Ecovyst Inc. (ECVT) Earnings Call Transcript & Summary

[Audio Gap] Packaging sectors of Bank of America, and I'm pleased to host a fireside chat with Ecovyst Head of Investor Relations, Gene Shiels; and Treasurer, Nate Connor. This presentation is being webcast. Many of you know Gene from his prior role at Investor Relations at Kraton Polymers. Over the past few years, Ecovyst has made a substantial transformation from PQ Corp., including the $650 million sale of Performance Materials, also known as Potters, to The Jordan Company in December 2020, and the $1.1 billion sale of Performance Chemicals to Cerberus and Koch Minerals in August 2021. Ecovyst now reports in 2 segments. There's Ecoservices, which includes sulfuric acid regen services business, or regen for short, which basically sells strong acid to its customers and the customers process that acid. Strong acid weakens and then the customer returns the weak acid to Ecovyst to restrengthen it, to just resell it again. It's a nice virtuous circle. And the second is Catalyst Technologies, which manufactures catalysts for the manufacture of polyethylene and metal methacrylate, the monomer MMA or the monomer to make polymethyl methylate, which you might know with the trade name plexiglass, for instance. And Zeolyst joint venture with Shell, which manufactures hydrocracking catalyst used in refineries and other catalyst products. So as we go through the fireside chat today, just raise your hand if you'd like to ask a question, and we'll bring a microphone to you. But with that, I'll maybe start it off.

Over the past 2 years, your company has undergone a significant transformation as I just mentioned, resulting in the rebranding of old PQ Corp. to Ecovyst. This transformation included selling 2 business segments as well as a new CEO. Can you walk us through the rationale in selling the 2 businesses and your strategy for your remaining business segments going forward?

Yes, I certainly can. And Roger, let me just say thank you for having us at the conference. It's always a good conference, and it's actually good to be back in a non-virtual format. So thank you for that. I think the answer to your question in short was as we looked at the old PQ Corp. and one of the things that we kind of heard from the Street was that the business was a little bit complex with 4 different sort of businesses. And the 2 businesses that were disposed of, while good businesses in their own right, had probably higher capital intensity, and we had 60-some odd locations around the world. And so what we've done basically is we're down to the core assets that we think not only leading share positions, but very well-positioned businesses from a customer standpoint and from an end market exposure standpoint, and great cash generation capability and great contract structure and all of those things. So we're down to kind of a core group of assets that we want to build going forward. We did make a small acquisition last year, which was the Chem32 business. And so our plan is to continue to lever the organic growth opportunities and be on the lookout for M&A opportunities to continue to build out the platform.

Your business has performed very well this year. In the third quarter earnings call, you affirmed your full year adjusted EBITDA guidance towards the top end of the range while many companies have actually reduced their guidance expectations. Can you speak about why your business is so resilient?

Well, starting with Ecoservices, the role that we play there in the regen services that you referenced, we are a supplier of regenerated asset to the refining industry where it is a critical component in the production of alkylate. Alkylate for those of you who don't know is really the ability to boost the octane in gasoline production. So we like to refer to alkylate as liquid gold. Without alkylation, basically, it backs up the whole refinery. So the role that we play in the regen business is kind of a constant loop. We're taking the spent sulfuric and we're providing regenerated acid to our customers. And we're viewed by those customers as a utility. It's more of a service business than anything else. And given the critical role that we play in the alkylation units, these customers tend to want to lock up capacity, if you will, for long-term periods of time. So our contract structure, if you look at the term of those contracts, there are 3, 5, 8, in some cases, 10-year contracts. And we have a lot of visibility. Those customers share their plans around turnarounds and things of that nature. So we have a lot of visibility into that business. And I'll add that the quid pro quo for these long-term contracts is we have contract features that allow dollar for dollar pass-through of sulfur cost and index pass-through on things like natural gas and labor and other variable cost inputs. So it's one of the things that has contributed this year to the business stability and the margin stability in a fairly significant inflationary environment. And then kind of the other side of the Ecoservices business is the virgin sulfuric acid business. You mentioned a couple of the end markets, but we serve a wide array of industrial applications. A lot of people don't appreciate it, but sulfuric acid sits on the front end of a lot of chemical and production processes. So we serve the mining industry for leaching of things like copper or lithium to come. We go into applications like semiconductors, and we sell very special purity and high strength grades of sulfuric acid. So it's a wide array of industrial applications and those have all been performing fairly well this year. And then the Catalyst Technologies business, again, we serve hydrocracking catalysts and polyethylene and those types of end markets, and those businesses have been stable as well.

So polyethylene and polypropylene, in my mind, are probably more resilient to downturns because there more goes in the packaging. So it's more nondurables versus the other polymers. But still, we're starting to see lower volumes from some of the polyethylene producers. Has that -- have you seen that yet in your business or the lead time for buying catalysts such that it hasn't really hit you because it's been -- that downturn for the producer has been relatively recent, but maybe you sell 3 months ahead, they buy 3 months ahead for your catalyst or something like that.

Well, here again, we like our position because one of the differentiators for Ecovyst is in the polyethylene, we sell specialty catalysts that, in a lot of cases, are designed -- or the assets are designed around our catalyst. And so, if you look over the last several years, polyethylene demand has been growing 4%, give or take. It may be now 3% depending on who you're talking to, but our growth rate, our win rate on new capacity additions has been twice that. And when you have assets that are designed specifically around your catalyst, it tends to be a fairly sticky business. And so we feel pretty good about our market position there.

While inflationary pressures have been significant this year, Ecovyst has been able to defend margins. In fact, you have a comment on how unit margins in your Ecoservices business have actually expanded in the current environment. How is your company addressing inflationary pressures for raw materials, transportation and logistics and other inflationary costs?

Yes. That's a great question. Back to Ecoservices, on the sulfur component of it, it's a dollar-for-dollar pass-through. So the dynamic there is it inflates your sales line to some degree because it's a pass-through and the mathematical reality is that it has an adverse impact on your adjusted EBITDA margin. But our actual unit margins in this business, in this inflationary environment have been expanding. And one of the reasons is, as these contracts come up for renewal, not only do we have pass-through on sulfur and other variable costs on the index basis, but as these contracts come up for renewal, we're actually repricing the base component of those contracts. And so that is additive to the overall dollar margin that we're earning on that business. I don't know, Nate, if there's anything you want to add.

I would just add, Roger, that also we do a lot of work from a continuous improvement standpoint in our facilities all across the country to increase capacity, to reduce bottlenecks in the processes, and that just leads to efficiency from a variable cost standpoint for us.

When you're saying you're repricing the base component, how often are you able to do that? Is it -- I mean, I suspect it's when contracts turn. And I think you're referring to a regen, in particular, there?

Right.

So those are 3- to 10-year contracts. So it takes a long time. The lead time to -- the outlook to change that base component presumably takes a fairly long time for your full portfolio.

Well, every year, there's a certain contingent of those contracts that are coming up. We don't have a big lump like every 5 years all the contracts come up. So there's a certain portion of those contracts that are rolling every year, and that's when we have the opportunity to reprice the base component of those contracts. And one of the reasons we have that ability is the importance of the regen business to our customers, but also in the big scheme of things while we are a very important part of that value chain, the overall cost in terms of the overall operation of the refinery or the production of the alkylate is relatively small. So it gives us that price leverage to continue to reprice the base.

And the ability to do that, is that because of, I assume, tight supply demand at the end of the day, but what is it making the regen business supply/demand tighter? Is it more refinery throughput, which would do something, but...

Well, alkylate demand continues to grow. There are several things that are contributing to that. One of them is the higher amount of premium gasoline in the overall gasoline pool, there are things like environmental regulations such as Tier 3 that are reducing sulfur. The process of reducing the sulfur lowers the octane, so you have to address the octane by adding more alkylate. Just to give you kind of a relative sense, if you look at a gallon of regular gasoline, probably about 15% of that gallon is alkylate. When you go to premium gasoline, 45% to 50% of that gallon is alkylate. So we often get the question, the U.S. refineries, we're probably down 4% to 4.5% on refining capacity over the last couple of years. How do you continue to grow this business? Well, alkylate demand continues to grow. Our customers have continued to debottleneck their alkylation units. U.S. is fundamentally short of alkylate. We're actually importing alkylate. So that is a contributing factor to the business, continuing to grow even with refining capacity static, if you will. But refining utilization is very, very high. Export demand is very, very high. We're the largest provider of regen services in the U.S. Our refining customers have a lot of opportunity. Export demand is very, very high. And I think the long-term future for our business and the U.S. refiners, now if you kind of look on the global stage, the U.S. refiners are in somewhat of a favored position given raw material availability and low energy cost relative to Europe and the other players around the world. So I think the U.S. refining industry is going to be valid for a long period of time.

Actually, the one ratio I missed is regular gasoline. What percent is alkylate...

About 15%.

So 15% premium, you go up to 45% or something in there. Okay. Substantial. Again, if you have any questions, just raise your hands, we'll bring a mic over. So Q3 was another strong quarter for Ecoservices. Adjusted EBITDA was up nearly 24%. Can you speak to what drove that strong performance in Q3?

Yes we had in the third quarter for Ecoservices, specifically, regen volume was up nicely compared to the third quarter of last year. And virgin sulfuric was up modestly, but it was volume growth as well as the unit margin improvement that we talked about. So it's the combination of volume and improving margin.

Got it. And the regen business in Ecoservices serves the U.S. refining industry. Given expectations for further penetration of electric vehicles, or EV, how do you view the future of the U.S. refining industry and the outlook for regen services?

Yes I think Gene hit on that earlier. We like our geographic position. So we think the refiners in the Gulf Coast are going to be the last men standing. As we look out, we don't necessarily see the transition to electric vehicles may be happening as quickly as has been forecasted in the past. So we like that. We also like the fact that a lot of our furnaces can be shifted to produce high-strength virgin sulfuric acid, which is used primarily in the mining industry. And given our geographic location on the coast, in the Gulf Coast, we have easy access to the copper and lithium mines that will be needed in that transition to electrification here over the next several years.

Can you discuss your virgin sulfuric acid business and the opportunities for that business you look forward? And I know you just mentioned some of them, right?

Yes. Again, it gets back to a lot of the industrial applications. And sulfuric acid is not just a generic product. As I said earlier, we produce some very pure and high-strength grades that are needed in certain applications like semiconductor production. So we think going forward, I mean, the mining industry, as some of these mines come on stream in the Southwest, that's going to be a big pull on sulfuric acid for leaching of lithium or copper, which is going to be required if we're going to meet some of these electrification objectives that we have in terms of building out charging networks or tying in wind farms and solar farms. And kind of the interesting dynamic to watch over the coming years is a lot of sulfur goes into agricultural applications in terms of the fertilizer market. But as you look at some of these industrial applications and the requirements for sulfuric acid, there's going to be some dynamic tension about where the sulfur and the sulfuric acid gets directed. And I think the other thing is we watch what's going on with oil and gas production because a lot of people don't appreciate that, but that's the source of the sulfur. And we have very good relationships. Our customers for regen, to some degree, are our suppliers for the sulfur that we ultimately convert into the sulfuric acid. So I think it's going to be a strong demand market for the years to come.

Thanks. We have a question over.

Just a few questions on capital allocation. You guys have shrunk the portfolio but have also decreased leverage, margins have gone up as a result of that a little bit. So how do you think about through the cycle leverage or sort of a leverage target? And then in the context of bolt-ons and M&A, what could you potentially be willing to go up to on the leverage front?

Sure. From a target standpoint, we're very, very comfortable between 2.5 and 3. When the company went public, we were close to 6x levered. So given our 80% cash conversion rate, we're very comfortable carrying leverage. Now that being said, there's always a balance there. So our target right now is about 2.5 to 3. I think when you think about our capital allocation strategy, I'll say from a growth standpoint, it's really both-and. We've got a lot of organic growth that we can fund with CapEx. We're always looking for opportunistic M&A bolt-on acquisitions. But we've also -- earlier this year, our Board authorized a $450 million repurchase program on our stock. We've been active in that throughout Q2 to Q4 of this year, repurchasing about $137 million. So we think we've got a lot of nice options between organic growth, acquisitive growth and then returning cash to the shareholders through either a buyback and increasing the stock price. I don't think we have any near-term designs on issuing a dividend, but that's also not off the table as we look at it or potentially maybe purchasing back some of our term loan at a discount. I think we're trading right around $96, $97 at this point.

I'd just add that the visibility and the stability of the business that we referenced earlier is one of the things it gives us significant confidence in our ability. I mean if you look in the third quarter as an example, we repurchased nearly $65 million of stock and our leverage ratio was unchanged from the end of the second quarter at 2.8 turns. So that cash generation capability really gives us a lot of flexibility around capital allocation alternatives.

A couple of follow-ups. On M&A, are you looking at sort of things within your businesses down the fairway? Or is it more of a something that's going to be margin accretive, cash flow accretive along those lines? And then second question is the recent share sale, is that CCMP still owns a portion of the business? Or have they exited?

CCMP has not totally exited at this point. I think they're down to about a 9% ownership, but they are on that exit ramp. So when the final exit happens is anybody's guess, but they're quite a ways down the path at this point. From an M&A standpoint, it really I think -- and Gene can correct me here -- would depend on the business unit. I think if we were doing an acquisition for our Ecoservice business unit, we'd probably be looking for something very adjacent to either acid production or in the case of Chem32 last year, catalyst sulfiding business of that nature. That was immediately EBITDA accretive. In the Catalyst Technologies space, it might be more of purchasing a technology. So we kind of look across the spectrum there from that standpoint. And there are a lot of attractive companies out there right now. I think given our point in the cycle, valuations aren't really where we think they need to be to make that next acquisition, but we're always looking.

That leverage target of 2.5 to 3, was that a gross or net basis?

Net leverage.

And should you find an acquisition, a bigger acquisition, what would you potentially take leverage up to, to execute that?

That's a great question, Roger. I think it really would depend on the profile of the acquisition. But as I mentioned earlier, we're very comfortable carrying some leverage in this business.

What input have you had from rating agencies? And what do you think it would take or they've said it might take to get you up to the next notch?

I think that's interesting. Our debt has always seemed to trade a little bit above where we're rated. One of the big concerns that we get from the rating agencies is they don't like the leverage. They'd like to see us down closer to 2. The other, I'll say, comment that we get from the agencies as well is the private equity overhang in the stock. And that's really working itself out right now. So we've got -- we're very optimistic that we'll see some favorable ratings here in the future.

Given the end markets you serve, where do you see the growth opportunities over the next 2 to 5 years?

Well, I think we're very well positioned, Roger, in terms of some of the greener technologies. So we talked about mining earlier. I think that's going to be a big growth area for us. In our Catalyst Technologies business, our pressure products around emission controls, so if you think in terms of these heavy-duty diesel vehicles on the tail pipe or think about it like a catalytic converter, we have the catalysts that reduce the nitrous oxide emissions. And there's a significant backlog right now of those heavy-duty diesel vehicles that kind of relates to the chip shortage and the logistics challenges. So that's going to be kind of a nice business going forward, particularly as this backlog clears. Renewable fuels is a really great business as we look forward, and it touches us in 2 different areas. Nate talked about our sulfiding business in Chem32, which is within Ecoservices. And today, we're doing a lot of catalyst activation that go into renewable fuel applications. And then in our Catalyst Technologies business, we also have exposure to the renewable fuels through the catalysts that are essentially used on the dewaxing side. One of the things that makes this a really interesting business for us going forward is if you take a traditional unit and you convert it to renewable fuels, let's say, it's 100,000 barrels a day when you convert to a renewable fuel basis, it's probably somewhere around 50,000 or 60,000 barrels a day. So you're going to need a lot more of these renewable fuel assets for a like amount of traditional fuel. And then the catalyst changeouts are much more frequent because if you think about the feedstocks going in, there's a lot of variability in the feedstocks, whether it's vegetable oils or animal fats or whatever. So it tends to gum up or use up the catalyst a lot more quickly. So as we look forward, a lot more assets and a lot more catalyst changeouts, which we think is a positive for both the sulfating business and Chem32 as well as the catalyst sales.

Are those based on silica catalysts for that renewable accounts or ZSM-5 or things like that, would you know?

That would be on the Zeolyst side.

So Catalyst Technologies Q3 results were down year-over-year. How should we think about that decline?

When you think about Ecoservices, this is sort of like an annuity business. It's just a constant stream. The Catalyst business, particularly in the case of hydrocracking catalysts, those can be very lumpy sales. The turnarounds and therefore, when you're changing out the fixed bed, the catalyst, that can be every 3 years or so. So you can get one this inherent lumpiness. What we saw in the third quarter kind of was a combination of -- there was a mix aspect to it. It was just a less favorable mix, if you will, than the third quarter of last year. But again, looking at what's going on with the refiners, given where crack spreads have been and the profitability, what we've seen is a lot of these refiners or customers are deferring the turnarounds because they want to just, given them the profitability, they want to keep running. So there was an element of timing with some of these sales related to the turnarounds getting pushed from the third quarter into the fourth quarter.

So you've talked a lot about the strong margins in both of your businesses and the great performance. You seem to trade at a multiple discount to your peers. What do you think is driving that?

I would say 2 things that maybe people would attribute to that. One, I think, has been solved, which is leverage. Leverage is down to 2.8 turns at the end of the third quarter. But I think the biggest factor that we see in that valuation discount is the sponsor overhang, which is also in the case of CCMP being resolved, they're down from a fairly significant ownership position to 9%. Our other equity owner sponsor is INEOS. They're not a traditional private equity holder. While we can't speak for them on the timing, I think they could be a holder for a long period of time, not a traditional private equity that may have a fund that has got a defined life and a clock ticking. And that drives some thinking. I think there's an appreciation that there's a lot more upside in the valuation to come. So again, not speaking for them, but I would imagine, no need and no reason to sell it at these levels with more opportunity to come.

We have another question.

Given your [indiscernible] take out the rest of the CCMP 9% basically using leverage and kind of [indiscernible].

Well, I guess that would be one option. But look, I think they're down to a level now where as some people have suggested to us, you're at the point where there's one clean-up trade, if you will. So again, I can't speak for how they decide to exit in total, but it could be some block trades or one more secondary offering, given the size of what we just did, would essentially get them there. So as Nate said, they're on the exit ramp, can't speak for the timing, but we expect them over the near term.

And I would just say I would expect us to participate as we've had in their last 2 secondary offerings alongside any probable transaction out there, just given our view on the multiple and where the stock price trades, so.

How did any of those get invested initially? Like you said they had a traditional owner, was it part of an asset sale or how were they initially…

We purchased their silica catalyst business in the United Kingdom and they got their ownership stake as part of that transaction.

Was it a few years ago?

Yes, it was…

It was a lot of years. It actually was out of I&E GRP.

So a lot of years ago.

Lot of years ago. Good. Actually, we're -- perfect timing. We're over. Nate, Gene, thank you very much for being here with us this morning. Very much appreciate it.

Thank you.

Thank you.