Eastman Chemical Company (EMN) Earnings Call Transcript & Summary

Next up, we have Eastman Chemical, a diversified chemical platform with roughly $9 billion in TTM revenues. Today I'm very pleased to have with me Eastman CFO, Willie McLain. I'd also like to personally thank Greg and Jake from the IR team, who I'm sure you all know. Eastman is in the mix of optimizing its cost base, improving free cash flow and focusing on new innovations within its portfolio. So I'm sure we have a lot to discuss today. Just as a friendly reminder, if you'd like to ask any personal questions and to be clear in a confidential form, feel free to e-mail me at christopher.parkinson@csg.com or also feel free to send me a Bloomberg as well. With that, I think we have Greg with us. Willie, gentlemen, thank you so much for joining me here today. It's great to have you and host you even under the circumstances. I look forward to doing this in person next year, hopefully.

The first question, I think, is on everybody's minds, trade, tariffs, a global pandemic, all of them unfortunately taken a toll on demand in 2020. And ultimately, profitability over the last few quarters, but it does appear to be reversing in the third quarter. Can you just walk us through a couple of the key areas and end markets you've seen? And how things have been trending throughout the beginning of the quarter through September? Just any insights would be greatly appreciated.

Thanks, Chris. And thanks for having us today. Momentum is definitely, I think, the key theme as we look at our business and also the trajectory that we're on. And as we wrapped up Q2, that momentum and as we outlined through July actuals, we were expecting the volume mix impact for Q3 on a year-over-year basis to be, I'll call it, roughly down, approaching 10%. As we've assessed our book of business today and wrapped up the month of August and see orders into September, we actually think that's going to be closer to a 5% decline year-over-year. And that's been led by both our most impacted end markets as well as the mix. And 3 that I will highlight are probably, transportation, building and construction, and our durables businesses. And you can also see that momentum picking up in the businesses that we thought it would, which is Advanced Materials followed by Additives & Functional Products. But we're seeing probably more of that in Advanced Materials because it has a shorter path to its end markets. And then that's followed by Additives & Functional Products, which has a little longer supply chain, some exposures to, I'll call it, key end markets like aviation that aren't recovering at this point. Industrial activity, I think is broadly picking up as well. I would say at this point, though, there's still, I'll call it, a lack of longer term visibility. So that visibility remains short. And you can see that as end markets and customers are reactive as their demand accelerates as well. On a -- I call it more global view as we think about the regions. Here in Q3, we're seeing the volume mix impacts in Asia Pacific be approaching or at pre-COVID levels. I would say, Europe is lagging. And it's lagging, obviously, Asia, but also in North America. And North America is probably at about the average, which is 5% down year-over-year here in Q3 based on our July and August results.

So you hit on a few of the end markets right there, but is there anything else in terms of -- I mean, there's been a lot of focus on this conference in auto and anything in the supply chain on those fronts, consumer durables, construction. Just what are you [Audio Gap] inventories, just how should we be thinking about your customer interactions?

Great question. And into your point, at the low of automotive and transportation, we saw volumes off 40% to 50%. And as we went into July, that was probably closer to down 20% year-over-year, and we're seeing that further improve. Now a part of it is, obviously, I'll call it, restocking the auto dealerships around the world. On top of that, I think there is a view of continued improving demand. But you're seeing customers still be cash conscious overall as they manage their working capital and prepare for that improving demand. I would say durables definitely is a bright spot as we've seen that in our specialty plastics portion of Advanced Materials. And as you would have expected, people paused and one, weren't out shopping for those types of things in the peak of COVID in Q2. But if things continue, to need to be either, I'll call it, replaced and/or as people have been in their homes for a while, and we've seen what that's done to the do-it-yourself and just the momentum that that's created of people making investments because they're spending a lot more time in their homes. Building and construction, I would say, some of the projects had declined, but you're also seeing momentum there as projects have come out of the lockdown and continued to I'll call it, at least finish those projects that are open. I think at this point, people are still putting new projects on the books. I think they're also like the broader economy, which is, how does Q4 and COVID unfold further out? People are thinking 1 to 2 months out and trying to create some scenarios for those longer periods of time, i.e., first half of next year. And that scenario analysis has allowed us to be effective from a cash flow and a capital allocation standpoint.

Very helpful. Just as a corollary of that question, which end markets, I feel like -- it feels though a lot of the investor conversations I'm having and I'm sure others are also having are -- while we've seen this nice snapback of recovery throughout the summertime. There is a degree of optimism. There is some -- also some degree of prudency in terms of not wanting to build up inventory, and so on and so forth. If we're looking at the normalization process, in terms of, if we were to index things to, let's say, 100% off of the 2019 level, which end markets do you think are more likely to kind of have snapback and relatively plateau below 2019 levels? And which ones do you have a little bit more confidence based on your current conversations, where the slope will maintain fairly positive and get back above 2019 levels into 2020? And if you want to tweak the time frame, obviously, feel free to do so.

Sure. I think prudency is a good term because when you have lack of visibility, you've got to be prudent and understand how fast you can, I'll call it, accelerate. I think what we're seeing here, at least as we go and wrap up Q3, as you're seeing automotive and transportation markets be at, but still stabilize below the 2019 levels. Again, I think if COVID is resolved and that we continue on treatments and/or immunizations as we go forward, that it will take some of that to accelerate the entire economy and to give the confidence. I think there's still potential for upside, but I think you've got to plan and be prudent that it's going to settle below 2019 in the near term. Durables and some of those others, the question is, can they be at sustained levels above 2019? And we've seen several end markets. Consumables, now durables that are above medical, in some cases that are above the 2019 levels. It's the larger ones that are automotive, building and construction, that I think you're going to see more prudence because of the significance of those purchase items.

That's very helpful. Shifting gears just a little bit. There's been -- they're saying that, in a conference from many CEOs and CFOs is, "don't waste the pandemic." I think there's some underlying sarcasm there. But just in terms of your own initiatives on the cost fronts, you've been fairly successful thus far. But just can you give us just an update on the time line of implementation? Any additional levers you could pull? And just how investors should be thinking about cost optimization within the context of your current story and obviously, modified volume outlook?

Sure. And let me do a walk-forward from the actions we're taking in 2020 and then how we see the structural items rolling through from '20 through that '22-plus time frame. Obviously, as we started the year pre-COVID, we had lined out that we were looking for, I'll call it, $100 million-plus structural program. Pretty quickly, we adapted as we saw COVID and said, "We're going to have to take near-term actions now." And that's a program that's $150 million this year, and we're well on track. We were roughly above $50 million in Q2, probably near that in Q3 and maybe slightly below in Q4. What we're looking to do is to make $50 million of that structural as we go forward in the long term. Also, we're looking at -- as we look across our asset footprint, whether that's sites, logistics in our network, looking at how can we refine that going forward. And we've had announced and we see programs that can -- in 2021, take out as much as $50 million of our cost structure there. Our key objective is, as the discretionary spending comes back with business activity in '21, then we fully offset that in '21, and that cost structure is not a headwind. And we're on track to make that a reality with the actions that we're putting in place in the line of sight that I have at this point. The overall objective, though, is to take out $200-plus million of structural savings between 2020 and 2022. And while we would expect $50 million this year, increasing that to $100 million or above next year and then fully enacting that in '22 and beyond. So that's the walk forward. This is key that we're making substantial progress this year. And I think, again, it shows that we can adapt and pivot to ensure that we can deliver cash and focused on stabilizing cash at that $1 billion-plus level. And then as we look out longer-term with the recovery, plus the cost transformation, how do we reset that cash level at a higher level going forward.

Great. You mentioned a few moving parts there, just in terms of the margin outlook. Just when we're thinking about 2020, the volume trajectory, albeit, some uncertainty still existing, seems like you have confidence on the structural cost savings and some of the initiatives you've already been undertaking. When we think about just incremental margins for the second half of the year, and if you have a glimpse on the 2021, you mentioned even your certain costs will come back in terms of some discretionary spending, for instance. Just how should investors be thinking about that over the next several quarters to the extent of which you have visibility?

Yes. I think we talked a lot in Q2 around the fact that we did specific actions around both, slowing our plants down, making fixed costs variable as well as reducing our inventory by about 15%. And that resulted, depending on your comp year-over-year or sequential, $120 million to $140 million of period-type cost. With the volume improvements that we're seeing in Q3, the utilization rates that we're running at, we expect to recover, I don't know, roughly half, maybe a little bit more than that in the quarter in Q3. First, you're going to see that in Advanced Materials because it's supply chain shorter, and we're seeing that with both demand as well as utilization rates. And it will be followed a little bit by the advancement to our Additives & Functional Products because one, it wasn't able to shutdown at sites because they're not as, I'll call it, end-market specific as Advanced Materials and the supply chains are little longer. As we go into Q4, I don't expect that we'll have the same seasonal decline. As I think about our own cash flows, our Q2 and Q3 cash flows are going to be above, I'll call it, seasonal or trend levels. So therefore, there'll be less working capital. And I expect that's true across the industry. So while demand may seasonally decline, I don't think you'll have the working capital on top of that, which then sets us up for better utilization rates as we go into 2021 and fully benefit from higher utilization, the lack of inventory reductions and period cost charges. So that will be earnings momentum which would obviously expand your incremental margins. The example that we had is we expect, in Q3, Advanced Materials to be ahead of Q1 of this year, which was a very strong result. And now we're sitting here with additional momentum and demand in that segment as well as others.

You're actually just alluding to this, and it's a very -- easing my next question, but there's also been a focus amongst your Advanced Materials and also A&FP in terms of product innovation and streamlining some of your products in terms of more of a specialty portfolio. Obviously, this has been a fairly difficult year. But can you just give us a brief update or take as long as you wish, in terms of just where you did stand, let's say, pre-COVID, where you currently stand now? And just how you're thinking about that with other senior management over the next couple of quarters and also over the long term?

Yes. I would highlight, obviously, the way we've talked about this in the past, and our successful track record has been around new business revenue. Obviously, in this environment, that's, while it's not a focus, still, internally, we're looking at that. And also, part of it is, how do we gauge, I'll call it, the connectivity on innovation with our customer and our successful product launches. One of those, obviously, this year, and we highlighted it on our Q2 conference call, has been the success in Advanced Materials of our Tritan platform and our investments there. On Q2, we highlighted Tritan Renew and how that is, I'll call it, will not only give you the same quality of Tritan, it will actually be 50% of renewable products. And that ties in to the broader circular focus that we have as well. And maybe we can talk about that in a little bit. So we're seeing momentum on Tritan and our specialty plastics. We're also seeing and making investments and growth in our paint protection films. They've recently had some, I'll call it, some of their best months as we think about our focus markets being both China and North America and those recovering at faster rates. Additionally, we are still focused in Additives & Functional Products in our coatings business. As we think about, can coatings and also coatings, single-coat coatings applications with some of our key brands and projects there. So one, we're reinvesting our incremental cash flow around Advanced Materials and Additives & Functional Products and targeted in our textile space as we also look to leverage the assets that we have there within our Fibers business. And success right now is the engagement level that will then generate the upward momentum as we start 2021 and beyond.

So you mentioned just very quickly a few new initiatives in terms of the innovation goals and obviously, COVID and implementing them, are in fact clearly the more challenging. Just how would you assess your team's efforts in this environment in terms of prepping yourself for a post-COVID world? Are you confident in your ability to, let's say, hit the ground running once this is, sooner than later?