Element Solutions Inc (ESI) Earnings Call Transcript & Summary

Okay. Good morning, everyone. Thank you for joining us. Welcome to the 2021 CJS Winter and New Ideas Conference, our second virtual one. And I wish I could say it would be our last, but I guess we'll see at this point. We are very pleased to be hosting Element Solutions. With us today is Ben Gliklich, the Chief Executive Officer; and I believe Varun Gokarn is also on the line, he is Head of IR. CJS has been covering life sciences companies for a long time now. They have delivered great shareholder value to this point. For Element specifically, since it was a platform acquisition formed by the merging of MacDermid, I think it was 7 years ago, and now it's been really nice to see how the company is persevered to matured over quite the journey so far. I'm going to Ben give a short presentation about the company and what they do, and then we'll go directly into a fireside chat format Q&A, while also taking submitted questions from the audience through the portal. Before we start, I'd like to remind investors to refer to the safe harbor statement in the presentation regarding disclosures and forward-looking statements. And with that, Ben, take it away.

Great. Thank you, Jon, and thank you to the team at CJS for hosting us today. We're very happy to be here kicking off our investor engagement for 2021 and spending some time with you guys. It's an exciting time for ESI. We're now just about 2 years into our journey since this company was founded, and we feel very good about both the way we've proven out our business model, preserving margins and generating strong cash flow through what's been initially a difficult macro climate. And the way that the exciting trends that are driving our growth are taking hold and propelling our business. Let me start quickly on the first slide with an overview of the company. So Element Solutions is a global diversified company providing chemical technology that enables performance. Sales are about $1.8 billion, split 30% in each of the Americas and Europe and 40% in Asia. We have about 4,500 people spread similarly around the world. The workforce is heavily weighted towards sales and innovation as our business relies heavily on on-premise solution selling and technical service. We specify that we provide chemical technology enabling performance. So all our customers receive invoices and they pay us for chemicals, we're not a materials company. We're a solutions company, and we provide innovation and technical applications expertise that our customers truly rely on. Our solutions enable breakthrough technologies, whether it's in electronics, in automotive and in other end markets. The chemicals that we provide are made in relatively simple manufacturing processes. So the business has light capital requirements. If you visited a facility, we would look to you more like a warehouse than a manufacturing site. So when you combine these integral solutions with simple manufacturing that translates to sticky high-margin sales and stable, strong cash flows. Across all of our portfolio, we are market leaders in attractive niche markets. These markets are attractive because the profit pools are attractive, the margins are high and the barriers to entry are high and because they're growth markets. We have 2 segments, our Electronics segment, which is about 60% of sales and our Industrial & Specialty segment, which represents about 40% of sales. And each segment has several different verticals, which you can see on the lower side of the slide, defined by the types of products that we're making, but each of these businesses share similar high-quality attributes from their asset-light manufacturing to highly technical selling and support and that leadership position in each of the markets. On the next slide here. And today, I'm going to talk about the 2 things that we are most excited about coming out of 2020. First, the growth drivers that will propel Element Solutions forward over the medium-term really accelerated in 2020. Now if anything, COVID has fast track these powerful secular trends from which Element Solutions will benefit. The drivers of the new economy, right, which you can see on the left-hand side here, will drive Element Solutions as well, whether it's the proliferation of 5G mobile technologies, greater penetration of electric vehicles globally, developments in next-generation semiconductor technologies, these are powerful technological dynamics that inflected positively in 2020. At the same time, we've seen a greater emphasis on sustainability from recycling through to more environmentally friendly technology. And those have become an increasing area of focus across the economy. And that's one that where Element Solutions can be a protagonist and a differentiated solutions provider. And I'll take you through each of these trends in a little bit more detail over the course of the presentation. The second thing that we're excited about coming out of 2020 is, historically, we've talked about our businesses being high-quality due to the stability of our margins and our cash flow in good times and more challenging times, but going back a couple of years we have to point back 10 years for a case study for what challenging times look like. And now we have a more recent one. From 2019 and 2020, we've proven out our models' power, our models' resilience and our ability as a management team to run these businesses well in those types of environments. Through COVID in 2020, Element Solutions will have grown its EBITDA, grown its free cash flow and reduced net leverage below 3x EBITDA. We're proud of that. At the same time, we didn't have to meaningfully restructure our workforce. We held investment in R&D and CapEx steady. We didn't sacrifice the long-term for short-term results. In fact, we made new investments in long-term strategic areas like our acquisition of DMP Corp., and we had enough confidence in our cash flow generation and the stability of our cash flow that we initiated a dividend in the fourth quarter. The way we were able to do that was to run our variable operating cost model aggressively and leverage our global supply chain to its fullest. Thinking back on 2020, it's not a year that we will remember fondly by any measure, but it is a year that we will be very proud of. So let me take you quickly through each of those trends I highlighted earlier. First, the introduction of 5G technology. This is something that has been expected for many years, but it began in earnest in 2020. New mobile phone models were introduced that included 5G capability and the infrastructure to support 5G applications has ramped significantly. But this is just the beginning of what will be a multiyear major growth cycle. Then we're going to see growth in units at smartphone units, substantial, very substantial investment in 5G infrastructure, and at Element Solutions, we'll see growth in content per unit as the increasingly technically demanding circuitry and 5G phones represents a higher content for us, 15-or-so-percent greater content per unit in our circuitry business and our electronics business. So in 2020, because of COVID and supply chain disruption and some of the economic weakness, mobile phone shipments are actually expected to have declined in 2020 and 5G penetration, 5G-capable phone penetration remains just a fraction of those total mobile units. You can see them on the left-hand side. So as we flip to 2021, we should benefit from a recovery in units. So unit growth in mobile phones and significant growth in content per unit as 5G penetration increases. Next, very quickly on vehicle electrification. It's a similar story in that we expect increased penetration of electric vehicles for many, many years and that translates to increased value per unit. You've all seen that the most major automotive OEMs are committing to significantly grow their electric vehicle offerings in the coming decade and across our portfolio, across many of our businesses, we're an integral enabler of electric vehicles. So despite the fact that we sell into the OEM tier structure, we've become a key partner to major OEMs through this evolution, and we have an important seat at the table. And you can see some of the areas where we play on this slide, whether it's in power electronics, where we have the market-leading and best-performing assembly technologies for power semis to advance circuit board technology that support the higher reliability advanced driver assist systems that we're going to see and to our surface treatment capability, which improves the weight and aesthetics of high-end EVs. ESI is a differentiated supplier to the market. On average, we expect 1.5 to 2x the content on a high-end EV versus a similar internal combustion engine. And so as EV penetration ramps, which we are seeing happen day-to-day, but there's a long way to go, we will benefit. The last of these secular mega trends before we turn to sustainability is around the proliferation of processing power and storage, which has really pushed the limits of existing semiconductor capabilities. At the same time, smaller semiconductor nodes have proven much more challenging and expensive for semiconductor fabs to deliver. And so as a consequence, we've seen innovation in packaging for semiconductors and in circuit board substrates. And so our capability across the spectrum from semiconductor, assembly materials and circuitry really puts ESI at the intersection of this innovation. And across the company, that represents a unique portfolio of capabilities to meet the needs of next-generation processors. So we're in a very exciting spot in this fast-growing, innovating marketplace. And we've invested significantly in our semiconductor business over the past 3 years to deliver the quality and the capacity that the industry is demanding. And you've seen in our results in 2020 that those investments have paid off. The business has been growing rapidly and has room and tailwinds to continue to do so. Moving towards sustainability. This is another powerful trend. It's the growing focus on sustainability in many pockets of the economy from investors to regulators, to OEMs, and Element Solutions has a long-standing history of investing in and developing technologies to help improve our customers' environmental footprint. And this investment increased last year with our acquisition of DMP Corp., which we formed into a new business, MacDermid Envio Solutions. And MacDermid Envio Solutions helps our customers reduce their water usage and the amount of contaminants in the water that they discharge. Water has become an existential issue for our customers. And MacDermid Envio Solutions is oriented towards our customers, not towards broader industry, but towards our customers in plating, whether it's industrial or circuitry. And we have an ability now to bring terrific technology to reduce water usage and discharge. The DMP business was mostly domestic U.S., we're leveraging their technology globally, and the initial feedback from customers around the world has been very, very positive. The other thing that we do in MacDermid Envio Solutions is provide equipment that reclaims metal from spent plating baths in our customers' manufacturing lines. That metal can then be sold by our customers. So this equipment is more than just environmentally friendly, but it's also a source of cost savings for our customers. So the paybacks are exceptional. Cumulatively across the life of these equipment installs, we have -- our customers have reclaimed more than 5 million kilograms of chrome, 1 million kilograms of nickel and altogether, that's translated to about $40 million of savings from our customers. And once again, most of these installs have been domestic, and we're bringing this technology to our customers globally. This isn't just a new product line for the sales it drives of these products, but it also drives mine share, which will drive market share as our business becomes a preferred supplier solving a broader set of problems for our customers. We just launched the MacDermid Envio website, macdermidenvio.com. I'd encourage you guys to take a look. It's pretty neat, takes you through some of the applications and in some case studies of what we've been able to do for customers. It's pretty cool and worth the time. Outside of MacDermid Envio, we have other recycling capabilities, whether it's our tin reclaim business, which allows us to sell an alternative to virgin tin to some of our assembly solutions customers. It's very, very important to many of our electronics OEMs, which are B2C companies and who care a lot about their reputations from an environmental standpoint. And that's a differentiated product within our assembly business. And we also have products that are used in PET recycling processes, so effectively enabling PET recycler. We're also investing in technology that makes chemistry greener. This is to say, improves the environmental impact of our products and of our customers' processes. And that runs the gamut across many of our businesses, whether it's our direct metallization technology, which requires less power and water to metallize circuit boards, to our evolved product, which is a market leader, first to market, eliminating hexavalent chrome from plating on plastic processes we offer solutions that help meet our customers' needs and meet -- help our customers meet increasingly stringent regulatory requirements and also the growing demand from OEMs from our customers' customers for lower environmental impact in their supply chains. Last year, we acquired an offshore production fluid that has best-in-industry environmental performance as judged by key industry regulatory bodies and that is table stakes in that market, and we're going to see market share gains in our offshore business through the introduction of that product. We've developed additional low-temperature solder materials, which also reduce energy usage and greenhouse gas emissions from our customers from electronics assemblers. We expect the trends that are driving adoption of these more sustainable technologies only to accelerate. And so we will continue to invest in these products. And these exciting new growth drivers are propelling. Let's go to the next slide, a stable, high-returning business model. So let me pivot quickly to the second aspect of that dynamic. We have a portfolio of great businesses that we are making better. They're great businesses because of their niche market leadership, because of their strong and stable EBITDA and cash flow margins, which are supported by excellent gross margins, a highly variable operating cost structure and a low level of CapEx, less than 2% of sales. And we're improving those margins by making our business more efficient in supply chain and G&A and by driving outsized growth, in our higher-margin segments. Our margins have trended positively since we founded ESI and even with volume pressure from COVID in 2020, EBITDA margins in 2020 will improve year-over-year. And cash flow will have grown as well, as I mentioned earlier. On the bottom of the chart, you can see our outperformance relative to our key end markets. As mentioned earlier, 2019 and 2020 were challenging macro backdrops. We saw declines in mobile phone shipments and automotive units for the past 6 quarters, really driven by the macros. But in each of those quarters, you can see ESI sales has outperformed these 2 markets, these 2 markets that together account for nearly 50% of our total sales. And as these markets recover, which they will into 2021 and beyond, driven by the secular trends that I've just gone through, we expect to continue to outperform. On the next slide, you can see how asset-light manufacturing and strong, stable earnings and cash flow profile can translate to leading cash flow and returns metrics across the specialty chemicals space. So we've benchmarked ourselves here against U.S. specialty chemicals companies. You can see EBITDA less CapEx margin a second in the cohort. And I'd note that this metric is stable. CapEx for our business and EBITDA margins are not lumpy. They are stable and improving. The returns metric on the bottom half of the page is EBIT over tangible assets which is what we look at because we've got quite a bit of goodwill and intangibles on the balance sheet associated with the revaluation of the assets we acquired in recent years. And unsurprisingly, our model translates to leading returns metrics across the space. And again, these are metrics that should improve over time as growth in our business does not rely on significant capital investments, as we've just outlined. And on the topic of capital, on the next slide, let me briefly touch on capital allocation. The framework you see on this slide is the frame is a framework we've shared previously. We're opportunistic about capital allocation, capital deployment when our shares traded at a discount to our view of intrinsic value, more likely to deploy capital to repurchase them. And our hurdle for M&A goes higher, as valuation improves, shares become less attractive and the hurdle for M&A is lower. But that hurdle never reduces below an absolute threshold. And if you look at our capital allocation at ESI to date, it's really reflected that approach. So since January 2019, we repurchased about 17% of total shares outstanding at attractive levels. We've deployed $75 million into tuck-in acquisitions that fit well within our existing businesses at highly attractive multiples. We've deployed capital at attractive rates of return to improve our balance sheet. We did a bond refinancing in August, which will significantly reduce our interest expense and it had a 2-year payback attached to it. And we have due to dividend in Q4 of last year. And despite all of that, with all of that capital deployment, our leverage has remained below 3.3x EBITDA throughout, and it's further improved to less than 3x EBITDA at the end of 2020. So I'll conclude here with a final slide on what you should expect from Element Solutions. And this is a slide many of you have likely seen before, and I know that really hasn't changed. And our goal is to drive intrinsic value per share by running our high-quality businesses better every year through strong execution and continued prudent capital allocation. These are things that we've been doing over our first 2 years as Element Solutions. We should and have outperformed our end markets continue to drive strong margin and cash flow performance and invested that cash behind our businesses in prudent and accretive ways. Leverage should remain below 3.5x. And as I mentioned, we'll be below 3x following the fourth quarter and lastly, you should expect us to continue to return capital to shareholders, which we've done over the past 2 years through buybacks and the dividend that we recently initiated. And altogether, this translates to doubling EPS from $0.68 to $1.36 from 2018 to 2023. And despite what's been a challenging macro backdrop for the first 2 years in our existence, we remain committed to that target, and we believe we can achieve it. So with that introduction and maybe a little more than introduction, let me thank you for your time and attention and turn to questions from Jon or anyone listening online, I look forward to them.

That was great, Ben. And then before I start the Q&A, I just want to remind investors you can tune the question through the web interface. I'm going to start with 2 or 3 of them, and then we'll try to take some from the audience. Ben, my first question, and you touched on some of the sustainability and environmental stuff in your presentation. But ESG investing has been a trend that has only become stronger. What we're trying to make a conscious effort to focus on this as a trend in 2021 at CJS. Just to start, tell us about how your business naturally aligns with this principle. Again, you covered some of them already. But what active ESG initiatives or accomplishments or certifications do you have? What initiatives are underway. And where do you think you'll be in a year or 2? And then what's your ultimate goal for ESG and overall?

Thanks for that question, Jonathan. It's a good one. And something that has been front of mind. Coming into 2020, we were excited to market our ESG shops. Because across our portfolio, as I went through, we've been pursuing ways to improve our customers' impacts on their supply chain for many, many years. What we found in the middle of the year was that we were actually being deemed that ESG was a headwind for us from an investor standpoint because we hadn't really engaged with the ratings agencies around ESG dynamics. And so while we were pursuing ESG initiatives that were good business, that were good for our customers, we weren't getting credit for that at all. And so we found ourselves on the back foot, and we're rectifying that this year. You should expect us to put out a sustainability report in 2021 that will show how favorably we stack up to our peers from an environmental impact perspective from our own supply chain. As I mentioned, our manufacturing is asset-light. It is relatively low-touch from an environmental standpoint within our industry. And also highlighting some of the things I just took you through, some of the investments we've made not just within our own supply chain, but within our customer supply chain who have more manufacturing intensive processes to lighten their touch to leave smaller footprint on the environment. And so it's something that we're dedicating time to. We think we'll be a tailwind. The story we have to tell is a good story. In general, we believe these things work best when it's really driven by a business case. And in our case, it absolutely is.

Great. And obviously, this is the most pressing thing that everyone is dealing with right now, it's the pandemic. What is the biggest issue or maybe even opportunity that you have in dealing with COVID today? And maybe after that, when do you think will we get back to a normalized environment?

Yes. It's a good question, Jon. What an uncertain environment. COVID was -- had a huge impact on our business through all of 2020 and continues to. But as you rightly pointed out, it created great opportunities because I made a comment earlier. We leveraged our global supply chain to the fullest, which allowed for us to have a differentiated service capability to our customers. We didn't have any issue supplying our customers when many, many of our competitors' supply chains were significantly disrupted. Our global footprint, our ability to manufacture the same products in multiple places and get raw materials because of our scale, deal with logistics because our purchasing power was highly differentiating. Similarly, the way the leadership team came together, we are a relatively new company, and we really coalesce around this crisis, which will pay dividends for an extended period of time. We're still seeing idiosyncratic impact from COVID on our supply chains, whether that's availability of labor and some of our customers' facilities, whether it's availability of raw materials, seen some headlines about chip shortages. We're navigating those that we can't expect the economy to continue to come up as is the way it has for quarter after quarter. And so we're in a sort of crisis posture still. What's really encouraging is that the underlying demand for our products is driven by the secular trends, I took you through, remains really healthy. And so through it all, we may have some bumps in the road. But through it all, we expect real growth as we recover from this. And the secular trends continue to take root.

Got it. And one thing that's been really impressive is that your business model has generated the earnings and cash flow in line or better than what you've guided to in February before COVID came to the U.S. I think that's a major accomplishment. Can you build on that as the world recovers? Or does the leverage in your business model cut equally both ways? Just help us understand the ability to withstand that kind of pressure on the downside and kind of how it works when demand returns to normal.

Yes. So we pulled a lot of levers to take advantage of this variable cost operating model that we have in 2020 and took many millions of dollars of cost out, which allowed for us to preserve margin and put up the results you just highlighted. And we would expect some of that cost to come back into the business as we return to growth. What you shouldn't expect is for us to allow that cost to come back without the top line supporting that cost. And so I would expect our earnings to grow in line with the top line because we have the ability to manage costs very actively and short term. So we're not going to allow for, call it, operating deleveraging as cost comes back and the business ramps in 2021. So we may not see the same level of operating leverage you would expect in a normal year from the top line.

Got it. But it's still nice to see that you're confident in your EPS target by 2023, which is what you gave in 2018. What are the risks on the way to getting there? Kind of what's the mix of, I guess, the M&A and share buybacks required to reach that objective? And I think your compensation has a clause where if you reach it by 2022 you're highly incentivized to get there. Just talk about that target? And how are you going to get there? And if there's any upside to that?

So well, the macro environment in 2019 and 2020, clearly, weren't supportive of that target. What we've been able to do are on the balance sheet from an interest expense perspective, from a tax planning perspective and from a capital allocation standpoint, has been far better than we would have expected. And so those 2 things generally offset. And so with the benign macro, we think we've got a good shot at delivering on that objective. We don't get there simply through organic growth that relies on capital allocation. And so we need to have some good opportunities to deploy the very healthy cash flow this business generates over the next couple of years to get to that high teens EPS compounding that we believe we can. And so I would expect that we will have those opportunities. It doesn't require anything transformational. As you've seen, we've been able to steadily make some attractive tuck-in acquisitions every year, and we would expect to continue to pursue that. And if share buyback opportunities persist, we will pursue those at attractive values. That's the biggest question mark as I see it. The organic market or the macro environment, it looks supportive. It's really around capital allocation from here.

Great. And I don't see any questions from the audience to see if we will keep going. Just a reminder, you can add some things that won't be shy. Ben, just to follow-up on the secular trend that you've been focusing on. Can you kind of give us the percentage of your business that's exposed to macro trends and end markets that are growing, kind of, in these really exciting ranges? You talked about the semiconductors, 5G, auto electronics. And contrast that to the rest of the business, which is maybe more of a GDP or as not as fast growing? And kind of where does that leave you on the growth trajectory for the next 2 or 3 years?

Yes. So about 20% to 25% of our business is in mobile phones, mobile infrastructure markets. So you get to about 1/4 of our business there and about 20%, 25% of our business is in automotive. And so only a small fraction of that is going into EVs. Some of the electronics business also goes into EVs. So a good half of the business, at least, if not more, is touching, if not sort of centrally impacted by these secular mega trends that I took you through. And then other parts of the business are going to benefit in the near-term from the cyclical recoveries, right? So let's not forget that while we have secular drivers driving a big portion of the business for the medium term, as we look into 2021 and beyond, we're going to be recovering from what was a very material, broad economic dislocation in 2020. Auto units will be recovering. And other -- the energy prices going up to our offshore business should see some tailwind from that. The graphics business had a dislocation in 2020 as well. So we've got a blend of secular and cyclical growth here in the next year or 2.

Great. Just wanted to focus on the 5G opportunity a little bit more. It's been something everyone's been talking about carriers investing a lot of money. You highlighted the upside in a 5G phone versus, I guess, the 4G from legacy one. Can you talk a little bit more on the base station side, your exposure there? How much more content you have for a station? And if you're taking more share there versus, I guess, your competitors and what are they doing compared to you in trying to get a share of this market?

So this is really a unit story. The application for 5G base stations is very technically demanding, right, lower latency, smaller circuit boards. Those are things that play into our strength and the strength of just a couple of our highest end competitors. And so we should have a better-than-average share in 5G base stations and then it's really a unit story, right? 4G technology investment had tailed off in anticipation of 5G infrastructure or the rollout of 5G, and it's going to take many, many years and millions of base stations in order to provide the density that's required to support 5G phones. And so for the next 4, 5 years, you're going to see huge investments from carriers in these base stations. And so as those units grow, so does our value.

Great. And then my last one, just an update on the M&A pipeline, if you could Ben before we run out of time.

We remain committed to the type of M&A you've seen from this company thus far. Opportunistic tuck-ins of businesses that fit with what we're doing. We are market leaders in our markets. And so consolidation around us doesn't change that approach. It doesn't impact our leadership position. We're not going to be forced into a big acquisition. And because of consolidation around us, rather, we're going to continue to focus on transactions that fit our criteria. Businesses that fit within our model that we know well that are better inside of our company than outside of it available at reasonable valuations and with strong cash flows. And those businesses exist. There's almost an indefinite list of those businesses at a relatively small scale, and there are a couple as they get a little bit bigger, and we've got our eyes open for them.

Great. Thank you very much. That's all we have time for, and have a great day.

Thanks guys.