Ecovyst Inc. (ECVT) Earnings Call Transcript & Summary

Good afternoon. My name is David Begleiter of Deutsche Bank's U.S. Chemicals Equity Research team. Thank you for joining us for the -- for Deutsche Bank's Virtual Global Industrials & Materials Summit. I'm very pleased to have with us today the team from PQ Corporation led by Belgacem Chariag, Chairman, President and CEO; Mike Crews, Executive Vice President and CFO; and Nahla Azmy, Head of Investor Relations. Belgacem will have some prepared comments, and there's a slide deck to accompany these comments, and then we'll go into the Q&A portion of the presentation. If you'd like to ask some questions, you can submit them through the web portal via a chat box on the left-hand side of the screen. So with that, Belgacem, it's all yours.

Good afternoon to everyone and thank you for having us. I will reference a slide presentation displayed here, which we have also posted to the investor section of the PQG website. Please note the legal disclaimer on Slide 2. The forward-looking statements that we make today are subject to the risks and uncertainties discussed in our SEC filings. Reconciliations of the non-GAAP measures we discuss today to GAAP measures are available on the appendix portions of this presentation. Moving to Slide 3 for a brief overview of PQ. We are a leading specialty chemicals provider with a long history of expertise in material sciences and track record of innovation. We enjoy #1 or #2 supplier niche positions with many of our customers and a diversity of product end uses. PQ's businesses benefit from favorable long-term secular global trends. These include increasing environmental regulations for fuel efficiency and emissions, higher transportation safety standards and a shift in consumer preferences for lightweighting and environmentally friendlier products. Our healthy adjusted EBITDA margins provide sustainable and strong cash flow from operations. Turning to Slide 4 for an overview of our 4 business segments. Beginning with the Refining Services business, we provide end-to-end services to North American refiners in their alkylation production through the regeneration of spent sulfuric acid, the leading catalyst in the production of alkylate, which is used to increase the octane rating in gasoline. And we have greater than 50% supply position in the sulfuric acid regeneration markets. The catalyst business includes 100%-owned silica catalyst business and a 50%-owned Zeolyst Joint Venture with Shell Catalysts & Technologies, which has been in place for more than 30 years. In Silica Catalysts, global consumer demand is accelerating for high-strength and lightweight plastics. We are qualified with the largest polyethylene global producers and licensors for both silica-based finished and support catalysts. With the Zeolyst Joint Venture, we have strong expertise in zeolite catalyst technology, and we capture growth as a result of tightening environmental standards for global fuel emissions. In the Performance Materials business, we are the largest and most diversified global bead supplier for transportation safety. With ongoing replacement business and increasing focus on higher safety standards in the transportation industry, we see steady growth for our highway safety products. Finally, in the Performance Chemicals business, we are at least 2x larger than the nearest competitor, sodium silicates. Demand is driven by continued consumer preferences for environmentally friendly and safe products in consumer personal care, food and beverage, surface coatings and other industrial products. So in summary, it is these competitive and unique positions that enable the 4 businesses to deliver adjusted EBITDA margins in the range of 20% to 40%. Moving to Slide 5 for PQ's financial performance. Since 2005, we have demonstrated PQ's ability to deliver healthy margins during changing macroeconomic environment. This is enabled by long-term contracts with favorable commercial terms, including value pricing and the ability to pass through raw material price changes. We attribute this to PQ's niche positions with customers, diverse and largely secular end-market drivers and a track record of reliability and continued innovation. Shifting to Slide 6 for a discussion on end-use trends for the remainder of 2020. The COVID-19-related stay-at-home mandates, combined with the shock of oil price collapse, have resulted in significant and rapid demand shifts from consumers and consequently, our customers, which is driving some uncertainty for the rest of the year. Starting with the Refining Services business, which typically benefits from low oil and gasoline prices. Beginning in April, the unprecedented stay-at-home orders had significantly reduced miles driven and demand for gasoline products from our refinery customer base drove lower regeneration volumes. Further, reduced automotive and industrial activity had a negative impact on sales of our high-purity virgin sulfuric acid. To frame some of these key metrics that we track, U.S. refineries production was down about 30% in April through mid-May with a disproportionate impact on the East Coast refining versus the Gulf Coast. At the end of May, U.S. refining utilization rates improved to nearly 80% of prior year levels. Gasoline demand bottomed out at a decline of more than 45% versus prior year for the month of April. But by the end of May, it improved to a 20% decline from last year. As stay-at-home orders continue to be relaxed, it is projected that the second half 2020 demand will rebound to more than 90% of the levels in the second half of last year. Finally, miles driven that declined by more than 50% in April and 29% through mid-May are ramping up with the ongoing reopening activity across the country. As the virgin -- as for the virgin sulfuric acid product line, impacts from lower demand are largely for end use in nylons for automotive applications with some additional demand loss in the general industrial markets we serve. We expect demand from general industry largely to recover while auto-related demand to have a slower recovery due to the ongoing disruption in the auto production. Next on Performance Chemicals, which we expect to be impacted for the balance of the year. With a forecast decline in the U.S. industrial demand of more than 8% on global industrial demand of about 4% in 2020, we expect a material near-term impact on the sodium silicates product line, which serves as a broad and diverse set of industrial end uses. We anticipate that for the balance of the year, there will be continued pressure on a few of our industrial applications related to automotive, tire and rubber and refining catalysts. The specialty silica product line, however, captured share early in the pandemic as the competitors were challenged to supply the customer base. From an overall demand perspective, strength in personal care has partially offset reduced demand for beer and surface coating markets severely impacted by lockdowns, such as restaurants, hospitality and construction. These markets continue to be in different stages of recovery from region to region. Turning to Catalysts. We continue to forecast a strong first half performance on the firm customer orders with some uncertainty in the second half as refiners may slow the rate of refining catalyst change-outs. For the Silica Catalysts product line, despite projections for flattening polyethylene demand, we still expect outperformance for our polyolefin catalyst due to continued customer shifts to our preferred silica technology from both new capacity coming onstream and gains from existing capacity globally. Additionally, domestic demand has temporarily benefited from COVID-19-related surge for film, flexible packaging and blow-molded bottle applications for medical and packaging consumer end uses. For example, U.S. flexible plastic packaging demand increased 44% in Q1 2020 versus 2019. This helped offset lower consumer discretionary and construction end uses for which the recovery profile remains uncertain. For 50% Zeolyst Joint Venture, we anticipate solid performance on firm orders through the second quarter. However, there could be some delays in sales of hydrocracking catalysts as refinery utilization rates are currently down from prior year levels on lower oil prices and demand. Finally, the Performance Materials business should exhibit the most resilience and stability in performance during the pandemic, particularly for its replacement highway safety reflective beads. All but a couple of states are continuing road-striping activity with some states actually accelerating projects during the low-traffic period. Looking ahead, the highway safety business continues to be resilient, especially as we enter the summer striping season despite some budgetary delays risks related to new infrastructure projects. Moving to Slide 7 for an overview of all of our actions to address COVID-19. I am very proud of the PQ leadership team and employees as a whole. Their proactive and tireless response efforts have been instrumental in navigating through these extremely challenging operating circumstances, focusing on health and safety while optimizing business operations that helped successfully minimized disruptions in order to meet customer demand. During the first quarter, we improved our financial and liquidity profile, locking in lower interest rates by repricing and extending the term loan on asset-based revolver. With minimal impacts from COVID-19, we were pleased with the first quarter results, which reflected solid performance across the portfolio on improved volumes. While we suspended full year sales and adjusted EBITDA guidance, we did provide an outlook for the second quarter. Finally, we are undertaking actions to further improve free cash flow in response to lower expected adjusted EBITDA. This includes using capital expenditure, working capital improvement and cash interest savings from the recent debt refinancing and lower interest rates. We anticipate these actions will result in adjusted free cash flow in the range of $130 million to $150 million for the year. In addition, with the steps we are taking to reduce operating and SG&A costs, we are targeting adjusted EBITDA margins in the mid-20% range for 2020. These timely actions provide us additional financial flexibility during the COVID-19 pandemic. Moving to Slide 8 for a discussion of adjusted free cash flow and debt profile. Over the last 3 years since becoming a public company, we have sequentially delivered higher operating cash flows, reduced capital expenditure and monetized assets. Our single biggest priority has been to lower leverage and increase financial flexibility, and we have consistently used nearly all of the free cash flow to pay down debt. By year-end 2019, PQ's leverage ratio was 3.9x, down from 4.9x at the end of 2017. We have been proactive to position PQ with sufficient liquidity and financial flexibility. We have no significant debt maturity until November 2022 and have no material covenant that requires us to maintain a leverage ratio at a particular level. We ended the quarter with available liquidity of $236 million, which we believe is sufficient to manage through the sustained economic downturns. Turning to Slide 9 for our portfolio optimization path. Despite the challenges of COVID-19, we remain committed to growing and strengthening our leading specialty positions. We are also focused on maintaining strong margins to drive improved free cash flows through the cycle. We have planned, executed and realized several achievements over the last couple of years. We expect to make additional progress during 2020 as we continue to pursue pathways to strengthen the individual businesses, to monetize noncore assets and to optimize the overall portfolio. Now in closing on Slide 10. We believe the PQ portfolio will continue to demonstrate its resilience during this crisis. We have taken proactive steps to enhance our balance sheet and liquidity position. Finally, despite the ongoing disruption from COVID-19, I continue to be optimistic about the mid- to long-term prospects for PQ. This is based on the strength of the portfolio with its business and market, you see a diversity, unique competitive position and the underlying long-term secular growth drivers. That concludes my formal remarks. Thank you. David, we are now ready to take questions.

Belgacem, thank you very much for that very thorough overview. So I'll jump right into it here. As you mentioned, you're guiding to mid-20% EBITDA margins for 2020, which is pretty resilient here. What gives you the confidence around this metric? And how should we think about decremental and incremental margins for the portfolio going forward?

That's -- thank you for the question. And I believe the strength of the individual components of the business leads us to make that conclusion. The resilience that is driving the business gives us the confidence to realize the benefits of the diversity of the products. In slower demand periods, we have the flexibility to reduce production to lower cost structure, and we maintain margins while retaining the ability usually to ramp quickly and capitalize on the demand recovery for most of our business. And that ability to manage the cost line and manage the ramp up and down of activity allows us to be confident on the reduced decrementals on the business. And I would note that our margins can be affected by the seasonality, such as Refining Services and Performance Materials, or by the order timing in our Catalysts business. It's in the middle of all that.

Very good. Switching to oil, how does the low oil price affect your businesses? And how is this cycle different than past ones?

That's a great question. I have a long history with oil price swings and I find it very interesting to see how it impacts the portfolio of PQ. It does actually have a mixed impact across the portfolio of the businesses. For instance, our Performance Materials benefits from low oil price because it allows us to operate at the cheaper natural gas as an input. The same thing would be kind of favorable for Refining Services as well as the low gasoline price as they encourage more gasoline consumption and miles driven. Of course, this is not the case for a COVID stay-at-home mandate like we lived for the first time in many years or maybe in the history for a long time. Typically, it's beneficial to Refining Services. With Performance Chemical, the profitability just swings in -- as the oil movement between some of the largest chemicals customers and some of the refinery customer. Overall, it's a net neutral to slightly positive supplying both of their various -- of the customers' various end uses in packaged goods and maybe transportation fuels. And for Catalysts, it's typically a headwind as it can delay refinery hydrocracking. And as we talked earlier, the concern that we have going forward with the continued lower pricing is some disruption into the -- some of the refining hydrocracking change-outs, which could have impact on Catalysts.

Very good. Maybe I'll try and bring Mike into the conversation. From a capital allocation standpoint, what are your priorities at PQ? And obviously, debt reduction is still a priority, but how important is debt reduction here? And anything more you can do for additional refinancing to bring down interest rates and interest costs?

Hello, David, and good afternoon to everybody. As we think about cash, we've been maintaining a defensive posture in the first half of the year to have that financial flexibility until we have a little bit better visibility on our second half results. Deleveraging has been our top priority and will continue to be our top priority. But as you know, we generate virtually all of our free cash flow in the second half of the year so that prepayment is likely going to be towards the second half. As Belgacem noted, we were proactive in the first quarter. We refinanced our ABL credit facility. We refinanced the term loan. We upsized the ABL. So we're pretty good from a flexibility perspective there. We're watching the term loan in the high-yield markets very closely. We do have the secured notes that mature late in 2022. So that would be next on the priority list for refinancing. So as those markets continue to rebound, we'll find the proper time to look to refinance those secured notes.

Very helpful. Maybe going back to some of the near-term business trends you talked about, Belgacem. How did business trend in May from April? Any meaningful changes? And what are you seeing as we've entered June here?

Well we have seen -- as you note, we have seen April was a very tough lockdown period where everything was pretty much at a still -- hold still. Everybody was experiencing the ability or the learning curve to manage that way the business. So the reactions were almost random everywhere with people trying to stay home, not stay home, go to work, not go to work. So it took a bit of time until people got used to how to manage and live in and operate in such a situation. It's coupled with some of the return into some of the activities, such as the driving activity and the depletion of some of the gasoline inventory as the country start to reopen in certain places, notwithstanding the success opportunity for reopening the country. That was the beginning. And I think without giving any specific indications, but we do see the market -- with the reopening of the states and the highways and the miles driven increasing, we see some fresh air coming back into the system in that. But nothing else that I can comment on related to the industry in general or some of the markets in Europe were still kind of in a slower mode of recovery.

Understood. Belgacem, what parts of your business do you think come back to pre-COVID-19 levels by 2021 versus those that may take a little bit longer, maybe 1 to 2 years to recover fully?

Well high level, I think as we continue to recover on activity, we're going to probably see some regeneration -- the regeneration of spent sulfuric acid in our refining business should be improving. Not to say that it will be back at any time at the end of this year, we could be at around probably 90% of where we were last year in that sense. But then the question is, how far down 2021 will that change? So that -- to me, that's probably the fastest recovery because it's a direct linear measurement of driving -- miles driven and inventory of gasoline. The highway safety products are also in demand despite the shutdowns that we had in North America. I think that is going to continue due to the maintenance aspect to that business for us. That will continue, maybe not at a very high rate, but it's continue at a decent rate as we go into the end of the year and into next year, except for, of course, the seasonality that highway business in the winter is not as active as it is now in Q2 and Q3. Also, the return of the business next year will depend on how fast Europe reopens and how fast miles driven in Europe recovers and how fast the EGM business for that particular business unit recovers in Europe as it's connected to a lot of industrial activity that is slow right now. All in all, I think the part of the business or the end uses that is going to be an issue that we need to watch for the recovery is the automotive applications and tire applications, some of the small industrial applications that probably would impact our Performance Chemicals business more than anything.

Very good. Mike, back to you. Where do you guys have some flexibility on the cost side and the capital spending side in your businesses if things were to continue at low levels of activity?

Our cost structure is about 60% variable. So if volumes were to decline further, we do have some additional levers in all of our businesses to reduce cost. So we would continue looking at some of the same things we've already been doing, including reducing plant shifts, delaying furnace rebuilds and turnarounds, and that would reduce both cost and capital along with contractor and maintenance spend and SG&A. On the capital side, we noted on our first quarter call that we reduced capital spending in the first half of the year by $15 million, and we could make some further cuts as necessary. Hopefully, that won't be the case. I mean, thus far, we've started to see things kind of bottom out a bit. And then hopefully, we're up more on an uptick versus where we've been in the first month or so in the quarter.

Very clear. Belgacem, back to you. Any change in the direction or timing of your portfolio optimization plans due to COVID-19? And really, what are the key outcomes that you're looking to achieve here with this plan?

That's a great question. There really isn't any strategy shift from what we've communicated in the past. Obviously, the unplanned COVID-19 would create and did create some impact on speed of action and execution of these initiatives. What we focused on this year is -- primarily is maximizing cash opportunities while we're addressing some of the smaller components of our business. We did look -- if you remember, we talked about looking at the components and subcomponents of our business units. And we identified the ones that are need the attention, whether they are not necessarily the best today here or maybe their future is not going to be the right thing to be with PQ. So we're looking at those addressing and we're making efficiency improvements through our Performance Chemicals transformation project that we've announced last quarter. We're going to achieve a lot of efficiency, and that is actually ongoing. No, we didn't change any direction or stop it. It's just impacted by a little bit of a delay, as you could understand, on having to find contractors and have an access to even government authorities to approve things that need to make -- take place. So we still are firm on our projection of saving of $10 million to $15 million annualized within the period that we thought up to about 2021 -- end of 2021 for that business. On larger opportunities or portfolio-related opportunities, we are still very open to looking at any opportunity, and we have been looking at some that might shift the makeup of our portfolio. Remember, we do have leverage commitment as well. And if we can find a way to the great opportunity that fits perfectly our strategy to help accelerate the leveraging situation, we would not hesitate provided the opportunity is timely and of value to our shareholders.

You also mentioned that Performance Materials has been holding up pretty well here. But obviously, this is tied so much to the funding by state and local governments. Are you concerned about budget fundings going forward for some of the -- to drive the sales in this segment?

No. Look, the -- you have to look at things with a proportional view in terms of what is the component of the budget that we tap in, in our business of Performance Materials. And when you look at the number of projects and the infrastructure upgrades and funding that goes into the states and with the federal government budget as well it -- the piece that impacts our business is less than 3% to 5% of that total budget. So we believe there is a lot of other projects that have to be stopped and delayed and investment to be put on hold before they touch the safety and the striping piece of the business. So we feel more comfortable that our part of the business will be less impacted, at least to start with, but we'll keep watching it.

Very good. Another question. Which product lines did you see benefit as customers accelerated orders on supply chain concerns, which may potentially experience a decline in the second half of the year?

Yes. We actually did in the end of first quarter, in March, we did have an interesting trend of accelerated orders for products like the MMA catalyst. You noticed that everywhere you go, you see the acrylic sheet in the stores and everything, that products goes there amongst other things. So despite the loss of the construction and automotive demand on MMA, the acrylic sheets kind of made up for that. So that was positive. A few other elements that go into the PPE-related products in our chemicals business and some of our materials business also saw some acceleration for that period of time. I talked about the single plastic sheet and how things went into packaging as well. We also talked about the -- some of the medical application of the bottles, which we saw a surge in demand. But none of these, I believe, is an indication of the continued ramp-up in restocking at this stage. We don't consider that as a restocking. I think it was a temporary opportunity. Some is still ongoing, some is slowing down right now. And we're waiting for the real opportunity of markets going to a restocking phase of products because inventories have been and being depleted as we speak.

Very good. Looking at your Q2 2020 guidance, what do you see as the key differentiator that sets PQ apart during this pandemic?

Well the stability of the way we -- the way the business is behaving right now, the diversity of the market end uses and the fact that our business components are really important for some of the products for our customers. And the proof is, if we are #1 or #2 position with most of our products, that tells you how important it is for us to be there. Performance Chemicals serves multiple consumers and industrial applications. And usually, the stocking -- the destocking and restocking I just talked about a minute ago, it kind of lags a little bit. So in 2 different ways, when we are destocking, we -- it takes us time to see the impact of destocking. So we did see some of that early on this quarter. As the market starts restocking, we expect to see a demand for our products a bit sooner. So our products can go and make up the components that our customers are restocking for. So we get benefit on both sides. On Performance Materials, as you saw, it's the complex network that we have and the product quality requirements state by state that makes it very difficult for us -- for anybody to come in and create a very normal competitive environment based on what we have. And it's a transactional market. So you're not locked in, locked out of a market. You always have the opportunities to replace business opportunity as you go along. Our refining business, which is the most hit primarily in April, as we noted earlier, due to the miles driven and the gasoline inventory, is just direct linked to the reopening of the economy and the activities that we see out on the highways today with people going back to life. And we believe that it's solid and it's going to have a direct impact in the outcome. For the Catalyst business, I think we do have a very solid business in silica catalysts. And despite the flattening of the demand on the polyethylene, we continue to be growing simply because we're offering silica-based catalyst technology, which most of the new capacities that are being added into the market this year, they were delayed earlier, but some of them will come into the market in China, particularly, are silica-based demand products. So -- which gives us the ability to be comfortable that our demands on our component, that component of the business, which is the silica catalyst is going to be strong. The rest, which is for the rest of the year, the concern that we've mentioned is the hydrocracking catalyst might see some movement simply because of the oil price putting more pressure on the refiners to be careful on their plans. That is the reason why we think Q2 -- we're confident in Q2, whatever guidance we gave you. And we believe that we're more optimistic about the second half of the year in most of the businesses.

Very good. And that's a very complete answer. Just a quick couple of last things, Belgacem. First, on raw materials. What are you expecting for raw materials in 2020? And how do you see the dynamic of pricing versus raws tracking throughout the year?

I'll let Mike answer that.

Yes. I could take that. We've seen -- certainly, we see sulfur pricing with the pass-through impact our top line. But that's a dollar-for-dollar pass-through, so it has no impact on EBITDA. So generally speaking, we've seen some raw material price deflation, but we have long-term contracts and the key raw materials to tamp down volatility. So -- and because of the pass-through nature where we don't get hit as prices inflate, we don't necessarily get a benefit as they come down either. We do to a limited extent, but not significantly. That's why when you look at that page we have in the slides why our margins have been so stable. So generally speaking, it's a mild tailwind.

Very good. And Mike, also just on your cash flow guidance. What are some of the key drivers of that, particularly working capital assumptions? And have they changed given where oil has moved the last month or so?

The full year forecast for cash flow, the update that we did was really based on what we were seeing in the first half of the year. So we'll continue to update that. So it took into account where we were going to be for EBITDA for the second quarter and looking at, I mentioned, the cash flow reductions that we made of $15 million in the first half. And then also just with lower interest rates, we expect an incremental $7 million roughly of cash interest savings versus what we had for our original guidance for the year. Our working capital, it typically is a $20 million a year usage. We expect to be better than that. So that's one of the things we're looking very hard at particularly with reducing inventories in a lower sales pattern. So those are probably the key drivers at this point.

Very good. And lastly, Belgacem, I know M&A isn't a focus right now. You need to pay down some further debt. But as you move forward over the next 2, 3, 4 years, what role do you think M&A plays in your growth strategy for PQ?

The reason we are not very active on M&A today, David, is our limited flexibility from a financial perspective. And as we try to resolve for that issue by looking at our portfolio, by maybe looking for opportunities, we're going to be at a space from a financial flexibility that we will definitely be after opportunities for inorganic growth. We have been living off organic growth for a few years, and it's difficult to sustain. It's been going well. But we do have lots of opportunities that we're considering based on what will stay in the portfolio and that we will jump on right away as soon as we have some flexibility, which is our target.

Very good. With that, our time is up. So Belgacem, Mike and Nahla, thank you very much. And everybody else dialing in, have a great day. Thank you as well. Take care.

Thank you.

Thank you.

Thank you.