Element Solutions Inc (ESI) Earnings Call Transcript & Summary

I'm glad to present Ben Gliklich, CEO of Element Solutions. I've known the company for quite a while. I don't cover currently, but I've always followed the company. It was a lot of interest. I think there's a very strong technology and electronics and semis component to the story. And I hope to get into it today with Ben. Thanks a lot for [indiscernible].

I guess I'd start with the same kind of setting the stage question. Like where do you fit in, in the semiconductor and broader electronics industry with your portfolio?

Great. Great place to start. Thanks for having me, Aleksey. It's great to be here. Thanks for joining today. A little bit over 60% of Element Solutions sales go into the electronics markets. And that is from PCB fabs through to electronics assembly and then up into semiconductor manufacturing. We are the only company in our peer set that can speak to that full continuum from the board manufacturing all the way up through or if you think about it through the wafer manufacturing all the way down through electronics hardware assembly. And that's a very exciting place to be right now given the convergence we're seeing between printed circuit board technology and semiconductor technology. And that technology inflection is very exciting, and it's a big driver for the business. It's accelerating growth and an area where we've had great traction.

So as a technology materials company, what are some of the most exciting things in terms of your products or overall direction of where technology is going?

Absolutely. So proliferation of computing and circuit density is driving our business forward. And there's a huge amount of innovation in and around that area. If you think about what our technology does is we provide the metallization on next-generation circuit boards. When you think about your smartphone and the amount of computing power that's gone into it, battery power is extending too. That's because the batteries are bigger, the circuit boards have to get smaller, and they have to have more reliability and more technical capability. All of that is done through innovation in circuit board metallization technology. That is our product capability. If you think about the technical requirements associated with the ruggedization of electronics hardware, right? You used to have a desktop, then you had a laptop, now you've got a mobile phone. You leave your phone in the sun for too long, it stops working. But you leave your car in the sun in a parking lot all the time, right? So the technical requirements associated with mobility and ruggedization in next-generation electronics is where our assembly products shine, right? That interface where the chip meets the board is where you can have failure. And that's an interface we can speak to better than anyone else in the industry because we finish the circuit board and we provide the material that's used to put the chip on to the board. That's very, very exciting for us. And then on the semiconductor side, as we move towards system and package design, right, as more than more -- as Moore's Law is beginning to break down and next-generation computing requirements are being met through chiplets, right? That's where semiconductors and circuit boards are converging and the whole notion of the IC substrate with multiple different chips, we can speak to the technology that's used to make the substrate and the technology that's used to put the chips on to the boards and then the technology that's used to put the die into the package. So that whole breadth of applications speaks to our capabilities and is driving growth for our business. Our ability to speak to that breadth is driving preference with OEMs, with fabs and with the broader supply chain for our business.

So if I remember some time ago, the business' growth was kind of not scaling with wafers, right, because of exposure to printed circuit boards. But from what you're saying, it sounds like that's changing. Is it fair?

So within our -- so electronics is 60% of the business. I think about our company is about $2.5 billion of sales, about $250 million of our sales go into the semiconductor industry, right? And then there's another $1 billion or so that goes into broader electronics. And so we're not going to grow like a semiconductor -- like a pure-play semiconductor materials business. But we're seeing an inflection and acceleration in the printed circuit board business where we play. We have some very differentiated technology in power electronics that's driving real growth in the electronics portfolio. And then we have an Industrial and specialty segment. That's about 40% of sales. It's growing more slowly than the electronics business, but it's still growing. Our general market growth rate, if you look at the weighted average growth rate of our markets is 4% to 5%. And we believe and have demonstrated we can grow 1 point or 2 faster than that. So call it, mid-single digits on the top line with a disproportionate amount of that growth coming from electronics.

In terms of technologies that we're all familiar with 5G, EVs, et cetera, which ones are important in driving your business and driving content [ more important. ]

So I think you knocked 2 of the 3 biggest trends on the head. 5G is a substantial growth driver, right? We have 15% more content on a 5G phone versus a 4G phone. So we're getting more content per unit. 5G as a percentage of total phones is growing still at around 50%. So that share gain or share shift is underway. And then all the infrastructure associated with enabling 5G capability is another growth vector for us that's pretty material. And we're just in the teeth of that. We're maybe in the third inning of this 5G rollout and opportunity. Electric vehicles is another big opportunity for us. We get 1.5 to 2x the value on an EV versus a legacy ICE vehicle. And so I think we all are beginning to appreciate over the past year how much more quickly the transition from ICE to EV is going to take place. So there's a high level of conviction and the acceleration from that piece of our business over the next 5, 7 years. The third big opportunity is sustainability. Sustainability is a value driver for our company and our ability through innovation to improve our customers' environmental impacts is an area of differentiation. So elimination of hazardous chemicals, less energy intensive, less waste intensive manufacturing processes, that's where we've been spending a lot of our energy and we're winning real share through that. In an industry like our share moves very quickly -- very slowly. So you are spec-ed into a manufacturing process. It is very rare to see a change. But it's -- these new nodes or new capabilities when you see these technology inflections are -- when you have opportunities to expand share rapidly. And we're at the forefront of one of those, and we're very optimistic about the share of opportunities coming in the next couple of years associated with sustainability and some of the technology inflections we've talked about earlier.

I think what caught my eye in your recent earnings call is you were talking about business wins that so far in this year you already exceeded prior full year right? Could you talk about that? Why is that happening?

Yes. It's an interesting dynamic, right? Our end markets are softer this year than they were last year, whether it's auto, whether it's smartphones. We're going through a period of weakness, more driven by the supply chain than demand. But surprisingly in that backdrop, we're winning more business than we ever have, right? So we've won more business year-to-date in 2022 than we did in all of 2019 and all of 2020. So while production activity is a little soft, customer activity is very, very high. And it's because of this technology inflection, right, because of new designs, because of elimination of certain hazardous chemistries as mandated by REACH, because the automotive OEMs are putting a huge amount of emphasis on next-generation EV platforms, there's a huge amount of activity. And we're winning a lot of business right now, which gives us a lot of conviction in the 2- to 3-year horizon for the company.

This advanced semiconductor packaging, I thought was an interesting subject you mentioned. Could you talk about your exposure there? How quickly could it scale? How they could it be for Element?

Yes. So the legacy mechanism for improving computing power and cost was through shrinking the size of transistors, right, moving from one node to a smaller node and a smaller node. And that persists. At the same time, other semiconductor companies, players have been forced to innovate through package design, right? And that's multiple chips on what's called an IC substrate, which is the highest-end printed circuit board. And that's to get more computing power in this chiplet design. And we have a great capability to meet the needs of the OSATs. We're working on that innovation because we're laying the transistors on the silicon. We're attaching the die into the package. We've got great capability in that regard. And then we can speak to the materials that put the package onto that IC substrate, the materials that metallize that IC substrate, the materials that put that IC substrate or that chiplet onto the circuit board and the materials that metallize that circuit board. We can speak to that full continuum, which no one else in our industry can. And so you go to these OSATs, the AMDs of the world, the Amkors of the world, and we do technology road map exchanges, and they didn't know us to have that breadth of capabilities because historically, these businesses didn't -- weren't together as one electronics portfolio. And now we are, and we're bringing to bear that full suite of capabilities, which is driving preference. And those technology road map exchanges aren't just with the OSATs. They're with the OEMs, they're with the circuit board fabs, they're with the semiconductor fabs. And the market is beginning to better appreciate our capabilities at that next generation, and that is where a significant amount of innovation dollars has been spent by the semiconductor industry, and we're well positioned to win there.

So you mentioned broader portfolio. Maybe a little bit of a history lesson, how did you assemble your current portfolio, where are you going next?

Yes. It's a good question. And so Aleksey knows some of the gory details of how Element Solutions was formed. If you go back 8, 9 years ago, at this point, there was a specialty chemicals roll up called Platform Specialty Products that bought about $8 billion worth of specialty chemicals businesses in diverse markets for a whole bunch of reasons. The decision was taken to separate that portfolio. And so Platform Specialty Products sold the ag assets, which was about half of the company, AgChem, and converted to this business Element Solutions with a fundamentally different strategy and approach. It's not just the assets we acquired, rebranded, we define ourselves in contrast to Platform Specialty Products. This is an operating company that's focused on operational excellence and prudent capital allocation. It's not an M&A platform. Where we have made acquisitions, it's to bring capabilities into the portfolio that our customers would be excited to buy from us in markets we deeply understand, at attractive valuations, with high-quality people. And so we've made several acquisitions over the past 3 years, but they've been more modest in size. Our focus has been on executing an organic strategy in the attractive markets in which we participate. And that's gone exceedingly well. When we launched Element Solutions, our goal was to double our EPS in 5 years. We did it in 3. And at an Investor Day we had in February of this year, we set another goal to take EPS from $1.36 to $2.50 over a 5-year period. Our internal goal is to double it once again, and we're on track to do that.

So what does it translate in terms of EBITDA growth?

So if you look at the growth algorithm I started with, which is that our markets are going to grow 4%, 5%, we'll do 1 point or 2 faster, gets you to a mid-single-digit top line. The operating leverage in this business is real. So we believe incremental margin should be 30% to 40% on EBITDA. And so you should get to 1.5x top line for organic EBITDA growth. So I think high single digits. And this business, one of the hallmarks of the business is that it's not a capital-intensive business. We don't require capital to grow or to maintain our margins. So CapEx is usually less than 2% of sales, and that's steady going back decades. And so the business generates several hundred million dollars of free cash flow every year. This year, we're on track for about $300 million. Over the next 5 years, we expect to generate $2 billion of free cash flow and deploying that in a prudent way gets us to compounding EPS in the teens, which is something we've done over the past 3 years. And there's no paradigm shift in the past 3 years rolling forward. We have a clear path to continue to execute on that.

And I guess, as investors think about valuing your equity, they also try to consider cyclicality. How do different pieces of your portfolio react to cycles?

So the second hallmark of this business is that it's got a variable operating cost structure. This is a business that is unit-driven fundamentally. And so there are going to be air pockets. Secular growth isn't linear, right? And we are in one of those air pockets right now, it seems. The cost in this business is people cost. Our manufacturing processes are very simple. 15% of COGS is fixed, 85% is variable. And so there isn't a fixed asset utilization issue when we see units decline. And most of the cost is in highly qualified technical sales, technical service and innovation. And if the business isn't growing, we're not paying variable compensation, we're not paying incentive compensation, we're traveling less, the cost just falls out of the business. And so we're able to preserve margin in periods of economic weakness. So if you look at Q2 of 2020, the top line was down roughly [ 15 ] and EBITDA was down the same amount. We're able to preserve margin when things are soft, and we're able to grow at attractive incrementals when the business performs. So there is a level of cyclicality in the top line because we're unit driven. It's cyclicality around a secular growth vector driven by all the things we've been talking about. And in those pockets of weakness, we're committed to preserving profits and generating extra free cash flow, which is what we've historically been able to do.