Eastman Chemical Company (EMN) Earnings Call Transcript & Summary

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Cheers from Cleveland. This is Mike Sison. I cover chemicals for Wells Fargo. I want to thank everyone for joining us at our 12th Annual Wells Fargo Industrial Conference. I want to kick things off with Eastman Chemical, which has had a very strong start to '21. Stock is up 20% year-to-date versus the S&P 500, up 11%. During that time period, the company generated an impressive 8% sales growth during the first quarter, recently raised their guidance for '21 to $850 million at the midpoint, which would be a record for Eastman and up 38% year-over-year. Both of its specialty segments, Advanced Materials and Additives & Functional Products are generating strong double-digit earnings growth, and by our math, represents the bigger portion of the EPS growth in 2021. With us today, we have William McLain, CFO of Eastman; and Greg Riddle, Vice President, Investor Relations. Thanks, guys, for spending some time with us. Quick note, if anyone has a question, feel free to e-mail me at [email protected]. And if anybody wants to see this new business-tropical-suited person, Wells Fargo is allowing in-person meetings and be happy to make my way out your way to send me an e-mail.

Willie, let's start with your 2021 outlook. You started the year looking for something in the $740 million to $780 million range. You're now looking for 8.25% to 8.75% at the midpoint, again, above the prior peak of '18. It doesn't appear that your volumes will be at a peak in '21. So can you maybe summarize what you thought in '21? What was better, I'm sorry, in '21 thus far? And how much growth versus the $615 million is coming from the specialty businesses this year?

Thanks, Mike, and glad to be back again virtually this year and hope for -- look forward to meeting you in person. As I would highlight, as we came into the year, it was -- we were cautious as to what was the level of momentum. And I think with the vaccine as well as the protocols, we've seen increased momentum from a business standpoint. That's in our key end markets, whether it's durables, building and construction, and automotive and transportation. So what I would highlight is what's new and different today and the reason for our raise is the speed of recovery and the benefits that we're going to see from a mix perspective. And it will be primarily mix with some of that volume as well. And as you've highlighted, we believe that we have the capacities and the volumes to continue to grow in '22 and beyond. Also, I would say the tight underlying market has benefited our Chemical Intermediates business. And with that, we've seen spreads start to improve post winter storm Uri, and as assets and such get back up with that demand, we expect to see spreads expand in Q2 and going into Q3, still an unknown as to how strong that will be in the back half of the year. I would say 2 constants I would also highlight, which is, on the cost front, we continue to be very disciplined. Our ops transformations that we announced, which includes an array of projects, including optimizing our asset footprint and also being diligent as the temporary cost actions we took last year that were more than offsetting those, here, early in the year and expect that to continue throughout the year. The other highlight would be on a year-over-year basis, continue to expect to see the $100 million of utilization benefits from where we took very quick actions on the working capital inventory front last year. And on a year-over-year, you'll start to see that substantial benefit to show itself in Q2 and Q3 being primary year-over-year comps. And again, I still expect some moderation in the back half, but we'll continue to see if this momentum in the key end markets, along with our innovation-driven growth model, is allowing us to capture some of that growth even more efficiently. And you saw some of the wins that we highlighted on the circular and the speed that we're seeing, gains and commitments, with brands there.

Right. Okay. And then -- and for the second quarter, your EPS is expected to recover significantly. What do you think are the near-term sort of positives contributing into that growth? Which -- are there any end marks that are still struggling and which could be sort of an opportunity as you head into the second half and into 2022?

As I think about -- we'll look at it both year-over-year and sequentially because I think both are important here and probably sequentially is key. But as we think about the health, obviously, there's been substantial recovery in automotive. Within transportation, we're starting to see the momentum in aviation, but that's probably more of a second half of the year benefit, as we actually see the gains there. Durable products has been strong here in the first half, and we expect that to continue into the second half and building and construction. All of those are strong year-over-year. I would say our care chemicals has performed extremely well throughout both COVID and continues to here in the near term. But momentum and continued uplift into the second half, I would say, is textiles, aviation as we continue to see some of those that were more impacted and lagging in the recovery as being potential growth areas as we continue.

Got it. Why don't we shift gears a little bit. Willie, your balance sheet is in really good shape. You're expected to generate free cash flow over $1.1 billion. And when you think about acquisitions, they've been an important driver for you guys over the years. It's helped improve the portfolio. As your balance sheet has gotten a lot better, what type of acquisitions do you think Eastman is going to look for going down the road? And where could be the focus areas to continue to improve the specialty parts of your portfolio?

Thanks, Mike. And yes, we expect by year-end that our balance sheet will be, I'll call it, at or below the 2.5x debt-to-EBITDA that we said we want to be at strong investment grade. Additionally, we expect to continue to have a very high conversion rate as we think about our net income to free cash flow going forward. With what we see today, we definitely expect to be approaching $1.1 billion, which would be the fifth consecutive year of being greater than $1 billion. And I would highlight that we've been disciplined on our portfolio both ways, both from a divestiture standpoint in the past as well as those acquisitions going forward. Right now, we're focused on how can we accelerate our organic growth strategy and the mix upgrade to our business strategy and looking to how do we accelerate that with bolt-ons. We announced a small bolt-on in the animal nutrition space that we think builds upon our strong organic asset position, and that will grow the EBITDA margins within the Additives & Functional Products business. Obviously, the strategic flexibility increases. But we think our core strategy is where we're focused and will continue to be here in the near term. And obviously, we also won't let cash in on our balance sheet longer term. We will put that to use in an accretive and effective way.

Right. Great. And then can you give us an update? You have some assets that you were looking for strategic options, I think tire additives, formic acid and adhesives. Any thoughts on those businesses now? How have they performed? And what do you think the plan is for those going forward?

No, no, I think the business leaders and the business teams have done a great job of responding to our call to action around restructuring those businesses, and we continue to make progress there and take actions on both asset footprints, market strategies, contract strategies, et cetera. And so I'll call it success there. Also continued market momentum and the recovery is benefiting both businesses. And in addition to that, our innovation as we continue to get wins in those areas. Those have substantially stabilized the businesses. And again, we're looking at both partnerships as well as the potential divestitures of who's the highest and best owner of these businesses. And again, we'll update you as it's more appropriate. But these businesses right now are less than 10% of our overall EBITDA. And again, it's continued refinement so that we're focused on our innovation-driven growth model for the 2/3 of AFP and our Advanced Materials business, which is performing extremely well.

Right. Great. Why don't we shift gears a little bit. Eastman was ranked in the top 100 for both Barron's and Wall Street general surveys for sustainability. So I thought it would be good to get some sort of some time on sustainability front, something maybe different to talk about on these fireside chats. Can we start with your CRT, which I know it's called carbon renewable technology, takes an array of mix plastic waste, breaks it down and you can make new products about it, new products with it? Can you talk about the portfolio of products there and maybe where investors can see those consumer products?

Yes. So one, thanks for the recognition on the sustainability front. I'll also give a applaud for the team that put a great sustainability report together in December of 2020. So that's helped on our website and on the Investor link. So I would encourage you to go look at that. Also, as we think about holistically in our strategy and sustainability, obviously, we've been screening our business, both organic and inorganic through a lens of, I call it, climate, the caring and the circularity and being mainstream there. There's all 3 of the fronts. And obviously, you've highlighted the one on making circularity mainstream. And great progress on both carbon renewal as well as polyester renewal and methanolysis. And I think we highlighted both on the biopolymer as well as the methanolysis on our call. So I'd encourage you to go look at the scripts as well as a couple of pages highlighting those. And we've made great progress, and it's accelerating here in the near term. On the carbon renewal front, I think about that as it can take basically anything probably with the exception of PVC from a plastic content perspective. And we can take that, and this is where Eastman is uniquely suited to accomplish the circular because we have both polyester as well as our acetyl strains co-located at our corporate headquarters here in Kingsport, Tennessee. So there's synergies from the standpoint of -- we can actually prioritize the colored PETs, the polyester textiles as what goes into polyester renewal. And then anything else that's left over can go straight to our gasification into the carbon renewal. And that's where you can get both sustainable and biopolymers into our Naia brands within our Fibers business, and tremendous opportunities there as we grow that. And so you can see an asset synergy, logistics, and we derisk it from that perspective. Also, as we think about the business model, we're derisking it from the partnerships with the key brands that we highlighted, including the likes of Estée Lauder. And we're enabling corporate brands to achieve their sustainability commitments. So it's not only about Eastman achieving its commitments, we're enabling that downstream.

Right. And then in terms of your CRT product line, how much capacity do you have to offer customers? And is the product a little bit more expensive? Are customers willing to pay? And is it something where they can maybe highlight on their packaging that it's renewable to some degree and maybe gets the consumer pretty excited about buying that product?

So yes, I think you can see the level of excitement by the brands that we're partnering with overall. I would say on the volume commitment front, I'll talk broadly as we're ahead of schedule as we think about our methanolysis and polyester renewal. And what we're seeing is the value proposition for our customers is there, which is also enabling us to see premiums that are in line with the economics that we talked about when we launched this back in January. So again, we're testing and being successful on brands, volumes, commitments and pricing and have done that tremendous progress by the specialty plastics and the overall circular team here in Q1 and look forward to their progress throughout the remainder of the year. So the model is being proven. It also potentially opens up other models as we think about solving it for governments and/or people that want to fully integrate back to the raw material and intermediates in the future.

Right. And the other sort of technology you guys highlights the polyester renewable technology, PRT, use a molecular recycling technology and maybe give us a quick -- how much -- where do you get the waste from? Is it simply just getting drinks, carpet and that type of thing? And what products are you seeing that move into as well? I think Greg had a nice little bottle to show, too, on that one.

So sure. And Greg, if you want to show the bottle, we'll show an example so that it's real?

So, Mike, here's the bottle. This is CamelBak bottle, and it's using Eastman Tritan Renew. And so this is 50% recycled content that's included in this bottle. And you can tune that depending upon what it is that the brand wants, in terms of the amount of recycled content that they want, either in the product itself or in the packaging for the product.

Right. So Mike, the key thing here is we're actually on the shelves, we're in homes. This is not just a market test. We're commercial scale today. And the speed and the adaptability and the models that consumers can see and brands can see has a strong value proposition. And we do see the premiums that can generate economic returns. It's always good to get excited about a new technology or a new brand. I get excited when the financial returns are well above the cost of capital and generate the returns for all of our key stakeholders. So we're not only doing it for our employees, our investors; we're actually helping society on a broader play. And again, this isn't just -- we're not just focused on the first plant, we're focused on how can we grow this through a business model that enables that circular economy and molecular recycling to be mainstream. And there are, I'll call it, different recycling models around the world in Europe versus the U.S., and we're developing those value channels to ensure that continuity of supply. We do not need the clean PET clear plastics that go into mechanical recycling to be effective here. And there's a tremendous amount of waste in these other streams that you referenced, carpet being turned into pallets, colored PET bottles that each of us have in our homes and so on and so forth. And there are different structures, right? In European, there's tax model. So there's definitely benefits to society of, one, keeping this out of landfills and water. And on top of that, the other key component of this is, there's no compromise in performance, and it has a lower carbon footprint than starting with virgin fossil fuels. So that is the trifecta that we believe we offer, and we're seeing that momentum here in early 2021.

Right. Great. And then I just wanted to get a little bit of an update on the molecular recycling facility. It's going to cost you $250 million, gives you about 150,000 to 200,000 metric tons of capacity for -- I think, for the Renew product. How does that compare to your total PET capacity? And maybe can you talk about maybe the cost and pricing on that product and maybe scale up longer term? Is this something that you can continue to scale up if demand fills out pretty quickly?

Thanks, Mike, for highlighting, I'll call it, the scale and the investment size. And again, we think these are greater than 15% returns at these investment levels. And I would say the proof case is continuing to prove out. What I would highlight, we're in the specialty plastics business. We produce copolyesters. We're not in the basic PET business. We exited that back in 2010, 2011. And what we're focused on is, in this first model, to continue to prove out that we can take recycled content and make that a meaningful part of our overall intermediates and raw materials that can then be in brands and the consumer sales. So that's being successful on that front. As we think about -- ultimately, we would like to take our entire portfolio over to a renewed set of brands, and it would build upon that model to ensure that whether it's in cosmetics, whether it's in water bottles, et cetera, these are the business models that we're looking at today. And we're not looking to be back in the PET business, we're looking at being an enabler for a sustainable plastics in the world. And the fact that we can use less fossil fuel and ultimately have a closed loop as there's no degradation in product performance in molecular recycling, whereas a mechanical there is over time, you can only do it so many times. So this is a complementary set of profiles, and we think we're ahead of the curve, and we're looking to set up business models with partners that are interested in those sustainable features. We see PET and recycle grades continue to draw significant premiums definitely in Europe. We see products, like Greg showed you, be side-by-side on the shelf and have premiums in the 25%. There isn't enough value proposition as consumers and society have basically decided that we're going to do things differently. And that's also why now for the investment case. Ten years ago, we had some of these similar thoughts and models and technology. Society wasn't ready for it. But the momentum has changed, and we're seeing that, and I'm sure each and every person on this call has their own view of where they are in that spectrum. But today, there's a great momentum, and we look at making this mainstream.

All right. When customers sign up for some capacity, is the contracts different? Does it take-or-pay? Is it sort of a normal pricing can fluctuate type of contract? And how are you doing in selling this plan out? Is demand there that you might be -- by the time you turn it on, it could be all sold out?

No, no, I think that would be a good outcome. And to your point, there's going to be different structures and different models depending on the risk profile of a partnership. And again, I think we've got a balanced profile as we've engaged these customers over the long term. And again, we're upgrading an existing customer base. So the great thing here is, there's not a new adoption or fitness for use as we have to -- this is a drop-in solution. And as we think about those contracts, we're looking for -- like, people making sustainable commitments. We're looking for multiyear contracts as we do this and also balance risk sharing.

Right. Okay. And then I guess longer term, does this new product potentially cannibalize your current PET footprint? And if that's the case and pricing is better, returns are 15%. Is that not a bad thing?

It's a mix upgrade as we call it, right? So as we think about our strategy and the fundamental of products having recycled intermediates and feedstocks versus what we have today, I think that's the goal. As we make this mainstream over the long term, you would actually prefer that this is a closed loop and that we continue to make advances in technology that enable us to occur with stronger economic returns as we continue to make this -- the norm versus a new brand.

Got it. Just wanted to remind everybody, if they wanted to ask a questions, just send me an e-mail at [email protected]. We've got about 4 hours left. I'm joking. We've got about 5 minutes left. A couple of questions that did come in. Can you talk about Tritan a little bit? It's been one of the better growth engines for you guys over the next couple of years? You've added capacity. And obviously, this renewed product is going to give you some capacity, too. What type of growth do you expect to see in '21, obviously, looking pretty strong? And just maybe a quick update on that product line?

Yes. So we do expect significant growth in Tritan and the product line. We're actually, call it, bringing forward another line conversion of our copolyesters over to Tritan, here, at the end of Q2, early Q3. And we see great momentum. And the Tritan product line now integrated with our circular and molecular recycling strategy, we think will be an accelerator to the product line and the scale of that business going forward to a positive. So it will actually accelerate, I believe, the fill out of the second plant that we did that doubled our capacity and as we look to do these line conversions.

Got it. And then another question came in asking a little bit of color on your coatings business. Maybe just one part, how much of that business goes in architectural coatings business, and that's been a really strong market over the last couple of years? Just any quick thoughts on the outlook there, and then the impact maybe in the semiconductor shortage on the automotive side of that business?

Yes. So we're seeing momentum on both fronts, both architecture as well as in the automotive side. And just a reminder that on the automotive side, we're exposed to both refinish as well as OEM and probably more so on the refinish side. And we see, again, more momentum on each of those fronts. I think it was greater than 20% growth that we had highlighted on our Q1 call. So that momentum, I believe, is continuing. And as we are seeing maybe some things moderate, as people start to go outside again versus refinish the interiors of their homes, that's shifting the momentum to different parts. And that's part of the end market diversification that is a strength of that business and also with it's strong volume growth and strong margins, overall.

Great. And then a quick one on raw material inflation pressure. Obviously, something that is pretty pointy at these days. You're seeing a benefit in Chemical Intermediates. How is pricing in your other businesses doing in terms of helping close that gap?

What I would say is, to your point, both raw material and I would also highlight logistics inflation as well as we've seen tight supply chains in channels here recently. As we've highlighted, typically, we've been a value share and how we take our products to the market in our specialties. And we gave some of that back in 2020 as the raw materials declined in the COVID environment, and we're actively increasing prices here in Q2. So that we believe we will have caught up with those in the second half. So momentum on the pricing front in our specialties, but being true to our strategy over the long term as we think about from '17 to '18 to where we are today because that's ultimately what's led to the partnerships and that strong mix growth as well. In our Chemical Intermediates business, as we've highlighted, spreads are expanding due to the shortages in the market, some due to both supply outage issues and reliability within some of the key end markets. We expect that to continue into Q3, and we'll see what Q4 and beyond hold as we assess momentum here at the midyear point.

Great. I guess last quick question. 2022, a lot of folks in the more commoditized will struggle, maybe to keep their earnings up. I mean you're more specialty. Any just thoughts on the growth algorithm heading into next year, not -- obviously, you haven't given guidance, but your more specialty business? Should we see growth in earnings in '22 for Eastman, to some degree?

Yes. I fundamentally believe that we have momentum in our key end markets of our specialties and our innovation-driven growth model as we continue to introduce new products and multigenerational platforms, like our paint protection films that we're launching a third generation of. So we see growth in those key, where we're making the investments and are focused on. Also, I would highlight our cost structure. We have the multiyear program that will continue to see benefits as we transition from '21 to '22. I believe that more than offsets the potential moderation and declines in the Chemical Intermediates business. But again, we'll be more specific as we get later into the year.

Great. Well, this ends our 30 minutes. Willie and Greg. I appreciate your time, and hope -- look forward to seeing you and everybody else on this call live at some point this year. Have a great evening.

Thanks, Mike.