Eastman Chemical Company (EMN) Earnings Call Transcript & Summary

Good morning. My name is David Begleiter of Deutsche Bank's. U.S. chemicals equity research team. I'd like to welcome you to Deutsche Bank's Global Basic Materials Conference. Leading off the conferences here is Eastman Chemical. We're very pleased to have with us today Willie McLain, CFO of the company; and Greg Riddle, Vice President of Investor Relations. If you have questions you would like to ask, you can ask them via the chat function on the platform. So with that, we'll get started. Willie, good morning. How are you?

Good morning, David. Doing well. Thanks. Happy to be here again at the Global Basic Materials Conference with you.

Great. Well, if you could just speak up, that would be great. But you had a major announcement this morning, selling certain product lines within tire additives, a long time coming. Can you touch on maybe a few highlights and your perspective on that sale?

Yes, David, and thanks for highlighting that. What I would first like to highlight is, one, thanks to the business, we're staying very focused, delivering on the restructuring that we've highlighted as well as...

Willie, I apologize. I'm having a little bit of hard time hearing you. Can you just maybe speak close to the microphone? I apologize.

Okay. David, is that better?

Much better. Thank you for that.

No. Thank you again for highlighting, again, the sale of the rubber additives business this morning that we issued in our release this morning. So I would like to highlight the way the business has stayed focused, very professional throughout and delivering improving results through a dynamic period with COVID. We think this provides clarity for the [indiscernible] team as an independent company under One Rock as well as it allows Eastman to focus back on driving the specialty and the innovation-driven growth model. As we think about -- ultimately, the broader deal team delivered extremely quite good results in the outcome here for all the stakeholders, I believe, highlighting the fact that we delivered roughly and expect to be able to deliver, I'll call it, neutral to slightly positive EPS in 2022 as a result of this transaction while at the same time, keeping our debt-to-EBITDA leverage neutral overall. And again, that adds to our strategic flexibility on a go-forward basis here.

Willie, why were only certain product lines sold? And what was the multiple on the actual businesses that were sold?

Yes. So what I would highlight is the Impera resins business. We chose to keep that in the Eastman portfolio. That's a more natural fit with our adhesives business, which we've also highlighted as we think about the adhesives business. That's roughly 15% of the revenue as you think about the size of tire additives in total. The piece that we've chosen to keep is about 15% of the revenue. On a multiples perspective, I would highlight on a TTM, roughly greater than 10x. And on a normalized basis, I would call it greater than 8x.

Great. And in the release, Mark mentions that you're still exploring the other businesses, adhesives, formic acids. What can you say about the other -- the rest of the process within AFP for the underperforming businesses?

Again, I highlight that the businesses are staying focused on delivering the plans. With the adhesives, I would say, all options are under review, those partnerships as well as we think about, ultimately, are we the best owner of this business and same -- which creates the most value for Eastman and shareholders. That process is just further behind, and we'll give an update on that within the material events on a go-forward. I would say with the rest of the portfolio, we have substantially completed actions as we think about the formic acid and the sites associated with that, restructuring contracts, et cetera. So we're focused now on the adhesives and leveraging our strategic flexibility and new investments from the circular as we look forward to it.

And Willie, last question on this sale. After-tax proceeds of the $800 million, I know some is on performance -- based on performance so?

Yes. So the way I think about this total proceeds of $800 million, I would say, here in the near term, there's probably $300 million that it will take to stay debt-neutral as well as taxes. And so you can think about how we deliver slight accretion is through share repurchases on the remaining amount as a baseline.

Very good. So again, congrats on that deal. Maybe switching to more nearer-term issues at hand. How are demand trends in the businesses, maybe by region, by business and by end markets?

Thanks, David. So what I would say is primary demand trends remain strong or robust. We're continuing to see sequential improvement in the revenue line. I would say, obviously, that's been mitigated a little bit by the planned shutdowns that we talked about on our Q1 call. But the businesses across the board are also working through getting prices up to offset the headwinds and hit margins back in the second half of the year. On the demand front, I would say, strong in the U.S. and China. I would say, there's room to grow in Europe. And some of the impacts in India and Southeast Asia from COVID, still seeing some impacts there, but robust overall. I think as we look at the order books in Q2, we're seeing the sequential improvement that we thought that we would see and expect that to continue to grow. The key end markets, I would highlight, continue to be, I'll call it, autos and building and construction. On the microchip front, I'll call it, minimal impact that we've seen in Q2. And I know Deutsche Bank and some others have released reports that they see things improving as we do in the second half of the year and even potential growth going forward from that point. In some other key end markets, we've seen strength in durables. We're back above not only COVID levels, but 2018 levels as we look at our durables and some of the industrial applications there. So I would say continued strong volume and mix across the company. We're seeing better-than-expected margins here in Q2, particularly in our Chemical Intermediates business. And we expect Q2 EPS to actually be at or slightly above the high end of the current analyst range, so -- which is currently at $2.34. So strong momentum, we're executing on that momentum. And we're going to be coming out of Q2 and some of the turnarounds with incremental capacities as well. And with the pricing front, that sets us up for broadly the strong second half as well.

Willie, the upside to the high end of that Q1 range of $2.34, driven by more demand, by prices, catch-up to raws, how do you characterize the upside to that $2.34 high end of the Q1 range?

Well, as I think about the Q2 range, I think it's just a bit better. And ultimately, it's similar to Q1, which is how strong our logistics and the implications there. I think that's continuing to be a dynamic, both from a cost perspective but also from the predictability of order shipments as you close months and quarters out. So again, I think $2.34 was just a better slight potential upside, depending on how orders close out here and now in June.

Okay. Good to hear a little bit of upside to the quarter. Just on raw materials, you buy a wide range of raws. Have they stopped going up for you yet? And where do you stand on offsetting what price increase -- sorry, increase with your own selling price increases?

Right. Like I was highlighting on the strength of Chemical Intermediates, ultimately, I think, one, supply/demand continues to be robust there. And part of that's a continuation of the Uri impacts on oxo olefin derivatives. And we've been able to price given that demand. There's still inflationary pressures as we think through the NGLs, but we're more than offsetting those in this type of demand environment. We're actually seeing pricing increases in Additives & Functional Products as well as Advanced Materials and good progress there as we think about how we're all selling not only the raw material but the logistics inflation. And we think margins will be back to more normalized levels entering the second half, David. But I would say the pace of raw material inflation with natural gas and things seasonally are moderating here at the end of Q2.

Any issues with raw material availability for you guys?

Yes. I think we had previously highlighted some issues in our Advanced Materials business, specifically on VAM. What I would say is that has gotten substantially better through the quarter. And I would say that, that's pretty much behind us at this point and no further implications as we look out through the remainder of the year.

And in terms of your customers, are they experiencing, I assume some on the auto side, impacts from component shortages and input constraints limiting their own production?

Yes, I think it's been highlighted in the news frequently. I think the value add from an Eastman perspective is the fact that we're playing in those higher-value creation products like heads-up display, acoustic interlayers and some of the aftermarkets with the paint protection films. And as production has continued, those more premium products have been prioritized. And so we're seeing it impact limited due to the prioritization, but we're also growing beyond our current growth rates just due to the innovation reapplications that we can create for the automakers.

And Willie, just in terms of inventories really at your customer levels, where do they stand? How much of the strength is due to some inventory restocking? And how long do you think it will take to fully build inventories for both you and your customers?

Yes. There's -- here in Q2, we see no signs of ability to build inventories. We see that within our supply side at Eastman proper and through the channels. So we see primary demand being robust as you go into Q3. If there's any inventory build, that would have to occur in the second half. So I think that really gives added momentum to continue the production and sales levels.

Got it. And 2 more things on near term. You highlighted you'll be able to have a -- keep your cost structure flat this year. Is that still your expectation? And how is that being done?

So to your point, David, we've highlighted, as we think about in 2020, we've delivered roughly $150 million of cost savings compared to 2019. And we've got several initiatives. One, keeping our asset footprint optimized as well as continuing to transform how we do work digitally and through automation. And as we've started to invest, as things reopen in the economy, we're offsetting that additional spend through these continued actions. I would highlight, in many cases, we've taken actions to shut down our Singapore facility this year, sites in both Additives & Functional Products and Advanced Materials. So it's asset footprint optimization of our key business processes to ensure that cost structure is flat. The only item I would highlight is as companies continue to go through the year with both the financial markets as well as variable comp, those are probably the only potential headwinds that we've seen in first half of the year and going into the second half.

I meant to ask, discussing raws. Is this overall inflation we're seeing on raw materials, feedstocks, propylene, is that good for Eastern Chemical end of the day?

At the end of the day, we like, I'll call it, a less volatile environment, but overall, a higher and a normal inflation. I think the great thing that we've seen here is this is demand driven. So in a demand-driven environment, we can pass not only the raws but the value add that we create through our specialty products as well as in Chemical Intermediates. But broadly speaking, David, net-net, a higher environment is positive to Eastman on the net. And that's been also maximized here just given demand levels.

And really last question on earnings, you're having a very strong first half of the year due in large respects to Chemical Intermediates, which is a bit of a commodity business. It creates a bit of a challenge for next year, and I'm not asking about guidance. But how do you grow earnings next year having -- it will likely be a down year in Chemical Intermediates given just normalizing margin spreads?

Yes. So one, I think there's end market growth as we continue to go forward. So both -- we've highlighted, we've got a headwind of roughly $30 million this year in the aviation market as they've been slow to recover. We've talked about our exposure to transportation and that the OEM and autos broadly has momentum and a supply chain that's pretty thin from the dealerships all the way back to production. We see that as growth opportunities. Also, I would highlight in our key end markets is the innovation-driven growth model and the mix upgrade that we will also get on top of just the economic growth continuing at probably still above historical GDP levels. So as we think about mix, we think about our market segmentation that we believe that the growth in AM and AFP will more than offset the decline in potential spreads in Chemical Intermediates. Also, I would remind you, we had the headwinds earlier this year from Uri. That was roughly $30 million as well. So as I look through those, you take those market actions, cost actions. But then I would highlight in 2022, there's no further debt repayment. So we've got the strategic flexibility with our strong cash flow to allocate somewhere around $700 million plus for share repurchases or other value-creating opportunities.

Great. It's a great -- good segue to my next topic, your innovation-based growth model. You've had a lot of success with this. What makes a unique reason to have this on this innovation model? What makes -- what's your special thoughts here?

Yes. So again, I'll go back and ultimately, I'll start with a strong technology base as we think about our polymers technology, as we think -- and our ability to connect those. Also, I think as we've highlighted in our circular initiatives, it's that end market connect. We're connecting and influencing the markets downstream with our customers, in partnership with our customers and understanding those needs. And then it's developing the applications through multigenerational technology plans and market plans that create success and wins for not only Eastman but our key customers in the supply chain, in general. And Advanced Materials and the 2/3 of AFP have continued to demonstrate that as we transitioned from 2018 through a trade war, to COVID, to where we are today. And I think it's been able to demonstrate that in a pretty dynamic environment. And as we've been successful on the 1/3 of AFP, I think that will still come to the front even more. And now we have the option to accelerate that as we have our debt to EBITDA back in line on a go-forward basis.

And Willie, on your new product, do remind us of your current -- of your sales new products and your targets going forward.

Yes. So as we talked about 2021, we think we're going to be back approaching that $500 million level. We've continued to see even that accelerate as we've had our launches of Naia Renew and Tritan Renew. So we're seeing partnerships in those spaces. And just the level of the inquiry into Eastman, our specialty plastics business grew in 2020, and that continues to accelerate. Our films businesses are off to a great start and year-over-year growth due to those new applications and new solutions that are enabling value up for our customers downstream.

Willie, I know we always ask about Tritan. How is Tritan performing? And what are your capacity plans for Tritan going forward?

Yes. So as we think about our, I'll call it, integrated plans for Advanced Materials, and that fits in with our circular investments, we believe that the circular investments are going to accelerate the growth of Tritan. I think we've also highlighted that we've expedited here in Q2 and early Q3 another conversion of our copolyester lines to Tritan. And we'll be looking at the success of circular and how that impacts the plan, but we look to continue to grow our capital base and make sure that we have the assets and the capacity to meet the demands of the future. And we're excited about that because the returns on each of our projects that we've done to date have been extremely value creating. And now with circular, we think we can accelerate the pace of growth.

Willie, in Advanced Materials, I know feedstocks, raws can skew the margin. But given the growth of new products and the enhancement from circular, where do you think margins can go in Advanced Materials over the next period of time?

Yes. I think, again, part of this is we have pretty robust margins today, as you've highlighted. And this was a business that's had a decade of earnings growth. As we look forward, we expect to continue that. It also has been a transformation from, I'll call it, in that low 10% to 15% margins to above 20% margins as we see it today. And to me, it's more about growth and mix upgrade at those reasonable returns. And so we can -- that will be the focus, is growth from a volume and mix versus, I'll call it, a strong focus of accelerating the margin further.

Very good. Maybe switching to cash flow. I give Greg a hard time. You always have $1 billion of cash flow every year. This year is a little bit more. It's up to $1.1 billion, I think. But how do you meaningfully improve cash flow so that we can talk about maybe $1.5 billion going forward?

I like the way you're talking, David. Ultimately, it's twofold. One, it's delivering, I'll call it, upon the growth model. So as we think about on a post-COVID, how do we get back to the 8% to 12% growth model that we had in our 2018 Innovation Day, ultimately, that provides the EBITDA to grow free cash -- or operating cash flow and then, therefore, free cash flow. Also, I would say, we continue to see that we have an opportunity through multi-pronged approaches on our working capital. And we have multiyear plans and are making digital investments to ensure that as we achieve these, we lock those in. But I think there's accounts payable programs that we're continuing to implement, accounts receivable as well as the inventory of digital investments going forward. So it will be through both. I'm most excited about, I'll call it, the business growth. And working capital will just be the icing on the cake that allows us to grow from $1.1 billion to $1.2 billion and further from there.

Very good. Switching to capital allocation, really looking at M&A here, you've been very -- you've been paying down debt for a number of years, and you're getting close to the end of that process. Where do you stand on looking -- on M&A taking a more meaningful step-up in your growth strategy? I know you made a small acquisition earlier this year. But where does M&A stand? And how is the M&A pipeline?

Yes. First, I would say, the prioritization for this year hasn't changed on capital allocation. Also, we expect that we will be at our target levels of about 2.5x by year-end. And ultimately, we talked about growth for Tritan. So we could actually grow more through the organic, but we do have that strategic flexibility now. So ultimately, we're looking on the Advanced Materials and Additives & Functional Products space for how do we redefine and accelerate the growth there. And while right now, we're more focused on bolt-ons and the organic path, again, we'll see how things develop from there. But we do believe that the cash will be able to accelerate us not only through share repurchases but through value-creating acquisitions as we've done in the past, but more focused on bolt-on, obviously highly focused to Advanced Materials and the 2/3 of AFP.

How is the pipeline today, Willie?

What I would say is the businesses have been focused because they -- we've been talking about this coming for a couple of quarters now. And again, I think we're starting small, as you highlighted in Q1. And we'll look to see how we can accelerate that as we go wrap up '21 and go into '22.

Okay. And lastly, you have in the past done larger acquisitions, Solutia, Taminco. It took a while to get out front of those debt burdens. Would you be open to larger transactions, perhaps something maybe not transformational, but something material of those sizes?

Yes. I think what you're highlighting, David, as we've grown, the level of materiality for an acquisition has changed. So Taminco was $2.5 billion, and Solutia was $5 billion. But we're sitting here today at close to, I don't know, $22 billion from an enterprise value. So again, we think being successful on these divestitures prepares us to make sure that we achieve the business objectives and synergies as we go forward on a large bolt-on type of approach or potentially bigger, as you described. I'm not going to set a size to that today. But again, that's what we're focused on is value creation. It's not shrinking our invested capital base through the 1/3 of AFP. That's how we continue to redefine and accelerate innovation growth.

Got it. I want to switch to circular recycling, really a feather in your cap here. You've become a leader in circular economy and plastic recycling, not expecting a relatively small company versus maybe a BASF or a Dow. How does this come to be that Eastern Chemical has become a leader in this field?

Yes. I would connect it back to a couple of things. One, obviously, we've had a technology-focused, innovation-driven growth model. Two, as part of Kodak, we've practiced this technology for about 20 or 30 years. As you think about that, combined with us being focused on specialty plastics and the megatrends that are driving growth, both environmental factors, there's been other factors that have led to growth in that as well as like BPA. And ultimately, with our scale and integration here at our Kingsport site, it's enabled us to get to a commercial scale today where we're not talking theoretically about piloting in 12 to 18 to 24 months. We actually have commercial products on shelves with substantial renewable content, and that's exciting. Also, many of you probably heard Mark say we were the original biopolymer with cellulosics and our Naia products. So that is the connection to Eastman of why is Eastman. And to some, that may be a surprise. But I think, ultimately, also, the end market connect that we've been able to deliver with the brands. We've talked about Estée Lauder, Tupperware, Williams Sonoma. I think many people are surprised to the fact that we have those relationships, and we're driving outcomes at or near the consumer level. And it's those 2 coming together, like our growth model I described earlier, that are creating those wins, I believe, faster than the market is expecting. And we're going to have a world-scale plan here in 18 to 24 months that can take this to a new level with the side integration that derisk this. And then we'll see how the business models go from there. But we're also already active, as we've highlighted, in some of those business model discussions. More to come on those as we go throughout the remainder of '21.

Willie, on these recycled plastics, do you need a premium price for these to be economically viable? Or do you think consumers will pay a premium for these recycled plastic products?

Yes. So one, I believe that this is the right time for this because consumers are more aware, and products that are renewable on the shelves today are demanding premiums. Some of our customers' products, there is -- could be 25% higher than a similar product that is just fossil fuel-produced. And you're seeing that in other spaces as well. There's more awareness. And I think this is why it's the right time to have the environment plus financially attractive returns versus 5 or 10 years ago. And that's the why now. That's why we're confident in this first investment and how we're approaching it. And there's other models that we'll be considering as we think about creating the most value for the Eastman shareholders going forward.

Great. And maybe just update us on the methanolysis project. Where do you stand today? And is the time line still the same as you discussed a few months ago?

Yes. No, I would say the time line is still substantially the same. Like I said, 18 to 24 months, we'll be there with substantial completion. We're continuing and we'll continue to highlight the commercial wins as we go throughout the year. And ultimately, we're also continuing to make great progress on the feedstock front with the recycled materials.

I was struck by your LVMH announcement this week because it's not exactly -- it's maybe the anthesis of Eastman Chemical. How did that come about? And what potential for this collaboration going forward?

Yes. To me, it's another great example of that end market connect and the brand awareness that our Advanced Materials and specialty plastics teams have created over many years. To your point, this doesn't just come about because we announced a methanolysis plant. These are relationships that we've been driving over many years. And I think, ultimately, we've got key products that can make them successful. And that's always a value-creating proposition from a partnership standpoint. And ultimately, with the goal of improving the environmental and caring for society, those are things, I think, that brands that you wouldn't think could partner ultimately through those focuses and common goals are leading to successes in areas that maybe Eastman wasn't viewed in the past as that opportunity. And I believe there's more to come in those types of partnerships and relationships as we accelerate this and take this forward.

Excellent. So our time is almost up. So Willie, I would like to thank you for your time, and congrats again on your tire additives announcement, well received, I believe, by people, given the size and the timing and the amount. So congrats on that. And thank you for coming to the conference as always.

Thank you, David.

Okay. Have a great day. Thank you.