Element Solutions Inc (ESI) Earnings Call Transcript & Summary

Good morning, everybody. This is Bob Koort, Head of the U.S. Chemicals Equity Research at Goldman Sachs. And very pleased everyone could join us for our virtual industrial materials conference today. The format is going to be a fireside chat. We're going to ask questions of our guests, and you will have the opportunity, you could do it now or whenever you prefer, on the webcast to enter questions into the appropriate box there, and we'll have -- we'll ask our participants those questions on your behalf. I've also got on the line with me, Anthony Walker, who helps cover ESI for us here at Goldman. And pleased to introduce Ben Gliklich, who is the CEO of ESI.

Ben, I thought maybe starting out, one thing we discovered as we dug deeper into ESI is it is quite an interesting and novel company. I think most investors, given that you're just over a year old, probably don't have much history with the company, maybe have some history with its predecessor, Platform. But could you maybe talk through the evolution of how we got to where we are today with ESI and maybe the back-story of what happened at Platform and what created ESI?

Sure. Sure. Happy to do that. And thanks for having me, Bob and Anthony. Glad to take some time this morning. Platform Specialty products was the predecessor company to Element Solutions. It was a specialty chemicals buildup, focused on building a portfolio of market-leading businesses across multiple different verticals. It started with MacDermid, which is the core of what we have at Element Solutions, and also built a large portfolio in the agricultural chemical space. Without going into all the detail, we now define ourselves in contrast to Platform Specialty products, which was more diversified and more of an M&A capital allocation story. We are an operational company. This is an operating business, not a holding company, focused on a portfolio of excellent market-leading businesses that we're running well and deploying the cash flow that they generate. And these are businesses that generate very, very strong and stable cash flows in all environments as we demonstrated investing that capital behind these businesses, not venturing out into new markets. Through Platform, we built this portfolio of market-leading electronics and industrial specialty chemicals businesses, #1, #2 positions in high-value markets. And so we're thankful for how Platform built this portfolio, but we really are focused on running these businesses well and not venturing into territory that is unfamiliar. And so we're a year old, as you mentioned, Bob. We launched this Element Solutions in February of last year after the sale of the Agricultural Solutions division. And we've been doing exactly what we said we were going to do, running these businesses well, maintaining the strong margins and cash flow despite challenging end markets, and deploying that capital behind these businesses, either through small tuck-in acquisitions, through some significant share buybacks, all while keeping leverage, much more modest than it was in the Platform days. Our leverage ceiling is 3.5x. Right now, we've got about 3.2 turns, and are generating strong cash flow to support that.

And either Element Solutions, it's a good name, but maybe some of our listeners aren't quite as familiar with the portfolio. Would you mind just giving us maybe a helicopter view of exactly what it is you guys do and sell? What are the important end markets and products?

Sure. So the business is split into 2 segments: Electronics and Industrial & Specialty. The Electronics segment sells chemicals that go into printed circuit board fabrication, electronics assembly and semiconductor fabrication. So about 60% of the business. These are products that are mission-critical to end-product functionality, but represent a very small fraction of the cost associated with those products. And these aren't products that are simply sold and applied. There's a service aspect and there's a manufacturing process aspect, where our chemicals are built into the manufacturing processes of our customers, and our customers rely on us to provide service to ensure that these products are working as they ought. So it's not just a sale of product, it's really a sale of a solution, material and service, oftentimes specified, always qualified by OEMs. About 40% of the business is Industrial & Specialty. Some of that is industrial surface treatment that goes into automotive and other industrial end markets. And 2 smaller businesses are for the graphics space. These are flexible printing plates used in the production of flexible packaging and offshore energy exploration and production. All of these businesses share that integral quality, where we're integral to very high-value add end products specified or qualified by end customers and used in production processes, where the operators aren't chemists, aren't experts in our technologies and really rely on us to make sure our products are functioning. So it's a solutions business, not a materials business, with a very important service component, which supports the strong and stable gross margins that we have.

Ben, this is Anthony Walker. Thanks for walking through the various business lines. Particularly as it relates to the electronics business and segments in the industrial business, I think you're levered to some pretty attractive megatrends and some trends that are really set up for secular growth as we look out past COVID and into the out years. Can you just talk about your growth expectations for those various megatrends, and what you think the main drivers are for growth and volumes over the next several years?

Yes, of course. And thank you for the question, Anthony. While what I just took you through would seem like a very diversified portfolio, exposed to a broad range of end markets, there are a handful of megatrend that supports a large portion of our portfolio. And we're excited about the growth associated with this business on the back of that. In electronics, there's a lot of exciting trends: 5G, increased requirements for connectivity, data intensity. And then across electronics and our industrial portfolio is electric vehicles and autonomous vehicles. This is a business that has seen secular trends, supporting really robust growth through cycles. So you go back to smartphones. And before that, it was mobile computing laptops. The next big driver -- or the driver we're actually benefiting from today is 5G. And the next big driver is the electrification and digitization of the automobile and the -- and broader industry. 5G is supporting a strong performance in our electronics business this year. We've been counting on 5G or expecting 5G to come for a couple of years, but it's here, and we're seeing that tailwind today. It's supporting the electronics business in what is a challenging general macro environment. Our electronics business has been relatively strong in 2020 year-to-date and also in the back few months of 2019. That's driven by 5G, that's driven by data center investments. We're all living right now, as we do this virtual conference -- we're all living right now in a world where data intensity and high bandwidth connectivity is more important than ever and accelerating some of these trends. The EV opportunity is a big opportunity for us. As cars become computers, the technical requirements, the reliability requirements increased by orders of magnitude from the highest-end circuit boards that are being used in mobile devices. Because if you take your cell phone and you leave it in a snowbank or you leave it in the sun, it won't work. But you do that regularly with your car, and the cost of failure is lives. So we're seeing an incredible increase in the requirements for circuitry in automobiles as they develop more capabilities. And this isn't just self-driving capability, this is things like lane departure warnings and automatic cruise control, things that we have right now. And the more technically challenging, the greater the requirements, the more margin there is and the more opportunity there is for us as a market leader, both from an innovation perspective and across this cross-section of our industrial segment and our electronics segment. What does that all translate to? We think that our blended, sort of, our weighted average market growth rate through this cycle is 3-ish percent. And by virtue of our participating in the higher-value, faster-growing segments, this business should grow through this cycle 1 point or 2 faster than that, call that 4% to 5%. We've seen some headwinds in the past couple of years as mobile device replacement cycles extended and 5G infrastructure builds were delayed. So these end markets have been a bit slower when you look at the end of 2018 and 2019. And obviously, COVID is impacting demand across the business in this first half of 2020. Historically, we've seen these businesses snap back as innovation doesn't wait, and there will be pent-up demand. So we're very excited about the medium-term outlook for this business once we're through COVID and above -- let's call it, above-average growth for these businesses when we get through this.

Great. And then kind of rounding out the view of the company from a top-down level, how should we think about the competitors that are also chasing this opportunity and your secular growth trends? And then maybe just help us think through your competitive advantage as it relates to your products and your drag-free, and what allows your customers to remain sticky and remain with Element Solutions?

Yes, it's a great question. And we're increasingly excited about our competitive advantage after having lived through the past 3 months. This is -- these markets are niche markets. There's -- rather consolidated at the top with a long tail of local competitors, fragmented local competitors. And a few things are happening. The first is OEMs are demanding consistent capabilities wherever it is that they make something. So they want the door handle on their car to look the exact same, whether it's made in China or in Michigan. They want their circuit boards to meet the exact same performance standards, regardless of which printed circuit board fab is making it. And so their specifications and requirements are more demanding. And so that tail end of fragmented local competitors are losing to the larger companies, like ourselves. And so we're #1 or #2 in most of our markets, and so we've got a share opportunity from that. The other thing we've seen is supply chain continuity is so important. And between trade tensions, where there were issues associated with being in China, and most of the electronic supply chain is in China; and now COVID, where we've got a distributed supply chain, we can make products anywhere in the world and ship it anywhere in the world. And so even when factories were closed in China, we were able to continue to supply to our customers. That was highly differentiating. Now market share moves slowly in these businesses because, as I was explaining before, our products are built into the manufacturing processes of our customers. And so to take us out or to take out a competitor, you have to stop producing. You have to, in many cases, change equipment, and you have to requalify. It's a very expensive proposition for something that is a tiny fraction of the cost of the end product. So there aren't big swings in market share from 1 quarter, or even 1 year to the next. But over time, because of what we're doing, by being global, by being on the leading edge from an innovation perspective, by being able to provide continuity of supply, we're nudging market share in our direction. And I'm confident that we will be taking share over time, which allows us to grow faster than our market, which is our objective, as I outlined earlier. The other thing I would say that's important and different about our business is that, through the combinations that we've done, through the acquisitions we've made over the past several years, we have a broader portfolio of products than any of our competitors. So we're selling circuit board chemistry to the circuit board fabs, and we're selling assembly products that are used to put components onto those circuit boards. No one who sells assembly products sells a circuit board chemistry, and no one who sells circuit board chemistry sells assembly products like we do. And that is a critical failure point when you think about electronics hardware. So vibration, temperature changes, the -- that causes components to lose connectivity to circuit boards. And so we can generate collateral that shows how our products interface that none of our competitors can. And so having a broader electronics portfolio, we can do the same thing, by the way, with our semiconductor portfolio, allows us to have a bigger seat at the table with the specifiers and to generate data that our competitors can't. And so that's also an added arrow in our quiver to drive market share gains. And we've seen that benefit already and are very excited about that.

Ben, it's Bob. Maybe dovetailing on that. There has been a reasonable amount of consolidation in the broad electronic chemical space. How do you guys see yourselves participating in that? And are there tools that you don't have or products that you don't have that would enhance your offering and make ESI even stickier, so accretive by bringing in extra products? How do you think about that?

Yes. So there's been a lot of consolidation in what you'd broadly define as electronics materials. Most of that has been in the semiconductor space. Where we haven't been the consolidator, it's been in the semiconductor space. We've been driving consolidation in our markets. The really nice thing about our business is that we're a market leader in all of the markets in which we participate. And the strategic activity that's happening around us doesn't have any implication for our competitive positioning in our markets. So we've seen mergers. We've seen Versum. Merck has been a consolidator. And there's been a lot of activity around us. It hasn't impacted us competitively. And we are not in a position where consolidation around us will impact us competitively, given the state of the markets in which we participate in and how consolidated the top is, which is a really nice position to be in. So what are we doing from a capital allocation perspective? We're buying interesting technologies that broaden our portfolio, either in support of what we do today or in an immediate adjacency, where it's a technology we can run through our global footprint or it's something that overlaps with what we do, and we can generate a lot of synergies. So in the past 2 years, we've made 2 bolt-on acquisitions. One was a technology acquisition. It was a nonconductive adhesives business, right? So our assembly business are conductive adhesives, current flows through them, nonconductive adhesives for electronics. This is also used in the assembly of electronics hardware, but you're not running current through it, very similar customers. This was a company that was based in Korea, had 1 large customer in Korea. That's a very high-end manufacturer. We were able to take this technology. If it works for that company, it works for many of our other customers and build a book of business with that technology far greater than the sales that, that company had. Last year, we bought a business from ITW called Kester. That's an assembly materials business, just like our assembly materials business, more oriented towards aerospace and medical markets, whereas our business is more in electronics, diversified the portfolio, a lot of synergies available at a reasonable multiple. So that's the way we're thinking about capital allocation. No transformative, large acquisitions, bolt-on that really fit within our portfolio and/or modestly expand our competencies within our existing end markets. And we don't see consolidation around us as a threat.

Interesting. The webcast has a few questions. We've tried to leave them in. But one, explicitly looking maybe for an anecdote of a time where you have displaced a competitor, and why or where you may be -- have been displaced and why.

Yes. So what comes to mind is, very recently, we view the circumstances with COVID as a great opportunity. So we spent years emerging from working our way to emerge from Platform with a balance sheet that allowed us to be on the front foot. And so as we've -- and this is a business, and we haven't talked about this too much, but the hallmark of this business is its strong stable cash flow, as we generate more cash in downturns than in -- on a -- from a free cash flow conversion perspective than when markets are growing because of the working capital release. And we can take out OpEx very quickly because so much of this organization is people based, and that doesn't mean layoffs, that means reducing variable compensation, reducing travel and other discretionary spend. And so we're able to support very stable profitability and strong cash flows. So in a time like this, we're managing costs aggressively, but we don't have to do workforce redundancies and/or workforce reductions. And so we're fully staffed right now when a lot of our competitors, because they're not as diversified, they don't have the same balance sheet capabilities. Maybe they're in a place where their factories shut down, aren't able to stay open. And so we were excited, when facilities were closed in China, to go call our competitors, customers and say we're in business. But that window is pretty small. And we didn't get a lot of, let's call it, receptivity, and we weren't able to convert a lot of accounts then. But when this happened in Europe, it was a different story. And a lot of our competitors had forced furloughs. A lot of our competitors' facilities were closed. We were open throughout, and we were getting calls from competitors' customers saying, "We can't get someone pick up the phone." And we're still producing, let's talk, right? So that's a case study. Another case study, more recently, is we've been building an initiative, an effort around sustainability. Sustainability is existential for our customers. They use a lot of water in their manufacturing processes and reducing their environmental impact, allows them to stay open in places like China, where you've had increasing regulatory requirements on manufacturing sector. And we have some new technology that meaningfully reduces wastewater and some of the heavy metals that are in wastewater in plating operations, be it for print circuit boards or for automotive parts. And we're introducing this equipment with the quid pro quo that we get the chemistry. And those conversations have been going really well. It's early days, but we have great sustainability technologies resident within our businesses. We haven't exploited them across multiple of our verticals, and we're starting to do that. And we think that's a really nice growth driver. It's also a secular trend, just like 5G, just like EV, sustainability is going to drive growth for this business because of the capabilities we can have by being a market-leading innovator and should drive market share.

Ben, it's Anthony again. Thinking over the last 18 months, it's been a particularly challenging macroeconomic environment. And I did want to dive in a little bit into COVID, the impacts that it's having on your business, and then more specifically, how you're responding. And any commentary you can give as it relates to the flexible structure -- the flexible cost structure that you have, the performance of the business in '08, '09 and how you expect it to perform this time around, I think, would be helpful for investors as well.

Yes. Thanks for the question, Anthony. And I talked a little bit about this earlier. The hallmark in this business is strong cash flow and sustainable margins. And 2019 wasn't a great year for our end markets. Electronics were super -- were slow. Automotive was slow. And so we were taking cost out from the beginning of the year. We also were transforming from Platform Specialty Products and Element Solutions, which was a holdco to an operating company transition. So there was corporate costs that we were attacking as well. Last year, our top line was down low to mid-single digits, and we grew EBITDA organically. We did that through $50 million of cost out, $25 million of that was permanent. As I was talking about that transition from holding company to operating company, $25 million of that was, call it, temporary. So as I said before, this is a people-based business. We can flex cost down pretty quickly. If we're not growing, we're not paying variable compensation, we're limiting travel and so forth. Importantly, when we do this, we never target the growth drivers of the business, meaning we are cautious not to impact the long-term growth trajectory by cutting R&D spend. R&D spend was, I think, roughly flat from '18 to '19 across this portfolio, $44 million, $42 million. So it increased as a percentage of sales. We're not cutting R&D and innovation to support near-term results. Coming into this year, we were cautiously optimistic about electronics, a little bit more, let's call it, cautious about the automotive space. And then, of course, COVID hit, which had us rethinking a lot of those assumptions. The business performed well through the first quarter. The impact was primarily in Asia, and Asia came back nicely. The second quarter is more of a western story, where the automotive OEMs have been closed since the end of March. And so we're seeing a real headwind. And it's taking a little longer for that business to get back, get back firing than what we saw in Asia, clearly, and even relative to what the OEMs we're forecasting when they first closed and through April. So we're flexing cost, but we're not doing it again in a way that impacts the long-term growth trajectory of the business. We're not doing it through redundancies. We want to be -- we think we're differentiated, and that we can be in a position when things get back to normal, to have the same people calling on our customers that we're calling on them before. And we don't see that as a likely outcome for many of our competitors. As I talked about before, we've done a lot around supply chain redundancy and being able to make products copy exact all over the world. So should a facility be forced to close, we can continue to supply. As I mentioned earlier, a lot of our products are qualified and specified. And so making sure that they are copy exact is critical. Obviously, our first priority has been around our people, and we've implemented a lot of protocol to protect people at our sites. We've got a large portion of the workforce working from home. We've taken pay cuts amongst the senior leadership and amongst the businesses most impacted. We've had some furloughs, but they're rotating again, so there's always someone answering the phone when a customer calls. And we're navigating this real time, huge amount of communication, incredible productivity despite this disruption. I mean the team is coming together and performing exceptionally, exceptionally well. Anthony, did that answer your question? Or was there more?

No, it did. I appreciate that. Maybe one from the audience, and thinking about speculation that the semi industry may move onshore in the U.S. And what type of opportunity did that potentially represent for you -- for Element?

Yes. It's a good opportunity for us. Our manufacturing in the semiconductor space is mostly in the U.S. Our semiconductor business, it's a relatively small portion of our overall company, but it's growing really nicely, and it has great, great capabilities. I don't think it changes the competitive dynamic, again, where we participate in the semiconductor market. We're a market leader. We've got leading technologies and strong market shares. So I don't think it changes the growth trajectory for us, should there be an on-shoring of the semiconductor -- of more semiconductor manufacturing. But I would have thought it would help more than hurt.

Ben, it's Bob again. I thought at your Investor Day, you guys presented a pretty interesting and I think unique slide about your capital allocation and how you return cash, whether in dividends or share repurchase, and then how the dynamics of your share price may influence the return hurdles on acquisitions. Can you just sort of talk through that balance that you see in terms of how you deploy that capital?

Happy to do that. So the place to start is we're all about driving a long-term intrinsic value per share. And the goal here is not to get to a certain size from a top line perspective, it's to compound EPS, right? And so when we talk about what our goals are as a company, it's operational excellence, so running the businesses that we have well and prudent capital allocation. These businesses generate excess cash flow, far beyond what we can reinvest organically into the business in pursuit of organic growth. And so putting that capital to work in a smart way. And we're very opportunistic. And so what is -- what putting our capital to work in a smart way looks like depends on the environment and relative value. We are not afraid of buying our shares when they're dislocated from intrinsic value. We did that aggressively last year. We're also going to pursue tuck-in acquisitions, businesses that are better as a part of our portfolio and make our portfolio better, allow us to provide more value to our customers. The hurdle for those tuck-ins changes based on the value of our shares. So when our shares are far dislocated from what we think is intrinsic value, we're going to be more aggressive in buying our shares and less focused -- or the hurdle for M&A goes up. As the shares appreciate, the hurdle for M&A goes down, but not below an absolute level. The cash doesn't burn a hole in our pocket. We've got a firm leverage ceiling but no leverage floor, which is to say, if we don't see anything attractive to do for a period of time, the cash will build on the balance sheet, our cost of debt, our capital structure is safe. It's long-dated cost of debt is low. And so paying down debt doesn't make a ton of sense, given the cost of that debt. And so we're happy to wait for great opportunities to come up, if there aren't any immediately apparent. But that's the way we think about capital allocation. Those are the sort of governing metrics.

Ben, you made some comments around China and what you're seeing there. Can you just help us think through volume growth off of the bottom? What end markets you saw come back, the quickest to think through what the recovery could look like around the rest of the world as the stay-at-home orders are lifted and as consumers get back to more normal types of activity?

Yes. So we saw China -- as you guys all know, China extended Chinese New Year effectively by a week. Our facilities, by and large, were reopened before that week was over because our customers were reopening, right? There were ways to continue to manufacture, just like there are here, essential businesses, effectively. So I was sitting in New York -- or rather, in Florida, thinking we should get ahead of this. Let's close our facilities preemptively when, in fact, that was the wrong thought. And I was quickly corrected by the folks on the ground that our customers were open, and we're reopening quickly. And we need to get in gear, and we did. And so all of our facilities, with 1 exception, were reopened before that 1 week extension. Our other facility was opened a week later. And the dynamic we saw in China was that the higher up you were in the supply chain, the less of an impact you saw. So to make a circuit board, you need a laminate, which is effectively a piece of plastic, our chemistry and the facility in labor, right? So the inputs were fewer. To complete electronics hardware assembly, you need a whole bunch of components in addition to that circuit board and our product. And so the circuitry business remained quite resilient, while the assembly business saw a bigger impact. So the business was off high single digits in February and less than that in March but most of that was in the assembly business. As I was saying before, 5G has really supported the business through -- into 2020. And so our circuitry business is more oriented towards the higher-end Internet infrastructure, smartphone market, where the assembly business is a little bit more broad. And so that also was one of the dynamics that was supporting the circuitry business, more so than the assembly business. So over the balance of the first quarter, the circuitry business was fully recovered, and very quickly. The assembly business was still a little bit more slow. Today, all of our businesses are operating very close to plan in Asia, and in some cases, ahead of our plan because that 5G dynamic is so robust. In the Americas, our electronics business, which is smaller than in Asia, most of the electronics business is in Asia, the circuitry side has also been more robust than the assembly side. And obviously, the industrial surface treatment business, which goes into automotive, and is more weighted towards the West towards the Americas and Europe, has been quite slow through the quarter. What can we extrapolate from our experience in Asia? It's hard to extrapolate too much more than where you sit in the supply chain matters, and that where there's strong policy, things can get back to normal quickly. Obviously, it was centrally coordinated in China, and there was a great enforcement that allowed for facilities to get up and running very quickly and back to normal. And that hasn't happened here yet. And so our expectation for the ramp in the industrial business in the West is for it to ramp more slowly than what we saw in China. Obviously, the reopenings of OEMs have been delayed by several weeks. There is -- there has been some inventory build in the channel. And the recovery of production rates, we're not counting on that to be very robust through the balance of the second quarter.

Ben, unfortunately, we've got to end there. A very comprehensive discussion. I always learn a lot when we have you on. So appreciate that. And any clients who would like to follow-up, if you had other questions that weren't asked, we're happy to do that off-line and afterward. But thanks so much and appreciate everybody participating today. Take care.

Thanks very much. Thanks for your time.