-expected tax rate, which I'll detail shortly. Operating EBITDA margin of 25.8% increased 30 basis points year-over-year on stronger volumes and productivity. Operating EBITDA margin in the quarter, adjusted to exclude price costs, was over 27%. Finally, incremental margin was 33% on a as-reported basis. Cash flow from operations during the quarter of $419 million, adjusted for capital expenditures of $172 million and the $115 million tax prepayment related to the M&M divestiture, resulted in free cash flow of $362 million. We continue to experience significant headwinds from transaction costs related to the M&M separation as well as working capital headwinds primarily from the divested M&M business. Free cash flow conversion in the quarter for the total company was 73%. For the ongoing portfolio, if M&M was excluded, free cash conversion in the quarter would have been in line with our target of greater than 90%. Turning to Slide 7. Adjusted EPS of $0.82 increased 4% compared to $0.79 in the year ago period. Stronger segment results versus the prior year contributed 8% to adjusted EPS growth or $0.06 driven primarily by volume growth. Benefits from ongoing share repurchases continue to drive earnings growth, providing a $0.04 benefit to adjusted EPS. The absence of earnings related to non-core business divestitures and the impact of currency headwinds negatively impacted third quarter results, and we expect both to be more significant headwinds to year-over-year earnings in the fourth quarter. Our tax rate for the quarter was 26.2%, up notably from 23.5% in the prior year, resulting in a year-over-year headwind to adjusted EPS of $0.03 and a $0.05 headwind in the quarter compared to the midpoint of our previous modeling guidance. Our full year base tax rate is now expected to be about 24%, with the increase driven by currency and mix and geographic earnings. Turning to segment results, beginning with E&I. E&I delivered third quarter net sales growth of 3% and organic growth of 7%, including a 4% increase in volume and a 3% increase in price, partially offset by a 4% currency headwind. Sales growth was led by Semiconductor Technologies, which increased mid-teens organically as strong demand continued led by the ongoing transition to more advanced new technologies and high semiconductor fab utilization along with growth in 5G communications and data centers. Industrial Solutions posted another strong quarter with organic sales growth of high single digits led by ongoing strength from Kalrez semiconductor-related product offerings, Vespel products serving recovering aerospace markets, OLED materials for new electronic displays related model launches, and for health care applications such as biopharma tubing. Interconnect Solutions sales decreased mid-single digits on an organic basis due to volume decline. Coming into the quarter, we expected a return to positive organic growth within Interconnect, but continued softness in consumer electronics, specifically smartphones and lower PC and tablet demand globally, more than offset strong demand for Kapton film product applications in industrial end markets such as rail and defense and strength in Laird product offerings, including electromagnetic shielding and thermal management. Given this demand softening, we now expect Interconnect Solutions organic sales for the full year to be down mid-single digits. Operating EBITDA for E&I of $473 million was relatively flat as volume gains in semi and Industrial Solutions were offset by lower volumes and weaker product mix in Interconnect Solutions, along with lower JV earnings. Operating EBITDA margin of 31.3% was down 110 basis points from the prior year due primarily to the impact of price costs. Turning to Slide 9. W&P delivered net sales growth of 10% as organic sales growth of 15% was partially offset by a 5% currency headwind. Organic growth for W&P reflected a 13% increase in price and a 2% increase in volume. Organic sales growth was led by Shelter Solutions, which increased high teens driven by pricing actions and further aided by volume growth on continued demand in North America commercial construction. Sales for Water Solutions were up an impressive mid-teens organic growth rate on strong global demand for reverse osmosis and ion-exchange resin technologies, as well as pricing gains. Sales for Safety Solutions were up low double digits on an organic basis as pricing actions were slightly offset by lower Tyvek volumes given the shift from garments to other Tyvek applications and the resulting impact of manufacturing line changeovers on production efficiency. Excluding the year-over-year Tyvek garment headwind, total W&P volumes would have been up approximately 5%. I will also acknowledge the dedicated work of our teams for safely and promptly restoring operations at our Spruance plant earlier in the third quarter from an unforeseen utility disruption with minimal impact on the quarter's results. Operating EBITDA for W&P of $382 million increased 8% versus last year as pricing actions and volume gains more than offset higher product costs driven by inflationary pressure, weaker product mix, and currency headwinds. Operating EBITDA margin of 24.9% included a 170-basis point headwind related to price costs. Excluding this price/cost impact, operating EBITDA margin would have been 26.6% during the quarter. I'll close with a few comments on our financial outlook and guidance for the full year 2022 on Slide 10. We expect solid demand trends to continue in the fourth quarter in many of our key end markets such as Water, Industrial, and Auto Adhesives, to name a few. That said, we anticipate continued softness within Interconnect Solutions related to smartphones and personal computing globally and expect some slowing in customer fab production rates in our semi business. Additionally, we expect some impact from reducing our production to drive down inventories on a consolidated basis. Lastly, we expect further currency headwinds to negatively impact both top and bottom-line results. Based on these assumptions, we are adjusting the midpoint of our full year 2022 net sales guidance to the low end of our previous range and now expect net sales to be about $13 billion. Compared to our previous midpoint, this change reflects about $150 million of incremental foreign currency headwinds, with the majority of those headwinds impacting the fourth quarter. For the full year, we now expect foreign currency to be approximately a 4% headwind to reported net sales. Our organic net sales growth expectation of high single digits for the full year remains unchanged. Due to the same factors just noted, we are adjusting the midpoint of our operating EBITDA guidance to the low end of our previous range and now expect full year 2022 operating EBITDA to be about $3.25 billion. We now expect full year adjusted EPS to be about $3.30 per share, within our previous range. The higher-than-anticipated base tax rate for the full year that I discussed earlier, which equates to a $0.09 headwind versus our previous guide, is expected to be offset by a lower share count and net interest benefits resulting from a higher cash balance and the capital deployment actions we are taking in the fourth quarter. In closing, our team remains focused on operational execution and expect to use the levers within our control to meet our financial goals and continue to drive value for our shareholders. With that, we are pleased to take your questions, and let me turn it back to the operator to open the Q&A.

Congrats on getting all that done. Just would love to put a finer point on how you're thinking about capital deployment beyond what you announced today. And specifically, as it relates to kind of M&A. Should we really think this will be bolt-ons and kind of neatly fitting inside of how the portfolio is positioned? Certainly seems like you could benefit from just letting things settle down for a while and allowing people to digest kind of what you do and how the portfolio is taking shape.

Yes. Jeff, I think very good points you're making. We're in no rush to do an M&A deal, especially in this environment. I don't think any of us know where things are actually headed. So we're going to take a pause here, see how the next set of months play out. We do have targets we've been interested in for quite a period of time, whether they're actionable or not is another story. And they clearly would be in the pillars of the secular growth areas, the five areas that we've talked about. So we're not going to deviate off into anything else. But we're in the same mode, I think, as your opening comment, Jeff, let things settle down. We've made a lot of moves. We've pretty much finished our transformation except still for the sale of Delrin, which will happen in 2023. And so no rush to do anything. But we do have the capacity to do some bolt-on-type M&A, and that's the way we're thinking about it, is more on the bolt-on size of the deal.

I expect about $10.4 billion net after tax from the Milan transaction, considering all the customary closing adjustments. By the end of the year, taking everything into account, we announced that our capital allocation will start with a $3.25 billion share repurchase authorization and a fixed payment of $2.5 billion due in November 2023. This puts our year-end cash at approximately $4.8 billion, which is a strong position for us. Regarding working capital, there are no benefits from a cash flow perspective, but we noted the headwinds affecting our numbers before the separation of the M&M business. The largest part of the working capital headwind was due to the M&M business, which means our actual cash performance would have been better without them. For the quarter, our free cash flow conversion reported was 73%. If we hadn’t included them in our results, it would have been over 90%, aligning with our target for the Remainco portfolio.

I'll ask just one here. In semiconductor materials, Entegris reduced the December quarter sales by about 10% for the new U.S. restrictions on China. And they also noted the memory chip weakness was affecting CMP disproportionately. Are you seeing anything different in the semiconductor market?

Yes. Well, on the export control issue in China, there's really three restrictions on that. And by the way, I would put it in a category of it's more because of advanced chip technology. So one of them is logic chips at 14 nanometers or below is restricted, it's one of the key ones. So for us, it's not that big. Most of the fabs in China are not the high-end advanced chips. So if you look at it on an annual basis, if we are restricted and cannot get a license to supply that, there would be about $60 million of revenue for us on an annual basis, so say about $15 million on a quarterly basis, which we took that $15 million into account in our fourth quarter guide that we gave. Overall, on the semi side, we look at the inventory index, for instance, like Gartner puts out and it's, give or take, 1.1 right now. If you kind of go back to the last downturn of semi back in 2019, it peaked out at 1.31. So just to give you a little bit of a parameter on where that sits. So it's on the high end. We think there's two or three quarters of correction there that we'll see. But the downturn in 2019 was like 6% to 7% year-over-year downturn. So just to give you some perspective. But at this point in time, it's not at the peak of where it was in the '19 time frame.

Are you guys surprised that the 8% price didn't fully cover cost this quarter? Were there some kind of intra-quarter cost increases or surprises there that caught you a little flat-footed?

No, Scott, it did not. Maybe we misstated it. We did cover all the costs. So our cost inflation, I think last quarter we reported we thought it was around $700 million. It's now $800 million for the year, and that's all based on mostly energy increase in Europe, as you're all aware of, on natural gas. By the way, just to give you kind of more color to that, we are obviously seeing commodities start to come off their peak. We thought we would start to maybe start seeing some benefit, and hopefully we do in 2023. But then energy spiked, so the energy just about offset what we've been seeing the benefit on the commodity. So hopefully, now as we progress over the next months, we start to see some spread there, that would be helpful. But no, we did implement more price increases. We covered the whole $800 million that we're going to have for the year at this point in time. And just to remind you, every price increase we did, we put it into the product cost. We did not do it as surcharges that would fluctuate off an index. So customers would have to negotiate with us when there's any price changes.

Yes. So we did announce a deceleration in our expectations for the Interconnect Solutions in general. So it will be covered by what you're hearing in the headlines with respect to smartphone and consumer electronics, and then ultimately, the underlying PCB demand. So for the year, we now expect Interconnect Solutions to be down mid-single digits. So that would all be wrapped up in that number.

Yes. Just to give you perspective, we thought in the second half of the year, Interconnect Solutions would be up mid-single digits. Now it's down mid-single digits. So I think we've taken all that into account. And by the way, just to remind you, it's hard to remember this, but we're already two quarters into the Interconnect Solutions and the whole PCB smartphone, and laptop downturn. So they don't last forever, but we've already had two quarters of it.

Given its election day, I'll make a recommendation, you should run for office someday, Ed.

I like what I do now.

Yes. I think you receive support from the analysts who follow the stock. In terms of fourth quarter pricing pressures, there was a 130 basis point headwind this quarter, as you mentioned. I might have missed that detail. I assume that will improve in the fourth quarter, but the calculations suggest it may not get better then.

Yes. So the dollar does get a little bit less in the fourth quarter because we start to lap some of the prior year increases. And so we're expecting about a 5% price increase in the fourth quarter versus the 8% that we posted in the third quarter and then 7% in the second quarter. As far as the margin headwind, it would be a little bit less, but our underlying guidance does suggest overall EBITDA margin improvement in the fourth quarter. So if you back into the fourth quarter from the full year guide that we gave, we'd be more in the low 24% range from an EBITDA margin perspective versus last year it's 23.2%. And I'd highlighted that sequential decline expected decline in EBITDA margin is really from one seasonality. So we tend to see some seasonality as our volumes are lowest in the fourth quarter. And also, we did elect to take down production to be able to better align our inventory levels. So we are seeing some stabilization in the supply chain that gives us confidence we can start to tweak down these inventory levels. And so there will be a unit cost headwind in the fourth quarter. So those two combined are the drivers of the sequential EBITDA margins' decline. About $240 million.

Yes.

Yes. So we're at $650 million year-to-date and another $150 million in Q4 to get to the $800 million for the full year.

Okay. And any carryover for next year when it comes to price? And you said now inflation, you probably won't get relief there, but any carryover on price into next year?

Yes, there should be some, especially in the first quarter. So that's when we really started to ramp the price increases. And then we did see some inflation start to ramp in the first quarter. Our number hasn't materially changed. I believe, back in Q2, we thought the full year would be $500 million. So we did see some escalation in the 2Q time frame. But the numbers have been starting to normalize in the back half of the year. So the increases that we just saw recently have been more in the European natural gas side versus the underlying raw material side.

Steve, it's going to be interesting for all of us going into 2023 as we work our way through it how carrythrough and handles this price cost issue because the commodities are definitely coming down pretty uniformly. Not crazy, but they're down 20%, 25% in many cases. So if the natural gas thing settles out, I think we've peaked on all this inflation and then how do we handle price cost as we move forward with all the price that we got.

Great. I have one question. Ed, could you provide more details about the decision to walk away from Rogers instead of seeking another extension or rework transaction? It seems like you're indicating it was ultimately unworkable from a regulatory standpoint. Is that correct? Was it simply a matter of being in limbo for an extended period?

No, it's very simple. We did not get regulatory approval in China. It had been a full year. That was our outside date. And we ended it, which was the contractual agreement. So really, there's nothing more to it.

Ed, you spoke a little bit to the Interconnect Solutions' weakness. Can you speak a little bit broader in terms of the macro trends that you're starting to see right now? Some of your business is pretty resilient through that. But are you starting to pull any levers just on macro concerns at this point that we should be thinking about?

Yes. I think as far as pulling leverage to make sure that we drive the best margin profile that we can, we did announce in the Q that we'll come out this afternoon with a restructuring program. Initially, it's really just to get after the stranded cost from the M&M transaction now that it has closed. So we signaled about $50 million of stranded costs associated with the M&M transaction. So we'll get at those first to take those out to be able to drive further profitability. And then we've got room underneath the restructuring that we announced to take further cost action as appropriate if we start to see further deceleration in the top line.

And we have already, as a management team, laid out what those. So we'll do the stranded costs, as Lori said, but we've already laid out the detailed actions we do for some additional restructuring if we felt it was needed. And then I'll go back to the point I made a minute ago, there's a big lever in price cost that we're going to have to figure how that plays out through 2023.

How do you think about the debt reduction versus potentially doing even larger buyback for this tranche of capital allocation?

We will proceed with the $5 billion repurchase as mentioned in our prepared comments. We may choose to participate in the market for some of that during the year, depending on economic conditions. The Accelerated Share Repurchase will take us about 8 to 9 months, but we can also make additional purchases if necessary. We will evaluate how that unfolds and have the option to initiate another ASR shortly after, based on our strategy. We have considerable resources available as we move through 2023, which could be used for potential acquisitions, but we also have the flexibility to increase share repurchases if we decide to. There is no urgency to make those decisions at this moment, but we will reflect on them throughout the year.

Yes, it does feel like we have reached the bottom in the Interconnect space between the PCB application. So as Ed had mentioned, we're a good two quarters in, so it feels like we bottomed out. We're not ready to call kind of growth in the next quarter or anything, but we do feel like the deceleration has plateaued.

Yes, we got a peak pretty deep into it at this point in time. I mean the PCB players in China really shut down. So I think they're correcting their inventory really quickly. I mean, they truly shut down. It's not like they cut back on production. So I think they can fix things pretty quickly. And so I don't want to put a date on kind of building out of it. But again, we are pretty far into it months wise at this point in time.

Nice quarter. Just one question for me. It seems like the consensus view is for a recession next year. Can you maybe talk about each of the businesses and how it should perform in a downturn? And just when I think about the fourth quarter outlook, multiplying that by four probably isn't the right way to think about a recession case, and maybe walk through the puts and takes of that sort of potential.

Yes. I mean, I think, first, starting in the financials, I think you're right to take the fourth quarter; it tends to be usually our seasonally weakest quarter. And so to take it and run rate it could be difficult. I wanted to highlight, too, just the natural EPS growth that we have from the actions that we've taken on the capital allocation side which will bolster us as we head into 2023. So between the share repurchase that we announced today at the $3.25 billion, the lower interest income that we called out of, lower interest expense that we called out of $100 million and further interest income from the cash that we'll be holding in the balance sheet, we've got north of 15% EPS growth just from those actions alone. So nice to be positioned to be in as we head into 2023. As Ed had mentioned, we'll aim to maintain favorability on the price/cost side as we start to continue to see the commodity prices decline. And I did highlight that we have initiated a cost restructuring program should we need it beyond the stranded costs that we've highlighted to take out. So from that perspective and from maintaining a good margin profile, I feel like we're protected as we head into next year. And from an end market perspective, we've highlighted that we probably feel like we're already two quarters into the consumer electronics downturn and the semi piece that I had highlighted, the inventory index that we pay attention to. And so while it is elevated versus where it was during the pandemic, it's not as elevated as it was back in the 2019 time frame when we saw semi volumes down in the mid-single-digit range. From the industrial side of the portfolio, so the remaining piece of electronics and then the broadness of W&P beside the shelter piece, those pieces, they're pretty stable. So Water, we've got a really nice backlog, at least 6 months of backlog in the Water business. A nice performance on the defense side, especially on the aero piece within the safety portfolio as we see those markets continue to recover. The one piece besides consumer electronics and semi that we're paying close attention to is obviously the Shelter business. The North America residential side, which is about 40% of the business, we'll pay close attention to, obviously, with the news out there on the potential headwinds in that space, but we're not seeing anything material at this point.

This is Dan Rizzo speaking for Laurence. You previously mentioned that prices should not be seen as surcharges but rather included in the production or product costs. I wanted to know, historically, in such cases, have you ever had to offer price concessions, or are prices usually quite stable?

Well, I think for all of us, it's hard to totally answer that question because we never had inflation like this in at least in my career and raised prices as much as all of us have. So our game plan clearly is to keep a spread there because I'm a strong believer we have big intellectual property. A lot of our products are needed, they're the best in the industry and they should have good EBITDA margins with them. And generally, we do have very good EBIT margins across the board. So the game will be to keep that spread there. But when you've had this kind of inflation, I don't think you'll hold on to all of it, and I don't think any company holds on to all of it, by and large, but can you keep a spread will be the real game.

So we've never given a rule of thumb the drop-down from the top line headwind. So in the fourth quarter, we expect about a 6% year-over-year headwind from a currency perspective. The drop-through down into EBIT is not materially different than the overall EBITDA margin that we have for the total company. So you could use that to kind of model where we think the roughly $200 million year-over-year headwind in currency translates to EBITDA.

Just given the solid result on W&P margins on your longer-term pathway back to '27, '28, has the calculus changed at all between the buckets of price cost over intermediate to long term, improving ops, and just overall business mix? Is there any change of thought process? Or is just hey, we have a lot of things going in the right direction, and we'll get there in due course.

No, there's no change in the EBITDA margin improvement drivers that you had mentioned. The one piece that we'll continue to watch, as I had mentioned, was can we drive continued favorability within the margin improvement from price cost? So as the costs start to decelerate, are we able to maintain a more favorable price profile? Yes. I would say longer term, there's no material change in the profile of high single-digit CapEx going in and driving high single-digit increases in production. Some of the numbers, as we head into 2023 from a market research expectations, do see a decline in MSI. So the initial numbers right now are around a 5% decline in MSI, but we would still expect that same outperformance of 200 to 300 basis points. And so if MSI is down 5% next year, we would expect to be down 200 to 300 basis points ahead of that.

I wanted to follow up on the recession question discussed earlier. You mentioned that annualizing the fourth quarter is not the appropriate approach. That represents about $3 billion in EBITDA. We talked about several positive factors regarding pricing and some restructuring efforts. Is it correct to say that your initial target for next year, from an EBITDA standpoint, is roughly flat year-over-year even in a recessionary scenario?

Yes. I think it's a little too early to call what 2023 EBITDA looks like. So we highlighted the actions that we're taking to drive EPS improvement from the share repurchase and from overall improved performance in interest expense and interest income. But we haven't really indicated anything yet about what the EBITDA profile would look like beyond the actions that we're taking on the cost side to take out the stranded costs, and then we've got the ability to do more there should we see further need to.

A lot of this depends on how you will individually model a recession scenario for next year, particularly regarding commodity inflation or deflation, as that will significantly impact all the multi-industrial companies if you start seeing benefits. Additionally, revisiting an earlier question, whether you can retain some of those benefits will be a critical question for all the multi-industrials. The way this unfolds will be quite different from any other recession we've experienced.

Yes, I wouldn't say there's anything material at this point. There are elevated inventory levels at some of the big box retailers, but we haven't seen any material destocking yet at this point. So we did see positive volume growth in Shelter in Q4. And I'll just remind you of the distribution of the Shelter business, roughly $1.8 billion of sales. About 40% of it is commercial, which remains to be very strong for us. So that's selling into health care and education and other types of commercial applications. 40% residential, and then 20% kind of the do-it-yourself market.

We observed positive volume growth in Shelter during Q3. We expect this to moderate somewhat going forward due to inventory levels in the channel. However, there hasn't been any significant change in the order book at this time.

I have two questions. First, could you describe the volume outlook for Water in parts of the portfolio that are less sensitive to economic changes? Do you anticipate that the lower variability in earnings will continue as you previously communicated?

Yes, we are continuing to see strong performance in water. In the third quarter, volumes increased by low double digits, and we anticipate mid-single-digit growth in the fourth quarter. Additionally, we have a robust backlog, which provides us with more than six months of work to support the overall volume for the Water business, even if there is a decrease in demand.

We are moving quickly with the share repurchase, but we can only buy back so much volume at one time. We are not in a rush to make any bolt-on M&A decisions; we want to see how the economy unfolds. We might find a better entry point in the next six months to a year. Currently, there isn't much we plan to do with any excess cash we have, and we'll keep an eye on the situation in the coming months. Also, we still need to sell Delrin, so we don’t have those funds available yet, and that sale is likely more towards the second half of 2023.

Ed, Auto Adhesive is performing quite well. What are the prospects for this business? Will it remain part of Corporate & Other in the future?

Well, Lori manages it, and it's growing like a weed so I'll let her answer it.

Yes. So we are seeing really nice growth in the Auto Adhesives, primarily driven by the conversion and the opportunity that we have on the battery side. And so we saw the 25% organic growth in the third quarter, and we expect further growth as we move forward. The distribution between ICE and EV from a 2022 builds perspective is really pretty disparate. So the overall expectation for ICE vehicles is actually, I think, to be slightly down. And for EV, EV-related materials is to be up well into the double digits. And so that dynamic is what is playing into our growth portfolio as we move forward. As far as finding the permanent home for the Adhesives business, it will not stay in corporate. So here in short order, we'll figure out where those businesses need to be aligned. We wanted to make the decision after we had got through the Rogers decision. And now that we know that path forward, we can figure out where these businesses reside permanently going forward.

Yes. We think we can leverage it well with some of our other auto exposure, especially on the EV side. So we'll organize ourselves to advantage ourselves as we talk to that customer base that we have other products and opportunities to sell into. So it will advantage the adhesive business over time. But by the way, we're feeling very good about our win rate there. And you can see by the organic growth, Lori, what was that? Yes, 25% growth is pretty spectacular in that business. And I don't see it slowing down just because of what Lori just described, the EV build rates coming over the next five years. Nothing new to report, although we've been having intense discussions. I want to assure you that I am personally working with my General Counsel, and we are hopeful for a resolution, though I prefer not to set a timeline. It is public knowledge that the judge has been encouraging settlement talks with the plaintiffs, which is a positive indication, possibly even utilizing a mediator. We've made significant progress, but I still don't want to specify a timeline. This is an ongoing process, and as you know, settling the water district cases is our main focus.

Yes, Ed, you mentioned some cross-selling between Laird and legacy DuPont, and you also noted a technical difficulty.

Yes. Just thank you, everyone, for joining our call. And for your reference, a copy of the transcript will be posted on our website. This concludes the call. Have a great day.