Cabot Corporation (CBT) Earnings Call Transcript & Summary

Again, my name is Dave Begleiter of the U.S. Chemicals team from Deutsche Bank. Next up is the team from Cabot, CEO, Sean Keohane; and Steve Delahunt from the Investor Relations team. Sean will have some comments and presentation, and we'll go to the Q&A portion of the session. So Sean, with that, it's all yours.

Great. Thank you, David, and thanks for hosting the conference, and it's great to be back in person here, although I think a bit of a mix, some people still wanting to participate virtually, but great to see you all. So my name is Sean Keohane. I'm the President and CEO of Cabot Corporation. I've been with the company for about 20 years in a range of different roles, have run all of our business segments, had responsibility for our Asia Pacific region as well as a number of functional responsibilities over the years, including global engineering and led our commercial excellence practice as well. So been in the role as CEO since March of 2016. I'm going to spend probably about 20 minutes today just talking about the state of the company, the growth opportunities that we're excited about and then we'll certainly have an opportunity to entertain some questions at the end. Before I start, I want to remind you that any forward-looking statements made today are subject to risks and uncertainties that could cause actual results to differ materially from those projected in such statement. Any non-GAAP financial measures referenced are reconciled in this presentation and also available on our Investor Relations section of our website. So to get started, perhaps a quick snapshot of the company is good grounding, I think, especially for those that are a bit share typically. We're a very global company with about 75% of our sales generated outside the United States. And our business model is one where we typically make and sell in the same region. So you'll see that our sales and assets are pretty well balanced. This structure is also advantaged in these dynamic times right now when customers are increasingly looking for regional supply chain solutions to mitigate risks and ensure supply security. We produce a range of products that provide critical functionality across a very diverse set of applications, functionality such as reinforcement, conductivity, rheology control, UV stability, color, free flow. So very broad function set across our products. Our end market exposures are pretty diverse, the largest being the resilient replacement tire market where we sell a broad range of reinforcing carbons that enhance critical performance requirements such as tire life and rolling resistance. In addition, we produce a wide range of specialty carbons, fume metal oxides, specialty compounds, inkjet dispersions and aerogel materials. And all of these are critical in a range of applications across automotive, the infrastructure and industrial sectors and a broad range of consumer applications. Across the portfolio of products and applications, the quality of returns is strong. EBITDA margin is close to 20% and return on invested capital substantially in excess of our weighted average cost of capital. And additionally, with our strong balance sheet and cash flow power, we've earned an investment-grade credit rating and have maintained a continuous and growing dividend since 1968, which is the year that the company went public. For the past 6 years, we've been pursuing a strategy that we called Advancing the Core, where we executed against 5 priorities. First, addressing noncore businesses in the portfolio, which meant divesting our Specialty Fluids business and more recently, our Purification Solutions business. Second, we focused our attention and resources around growing and strengthening our core businesses of reinforcement materials, specialty carbons, fume metal oxides and specialty compounds. The third priority was investing in and nurturing a set of new growth vectors that really build from our core positions of strength. Fourth, building a track record of execution and delivering on our commitments. And then finally, driving [ disappointing ] clarity around capital allocation. And as we shared at our Investor Day back in December, we've been very successful in executing against this strategy and have exceeded the goals that we set out at the beginning. Over the period, we grew adjusted earnings per share at 12% compounded annually and adjusted EBIT at 10% compounded annually. And I think capital stewardship has certainly been at the core of every decision that we make. And our focus on execution and capital discipline have yielded strong returns with adjusted return on invested capital of 18% in 2021. With the portfolio now focused, I want to turn our attention to look forward and with the focused portfolio and I think a track record of progress firmly established. We recently announced the next chapter in our strategy, which we call Creating for Tomorrow. And Creating for Tomorrow, we've evolved the strategy and we'll leverage our strengths to lead in performance and sustainability today and into the future. And we'll deliver on the strategy by focusing on 3 key pillars: the first is driving advantage growth; the second is delivering innovative chemistry to our customers to help them solve their sustainability challenges; and third, relentlessly pursuing continuous improvement in everything that we do. The new strategy preserves the underlying fundamentals of our previous one, while at the same time, drawing on a strong connection to our purpose as a company, which is to create materials that improve daily life and enable a more sustainable future. If we just move now to the 3 pillars of grow, innovate and optimize, I think it all starts with growth. We're seeking advantage growth, and that means growing by building on our unique advantages and from our positions of strength. And so you'll see us continue to extend our strong global reach and invest organically in differentiated capacity and through tuck-in acquisitions in key growth markets. Our recent announcements to acquire the Tokai Carbon plant in Tianjin, China and our previous announcement a few years back to acquire and expand the Nippon Steel chemicals carbon plant in Suzhou, China are good examples of how we're using M&A to support our growth strategy in a very capital-efficient manner. Innovation remains at the center of the strategy, and our efforts will be further focused on how we can develop innovative products and processes that support our customers and enable them to deliver on their sustainability objectives. In fact, one of our 2025 sustainability goals is to have 100% of our new products and processes delivering a sustainability benefit. And we think there's enormous potential here for Cabot to bring innovative chemistry to our customers to help them solve their problems and opportunities that come with focusing on sustainability. And finally, the optimized pillar. I think in a capital-intensive business, the work of our manufacturing plants is really central to our strategy. This is certainly where innovation comes to life. This is where we deliver on the brand promise to our customers. And so we'll continue our journey of success here in terms of world-class manufacturing performance, and our work will deepen to have an increasing focus on capital efficiency. I think you'll also see us renew our ways of working and look to bring the power of digital tools to our manufacturing processes to improve productivity further and differentiate us. So by pursuing the Creating for Tomorrow strategy, we'll transform the company and reshape the valuation potential of Cabot Corp. Maybe a few comments now around our end markets and what we're seeing out there. Cabot's businesses are connected very well to key macro trends. Those of what I would call the changing mobility landscape and increasing focus on sustainability from all of our customers across all applications and then how we're becoming a more connected world and the implications for that on our portfolio. And our product portfolio connects very well to these important trends in diverse ways. And I think the potential for innovation is significant and compelling. Now we're particularly excited about some emerging growth vectors in our portfolio, particularly battery materials, and I'll talk a little bit about that in the forthcoming slide. But also our inkjet business, and as the commercial and industrial landscape for printing transitions from analog to digital, the role of inkjet technology is pretty clear. And then finally, our E2C product line, which we believe can transform tire performance. Maybe a few comments about ESG and how this fits into our strategy. I've talked about the role of sustainability, really, at the center of our strategy and how our customers are increasingly motivated to solve their sustainability challenges. Clearly, ESG leadership is something where Cabot has a long history of leadership, beginning first with our deep commitment to personal safety and product stewardship. If you look at Cabot's total recordable incident rate, we're around 0.25. That is at the top of the league tables in terms of chemical companies as well as across the industrial landscape. The chemical industry is the safest industry from a recordable injury perspective, and Cabot is at the top of that and there's a long history of commitment to that. And then over the years, naturally, our focus has broadened to include environmental performance, community engagement and human capital factors. But the hallmarks of our approach, I would say, are strong governance, number one, transparency and disclosure, clear goals and a real commitment to continuous improvement and leadership. And we were the first in our industry to embrace external reporting, such as the Carbon Disclosure Project, or CDP. We produced our first GRI-certified sustainability report back in 2010. More recently, we have extended our disclosure to include adoption of the SASB framework and have also completed an assessment according to the TCFD guidelines. We've been widely recognized for our leadership by countless organizations, including being named for the third year in a row to Newsweek's Most Responsible Companies and most recently by Investor's Business Daily as 1 of their 100 Best ESG Companies in 2021. We've also earned the highest rating of platinum from EcoVadis for the third consecutive year. EcoVadis is the world's largest and most trusted provider of business sustainability ratings with more than 90,000 rated companies. Most of our customers rely on EcoVadis to assess and evaluate the sustainability of their suppliers. So they're clearly the leader. And a platinum rating is their highest rating and recognizes our sustainability efforts and really places us in the top 1% of companies that are rated by them. And I think this prestigious recognition really underscores our commitment to transparency, and it provides our customers with a reliable assessment of our sustainability performance. I'll transition now to talk a little bit about the growth vector of battery materials that I mentioned a slide or 2 ago. It is the most promising growth opportunity in the portfolio. It's clear that mobility is undergoing a rapid transformation with the electrification of all forms of road transport from passenger cars to trucks and buses. And Cabot plays a critical role here in enabling this transition with our conductive carbon additives. Over the past several years at Cabot, we've been systematically building out our product portfolio, technical expertise, customer support and global footprint that is required by the lithium, lithium-ion battery producers. Battery technology is complex and is evolving rapidly as manufacturers look to improve safety, increase battery range, reduce costs so that the product can proliferate and shortening charging time. So a complex set of performance requirements. And conductive carbon additives are one of the critical materials to address these evolving needs as they create the conductive pathway in the battery for electrons to move in the charging and discharging of the batteries. The conductive carbon additives are essential to battery chemistry and will be critical in all generations of lithium-ion battery technology from current chemistry to dry process to solid state, which is on the technology road maps out over longer period for most of the battery producers. Cabot is the only global conductive carbon additive player that has a broad portfolio that includes conductive carbons, carbon nano tubes as well as carbon nano structures. Each of them offer a different ability to tailor both conductivity and formulation flexibility for the battery players. And we've invested heavily over the past several years and are seeing great success today. The total addressable market for conductive carbon additives, we estimate to be -- grow to about $2 billion by 2025. And I think most industry analysts would say that this lithium-ion battery space will grow at about a 30% CAGR out for the next decade, so pretty strong growth fundamentals. Given our strong portfolio that I just touched on, our global footprint, Cabot is very well positioned to grow faster than the market. And we communicated in our recent Investor Day that we expect to grow earnings at a 50-plus percent CAGR over the next few years, so faster than the market is growing. And based on our strong momentum on our Q2 earnings call, we raised our outlook for EBITDA in this business to be between $30 million and $35 million for this fiscal year 2022. And so the midpoint of that range would put the earnings growth at about 100% versus the prior year. So a lot of momentum here in this business. We believe that the electrification of mobility will transform the world and will be one of the essential steps for the world to reach net zero. And at Cabot, we're well positioned here and we're investing to win. Maybe just a few comments on interim progress. So we're definitely very pleased with our results for the second quarter, which ended March 31. In the quarter, we delivered record adjusted earnings per share of $1.69. That was up 22% over the same quarter last year. Demand across all of our businesses was strong. And we continue to leverage our global scale, our differentiated portfolio and our track record around operational excellence. Certainly, while geopolitical events and the persistence of COVID-19 and global supply chain disruptions, all of these presented challenges to industries globally, we demonstrated continued resilience across our operations, driving the strong earnings and discretionary free cash flow. Maybe now turning to our longer-term outlook. We shared this information at our Investor Day, but I'd maybe just hit on a couple of points. So along with our new purpose and strategy at the Investor Day, we launched a new set of long-term targets through 2024. And our outlook is for a supportive market environment and strong momentum in the key macro trends that I touched on earlier of changing mobility landscape, rising importance of sustainability and as we become a more connected world. So we expect a very strong volume growth in our Performance Chemicals segment, ranging from 9% to 11% per year over the period, supported by strategic capacity investments. And in the Reinforcement Materials business, we expect a very resilient replacement tire market to drive steady volume growth, underpinned by a supportive market environment. And in Battery Materials, as I just touched on, we expect to grow the earnings of this business at a 50-plus percent CAGR over the next 3 years. So overall, we expect adjusted earnings per share to grow at a compound annual growth rate of between 8% and 12% over the period and to generate in excess of $1 billion in discretionary free cash flow to support the growth investments in these high-growth vectors and return cash to shareholders. Now I want to spend a little bit of time on value of the company. I think this is perhaps the most important slide of the day because it brings together everything that we're trying to do and illustrate why Cabot offers a differentiated investment opportunity. Over the past 6 years, we've divested the noncore businesses and invested in our operating platform to extend our leadership in reinforcement materials, specialty carbons, fumed metal oxides and specialty compounds. And then additionally, we've made sustained investments in these new growth vectors that really build from positions of strength. And so as we sit here today, we've grown the profitability of the core to new and durable levels of earnings. And additionally, the investments in these high-growth vectors, particularly Battery Materials, but also for inkjet and packaging and E2C for next-generation tire compounds, these are really beginning to progress. And we expect them to reach materiality in waves over the coming years, beginning with Battery Materials. So as we look forward, we expect the core will continue to grow in size and value, and we expect the high-growth vectors to become a more material value contributor to the company. In fact, given the underlying growth rates of these growth vectors, it's reasonable to believe in the coming years they should be a larger part of the company valuation than our core businesses. The core businesses are characterized by structures that I would say create a pretty deep moat around them, I think, therefore, underpinning the strong cash generation, which is -- gives us an ability to fund these growth plans in the high-growth vectors and return excess capital to shareholders. So I think the combination of strong cash flow generation and breakout value from these high-growth vectors presents a compelling case for investment. And I think this is probably the most important takeaway. So if I wrap up now on this slide, I guess, in summary, the investment thesis for Cabot is fairly straightforward. Our Reinforcement Materials business is structurally improved. And we expect to be less cyclical than in the long past of this industry, driven by the following factors. The tire migration that played out over the last 25 years were certainly very disruptive for the entire tire value chain. But that migration has stabilized, and we believe we're in a new normal in terms of the structure of the tire industry and the associated value chain. Our business model, as I touched on earlier, is built on making and selling in the same region. This is definitely driven by economic fundamentals of producing carbon black, but I think even more durable given the rising trends around regionalizing supply chains and greater supply security. In reinforcing carbons, there have been no material supply-side additions announced in the mature regions, and the supply-demand dynamics of the industry are very balanced. In fact, it's probably only getting tighter given the Russian invasion of Ukraine. And we see customers expressing significant concern about purchasing reinforcing carbons from Russia. Beyond these structural factors here, we've also implemented a range of self-help initiatives over the years that have structurally improved the profitability of the Reinforcement Materials business, things such as adjusting our formulas that pass through the hydrocarbon exposure to our customers in a timely fashion, tightening of those formulas so that we don't have any lag. It's a good match between how revenue and costs flow through in the company, making sure that the index that our pricing is connected to is working. And if there's any gap, making sure that, that's closed through things like a delivered cost adjustment as well as a lot of work to drive yield and energy recovery in our process. By doing this, this improves the economics, but also reduces both our Scope 1 and Scope 2 greenhouse gas emissions. So all of these self-help measures are a critical part of increasing the structural performance of the business that you're seeing today. In Performance Chemicals, this segment is made up of a collection of businesses that are #1 or #2 in their marketplaces and really benefit from attractive macro tailwinds. And so we're expecting significant growth here, as I touched on, in terms of our targets. And the third point is really the growth vectors, Battery Materials, inkjet packaging and E2C. And we're investing behind these to drive transformation of the portfolio. And we expect strong discretionary free cash flow to then fund these compelling growth investments and return capital to shareholders. And all of this will be underpinned by continued leadership of ESG. And we will continue to be recognized for our leadership here, and this is integrated into everything that we do. So with that, I'll close out the prepared remarks. And David, we could take some Q&A.

Great. It was excellent, Sean. Thank you for that. Please have a seat here. Relax. Maybe first on near-term business trends, how is demand by region, by end market, by product?

Yes. So it sort of depends by application. But if we start with mobility in our Reinforcement Materials business, about 75% to 80% of this market is driven by the replacement tire market. So the car park, of course, is much bigger than the number of new cars that come off the production line. And so it's really driven by miles driven. And that has been holding up quite well. It tends to track general economic activity. And you can look back over very long cycles, it's quite durable. So I would say that is remaining quite robust. In Performance Chemicals where we're really seeing -- certainly, the automotive OE market is still down, but we're not being impacted by that in a material way because we've got other growth applications that are really making up for that. As that recovers back to pre-COVID levels, that will definitely give us a mix uplift as a lot of the high-value products go into a car, think like finished coatings on the car or structural adhesives to lightweight the car, these things. But the areas where we're seeing a lot of growth across Performance Chemicals are in areas like alternative energy, where our fume silica is going to the manufacturer of wind turbine blades or in battery materials, for sure, a lot around infrastructure as investments to upgrade the grid. And any of this alternative energy that gets developed has to have power distribution cables to bring it back to the users of that power, and our products such as our conductive carbons are critical there. So I think the infrastructure sector is performing quite well, alternative energy as well as battery storage. We're seeing a lot of growth there.

How do the trial lockdowns impact your business?

Yes. So Cabot has a significant position in China, I think a distinguished leadership position. In our core end markets, it's really critical. So China makes almost 40% of the world's tires today, 50% of the world silicones, 50% of the world's lithium-ion battery. So if you're going to participate and lead in these end markets, having an important position in China, I think, is critical. And I think China, it's really a story of Shanghai and rest of China. And I think in the rest of China, the lockdown seem to have been more surgical. In Shanghai, they were more significant. Now we had commented on our recent earnings call that we did not have any material impact there. We continue to operate, produce, serve our customers. And we're starting to see, I think, sort of a dialing back as China has to find the balance point here. And so I think that's a smart thing to do and I think what they need to do to balance this. But we've managed through it well in our Shanghai site and rest of China. But they've got to recalibrate, I think, the balance point here.

And what are you seeing across our European footprint right now?

So I think Europe is an area. It's an important end market for us, certainly, in terms of tire, automotive, consumer infrastructure. Across all of our key markets, Europe is important. I think there's obviously the highest level of concern in Europe given the Russia invasion of Ukraine and what that's done in terms of destabilizing principally energy and how that all flows back. I think people are a bit unsettled and wondering how this is going to play out. So demand is holding up well. But I think this is a question mark, and understandably for everybody, as they just look across Europe wondering where does this go, what's the off-ramp here. I think that's a point of sort of macroeconomic uncertainty.

And from a raw material perspective, energy perspective, what do you think you'll see a peak in these costs for your operations?

Yes. So energy costs are up for everybody, and we managed that in different ways throughout our portfolio. So in Reinforcement Materials, we pass along that through our formulas. So there's kind of a mechanical pass-through and a very timely pass-through. So I think we're in a good position there. In our Performance Chemicals products portfolio, we tend to then have to get recovery of these through spot market pricing, which we've commented we have been effective at doing. But we have to recover these higher costs and we have different mechanisms depending on the business to do it. Now in terms of where the sort of energy prices are, it's anybody's guess. But they certainly feel like they must be at a more peak level given the peak of uncertainty right now. But how that plays out here, hard to tell. It looks like we'll be in a higher energy cost regime for a while because I think these things don't have quick structural fixes to them. But I think from our business and contractual relationships, we've got good ways of handling this so that there isn't an impact on our performance.

So mentioned on your Q2 call that the disruptions, the Russian carbon black capacity is closing customers, begins negotiations early to 2023. How have those negotiations proceeding? And how impactful could that be for you guys?

So maybe just an important question because, certainly, Russia is a significant supplier of reinforcing carbon black into the tire market in Europe. And so somewhere in the order of 40% of the tire market in Europe is supplied by Russian carbon black. So that's fairly significant. I'll maybe touch on that in a second, but I just want to pull back the lens a little bit. Over the last 5 or 6 years what's been happening in the Reinforcement Materials business is that supply-demand has been tightening. The cost of environmental compliance has been rising. And because of those 2 factors, we've been working closely with our customers to help them understand that in order to be a long-term sustainable supplier that we need higher prices in order to support that. And that's -- we've been very effective at that and have been growing the performance of -- and the returns and the cash flows out of that business. So I think that structural picture remains. The Russia factor is a new factor that will probably tighten things even more in Europe. And I think that supply security question as well as customers just not being comfortable with the reputation risks around sourcing material in Russia any longer is causing customers to seek out players like Cabot that are well positioned to supply them. Now 40% roughly of the tire market in Europe is supplied by Russia. That's a big number. So how exactly that plays out is going to unfold here in the coming months. But customers have definitely initiated conversations around contract renewals earlier this year. Normally, this is something that plays out in the September through December time period for new contracts, January 1. And the conversations have started earlier because of the supply security pressures of this. But I would say even before this, customers, whether it's sort of just rising sense of nationalism, whether it's just a desire to regionalize supply chains for more security, these forces were already building and I think now just accentuated, I suppose, by this.

On your conductive carbon additives business, talk about the competitive landscape and how durable is your competitive advantage in this area.

Yes. Yes. So conductive carbon additives are critical to the battery chemistry again and go in at a pretty low loading in the battery, but deliver critical functionality basically to the conductive pathway to transport the electrons. So we've got a broad portfolio of conductive carbon additives that range in -- on the spectrum of conductivity as well as loading that you need to get to in order to hit the desired conductivity level. So that gives formulation flexibility to the battery producers. And ultimately, our view on this is that with the breadth of the portfolio as well as our ability to design blends of conductive carbon additives for customers that that's a differentiated and a winning position. And I think we're seeing the success in the marketplace I think as evidence of that. Ultimately, I think it'll come down to the product portfolio, the ability to design blends of the conductive carbon additives for the battery producer and to have the footprint to support their globalization efforts. So while this is primarily an Asia Pacific business today, with all the producers being Asia Pac, they all either have announced or are investing to build out battery capacity in Europe and the U.S. And they're going to want suppliers that are going to have the footprint and the ability to serve them locally in those regions. And I think this is where Cabot's footprint is really distinguished.

You mentioned a $2 billion TAM by 2025, do we see Cabot having a 25% share of that market? Is that reasonable?

I think if you look at our share in specialty carbons, that's where we are. And so that would certainly be a reasonable way to think about it. Of course, we have big aspirations here and are investing to win here, and we think we've got a portfolio that differentiates us. So we would hope to outperform that, but I think that's a reasonable way to think about it.

And just briefly on inkjet and E2C, just size those opportunities for us.

Yes. Yes. So we see these coming in waves, Battery Materials first; inkjet for packaging, second; E2C formulations for tires, third, from a time perspective. On the inkjet side, what will drive this is the adoption of digital presses. So any new press that goes in today, whether it's for corrugated packaging or any of the other, what we would call, industrial applications is a digital press. And so it's really going to come down to how quickly that adoption happens. Every digital press then is an inkjet technology press. So our leadership in our legacy in inkjet, which started back in traditional printing of small office, home office and network office printing, that technology and that platform extends here. So I think we're in a great spot. But it's going to come down to that adoption. We think over the next few years, we had commented at Investor Day that we think that -- we'll grow that business at about 25% a year over the next few years. And then it really -- the adoption right now of digital presses into these like corrugated packaging, it's less than 1%. And so our view here is that over the next 10 years, that grows to about 10%. But that's a huge market that opens up. And then finally, just on E2C and wrapping up, this is a technology where we incorporate performance additives like our reinforcing carbons in a liquid form. You get much better in the liquid rubber form. You get much better incorporation in material and better rubber compound performance. This has been adopted by Michelin, and others are working with us on the same thing. What it does is give much better rubber compound performance. So it's starting in applications like off-the-road tires, big mining tires, things like that, where wear and performance is really critical. And then ultimately, we would envision that it has the potential to penetrate into truck tires, which would open up a significant market for us. So a little bit harder to size that TAM. The rubber compound market is enormous. Now what portion of this it's addressable to and over what time is a little bit of a harder one to peg.

Well, come back next year and tell us what the TAM is, okay?

Yes. Good.

With that, Sean, thank you very much.

Great. Thanks, David. Thank you.

Thank you.