Element Solutions Inc (ESI) Earnings Call Transcript & Summary

Great. So why don't we get started here? Thank you for coming to the Element Solutions session here. This is the Credit Suisse 35th Annual Specialties and Basics Conference, one of the longest running on Wall Street. I'm John Roberts. I lead the U.S. chemicals team here at Credit Suisse. With us is Ben Gliklich. Ben is CEO of Element Solutions. He's been at Element Solutions since 2014. He served as the Chief Operating Officer and Head of Corporate Development in the past as well. Ben came out of the original platform specialties portfolio, diversification initially and now are refocused company on electronic materials primarily there. Ben, do you want to start with any introductory remarks that you have on the. Business before we get into the Q&A?

Sure. I'd be happy to do so. For starters, it's great to be back here. It's been a couple of years since Element has been at this conference, and I'm happy to be here. So a great event. Element, as John rightly pointed out, is a more focused business than Platform Specialty Products, if you want to go back a 4-year history and is participating in really exciting secular trends whether that's vehicle electrification, next-generation, wireless and Internet infrastructure, sustainability. There's a lot of very exciting drivers for our company. We've hit some air pockets along some of those macro trends, but the business continues to grow and will grow organically in the second half. And I'm sure you'll have plenty of questions on our end markets and the specific drivers. So maybe I'll end there and turn it back to you, John.

Well, let's actually start with the end markets then. So we know we've seen a bit of a slowdown in PCs, cell phones, some of the consumer electronic areas. How does that impact your business?

Yes. So our business skews towards higher end electronics applications. That's next-generation smartphones, that is next-generation data storage, electric vehicles. We have far less of a presence in consumer electronics like televisions and laptops and peripherals, which have been under pretty significant pressure in 2022. The smartphone market is also hitting a bit of an air pocket. Units are going to be down mid-single digits year-over-year. Most of that softness is in the local sort of lower end Chinese market. Though the Apples and the Samsungs of the world are also feeling a bit of pressure year-over-year. So we're seeing some of that in our electronics portfolio, offset by the price that we've been taking actively to offset inflation, which is why we've got confidence in that organic growth that we've demonstrated in the first half of the year, and we expect to continue in the second half.

How about the electronic -- the automotive market.

So automotive is our single biggest end market, 25 or so percent of sales goes into automotive, and that runs across the gamut in our industrial products, which have functional coatings, so corrosion resistance for brake calibers, nuts and bolts and fasteners, decorative surface treatment to plate chrome and other metals on to plastic and then electronics and where we're seeing a lot of uplift in content per unit is in the electronics portfolio where we get 1.5 to 2x the value, for instance, on an electric vehicle versus a comparable internal combustion engine car. The auto market has been soft for a couple of years now. We've underproduced demand by more than 20 million units over the past 3 years, and that market can't seem to get a break for a variety of reasons, which I'm sure have been thoroughly explained in other fireside chats and other meetings folks have been to today. We expect some growth in auto units in the fourth quarter, that's baked into our guidance. Our exposure skews more towards the West. Let's say that today, that end market is roughly stable. We've seen some improvement in Asia. Things in Europe aren't great and things in the U.S. have been stable. And our outlook for Q4 is unchanged.

Great. Help us understand, we tend to talk about electronic chemicals as if they're homogeneous there. Talk about your semiconductor and packaging business as separate from the printed circuit board operations.

So 60% of our business is electronics. That falls roughly into 3 categories. The largest on a sales dollar basis is Assembly. Now it's largest on a sales dollar basis because we sell a lot of metal on a pass-through basis. That assembly business provides materials that put components on to printed circuit. At its most basic, it's [indiscernible]. But as electronics become more sophisticated, have more technical requirements, the pitch, meaning the size of the lines on the board gets smaller, you can't use legacy materials, you are using pastes, preforms, much more technically challenging materials. So that's the assembly business. Our circuitry business, which is the second largest from a sales dollar perspective, is metallizing circuit boards. So our solutions are what turn the plastic laminate into the printed circuit board, that final product, metallizing the surfaces, connecting the holes. There's a huge amount of value in that, particularly on the high end where we play as boards get more and more complex and smaller, the pitch gets smaller, the difficulties in connecting the different layers becomes more challenging. And then we do the same things that we do in the Circuitry business and the assembly business on the semiconductor side. So that's plating copper onto wafers and then putting those wafers into packaging that can then be put onto circuit point. We are the only company in our market that is capable of doing that full gamut of applications and the interfaces between these materials are of increasing importance, right? The key failure point in electronics hardware is chips falling off or circuit loss because of circuits jumping from one line to the other as the spaces become smaller. And we can speak to the compatibility of these materials in a way that no one else can, which is driving preference and technology road map exchanges and relationships up and down the value chain, which over time accrues to our benefit and will allow for us to win more than our proportionate share of the opportunities out there.

Well, how do you manage that segmented value chain then? So it's not one customer that you're selling to, but it might be one device. It ends up at the end of the assembly. So how do you sell into those individual components, knowing the finished product that's going to have all the parts.

So across all of Element Solutions, 80% of our products are either qualified or specified, meaning an OEM or a Tier 1 is defining the requirements for the products, therefore, eliminating many potential competitors. And our relationships at the OEM level, and the OEMs are not writing us checks, but our relationship with the OEM level because of the breadth of solutions we can provide and problems we can solve for them, drive preference down through their supply chains, right? So we've got deep relationships at OEMs talking about technical problems for next-generation applications, understanding the requirements of their next-generation platforms, therefore, doing -- facilitating our ability to develop with specific goals in mind. And then we've got deep relationships at the customer level, whether that's the printed circuit board fab, the semiconductor fab, the assembly shelf where we're working more closely and providing technical service to those customers, right, to support their manufacturing processes.

I've heard it simplify to me that as the feature sizes get smaller, either boards on the chips and so forth. It's just a less efficient process. So this is a good example, but it's like trying to spray paint a pinhead, the overspray is huge. And so the need for the materials goes up by a multiplier of the actual device actions because a lot of material just doesn't end up where on the finished product that's there because the feature sizes are so small, that you can't just accurately target, you have to kind of over apply it.

It's absolutely true, particularly in the semiconductor industry, where you're putting things down and then wiping them away. In the circuit board industry as well, the amount of consumables as you get more computing power is increasing very significantly. And so for instance, in next-generation smartphones the battery power required to run that greater computing power is significantly greater. The way you get more battery power isn't through battery evolution. It's the bigger batteries, which makes the boards need to get incrementally smaller. So even though we're selling onto a smaller surface area, we're getting more value because the lines are getting that much more fine and there are only so many people who are capable of doing that, we're one of them, and that translates to margin.

Okay. Let's transition a little bit to China. It's such an important market to the electronics industry. It's an important market to you. Give us just an update first of what's going on in China? They still have lockdowns going on periodically. I don't know if you have logistic issues or are things more or less normalized over there?

It's a new normal, what I would say, we buy manufacture and sell locally in all of our markets. So we've got a very substantial on-the-ground presence in China. And thanks to really superhuman efforts and sacrifices from our people in China, we have been able to provide continuity of supply to our customers who remain open despite lockdowns and so forth.

And then we've got growing political tensions over leading-edge technology in China between China and the U.S., China, Europe, maybe not an impact today, but is that something that's going to cause you to plan differently in the future?

So as over the past 4 or 5 years, we've seen periods of more intense geopolitical tensions. It's a reality in which we've been operating for a significant period of time this point. We are local in China. And we are navigating those dynamics as well as anyone. We are helped by the fact that our technology is critical for applications, and there isn't a local alternative in many instances to what we can provide or what our other Western companies can provide. And there's no emerging threat from a technology perspective that way. There is this notion of reshoring, offshoring some of the electronics supply chain from China, and we're definitely seeing that. But the reality is that there is such a large developed base of electronics manufacturing in China. It's not leaving, and we will be there, and we have been successful there and expect to continue to be successful in the future.

Okay. You talked earlier about being one of the only players that has a broad portfolio to be able to provide and circuit board packaging, semiconductor. When I think about one of your key competitors, DuPont and their strategy, they may be going even broader into antenna materials and other things. And then you have another competitor Atotech that's now been acquired in equipment as part of the breadth of the portfolio. Where are the boundaries here in terms of where you think you compete long term? Do you need to have other things beyond your current portfolio? Does equipment need to play a role somehow in your future as well?

So we're the market leaders in the very niche areas in which we participate. And the benefit of having ancillary and other materials has not proven in our competitive dynamic. So consolidation around us hasn't changed the competitive dynamics for us at all. There are very attractive electronics materials assets that are ancillary to what we do, we have taken foothold positions in some of those markets. That's not helping us sell our core chemistries. It's just solving more problems for our customers, which we see as a value opportunity for us. Atotech has had equipment sales in its history. So being a part of a larger company that has more equipment doesn't change the competitive dynamics for our businesses, which got out of the equipment business decades ago. Because we didn't see the value or to have an equipment business when third parties are happy to provide equipment to our customers in conjunction with our chemistry solutions. We can provide an equivalent solution without having the cyclicality, the capital intensity of an equipment business. And so Atotech combining with MKS doesn't change that dynamic competitively for us at all.

Okay. And since we're talking about acquisitions and portfolio, give us an update on Coventya that's there when you think you can achieve your targets from that acquisition? And what's the outlook for additional M&A?

So we acquired Coventya, which is an industrial surface treatment competitor of ours last year, and that's been a very successful acquisition for us, notwithstanding some of the end market pressure in Europe. We are on track to far exceed the synergy target that we committed to last year. And when all is said and done, the multiple we will have paid for that business will be in the mid- to high single digits. Great team. The integration is going very well. Those synergies are coming through. Some of the longer-dated synergies from some consolidation activities we have aren't even included in that base that we've committed to. So it was a great acquisition that solidified our market position, gave us great people and some really good technology. We're very happy that we were able to do that. From an incremental M&A perspective, our M&A criteria are very clear, which is to say we're buying businesses we deeply understand. They're better inside of our portfolio than outside meaning the synergies, there's incremental value that they offer to customers, good people at attractive valuations. There aren't that many scale assets that fit that criteria out there or in general. And our preference will always be to buy our own shares at comparable or even premium valuation to M&A given the risk and calories associated with M&A. And clearly, our shares represent that value today. Importantly, in any M&A discussion is a firm commitment to a leverage ceiling of 3.5x leverage today on the face of the financial statements around 3x, but we've got a swap that's in the money because our term loans are swapped to euros, which is about $200 million in the money. So it is actually lower than you'd see on the financial statements.

Do we need to talk about raw materials, supply chain issues, logistic issues, things that will affect your cost of goods outside of the metals.

So it has been a common topic of conversation. There's been significant inflation across our basket of raw materials, and we deal with that 3 ways. There's also been an issue of scarcity, which we've been able to manage as again one of the largest players in our markets, which has helped us, in terms of our ability to provide continuity to our customers. We buy metals and we pass through metal price increases directly. And that has been something that's had an optical impact on margins, right? So if you look at margin progression, you'll see a downward trend because of the price of metal has inflated. But if you back out the impact of metal we've actually seen margin accretion over the past 3 years, just by virtue of what we call operational excellence, running our businesses better, managing costs aggressively. The second bucket is surcharges. So there's some metals and some other products and things like energy surcharges and so forth, where when the price of a commodity is above a certain level, we have a surcharge, and that has been another driver of organic growth in the first half, just passing through some of those price impacts. And there's negotiated prices where our cost to serve has gone up, you can't tie it to a specific commodity. We can't take those price actions annually. We can take those price actions when our prices have increased. And we've been doing that aggressively. We are behind at the moment. As commodity prices have come down, we would expect to go after price or cost rather from our supply base in the coming several quarters. Scarcity isn't a big issue still, though in certain pockets, it has become one.

Okay. And am I right to remember this business largely produces to inventory rather than produces to ore. So you have to keep everything in stock that a customer might want next week, week after that. And does that limit the ability of working capital to either be an offset if business slows down, that you can bring working capital down or can you still bring capital down even though you produced the inventory.

Yes. So this is a business that generates more cash flow in periods of economic weakness than in periods of growth because of the working capital intensity. 20% to 25% of sales and working capital. And we have built safety stocks, and we have excess inventory on the books that's accrued over the past several quarters whether it's because we've got products stuck in ships at ports or we've had to buy what we can get our hands on to provide continuity to customers. So there is a working capital opportunity even in a growth environment, should supply chain stabilize, which they frankly haven't quite yet. And in a pocket of economic weakness, we'll release more working capital, yes. In general, we are making the stock but we have forecasts by business, by product that allow for working capital to release or collecting more. So inventory will come down, collections will improve.

Some of the growth end markets are 5G, EVs. Talk about your share in some of these applications versus your share in legacy or older applications. Are you just inherently going to gain share because of the growth in these applications that's there or -- is it more competitive because their growth applications, everyone's going after them.

You think about the growth algorithm we communicated when we launched Element Solutions in early 2019, and our underlying market growth rate was 3-ish percent, right? And if you look back at the legacy of these businesses, they were low to mid-single-digit growers. We have conviction because of the way technology trends have inflected that these businesses will grow faster from here than they did historically. And the reason for that is specifically what you just spoke to, proliferation of computing power. It's not just 5G and 5G phones or 5G infrastructure. It's what 5G capability will do to the industrial economy, right, with pervasive computing power with high reliability requirements and low latency. So the printed circuit board market in general isn't going to grow like the semiconductor market. But where we play in the printed circuit board market, will grow more like the semiconductor market than the low-end printed circuit boards that go into monitors and televisions. And that inflection is here with us, right? And there are fewer competitors, and that is where the growth is in our markets. Vehicle electrification is another great example where we have really differentiated proprietary technology around power electronics that is enabling the performance of high-end EVs. And we're getting 1.5 to 2x the value in EV versus an ICE, comparable ICE, and we're still at mid-single-digit EV penetration of the automotive fleet. We're in the early innings of that inflection. We're in the early innings of the whatever you want to call it, Industrial Revolution 3.0, that's going to see computing power with high reliability requirements in small feature sizes around the world. So we've got years of runway. Secular growth isn't linear. They're going to be -- there's going to be volatility around the trend line, and it feels like we're in an air pocket today. We have a lot of conviction that only suggests we'll snap back that trend line in the coming quarters. And with a high level of conviction in 2 to 3 years that there's going to be more electric vehicles on the road. There's going to be more 5G phones. There's going to be more Internet infrastructure to support -- and wireless infrastructure to support those 5G phones. Sustainability isn't going away as a trend in customers that want sustainable solutions to do business with Element Solutions.

So you talked about your content on a, let's say, a Tesla versus an ICE sedan being 1.5 to 2x. Is there a dollar per vehicle kind of number we should think about? And give us some examples maybe in the cell phone market or some of the other devices that you might be in.

So we're getting 15% of our value on a 5G phone versus a comparable 4G phone. From an electric vehicle standpoint, the higher-end electric vehicles are going to have pushing $100 of content versus $60, $70 for a higher-end internal combustion vehicle. And that content is growing. As you see more decorative capabilities, as you see more advanced driver assist systems or sensors and all of that comes with 1,000x the reliability requirements of the circuit boards in your smartphone, right? You leave your smartphone in a snowbank or in the sun for too long, it stops working. You park your car in a snowbank or in the sun every day. And if the features on that car don't work, it's life and death applications. So when you see reliability requirements, ratcheting up you see margin opportunities ratcheting up. And so our growth isn't just accelerating from a top line perspective, but we should see conversion of that growth at high incremental margins to profit.

And then when you talk about $100, let's say, of content in a high-end EV and $60 on a high-end ICE, does that include the chrome plating and electronics? And how would that roughly split?

It does. And so when we think about the value per vehicle, it runs across all of our end markets, we don't segment our business based on the end market, we segment is based on the application of the technology, right? So printed circuit board chemistry that goes into a car is sold through our Electronics business. And in some cases, decorative plating that goes on to a smartphone or a computer, is sold through our Industrial Solutions business. Most of the uplift from the ICE to EV conversion -- in fact, we lose a little bit of value from the Industrial Solutions business when you eliminate the motor. So most of that uplift is coming from our Electronics portfolio.

Roughly $40 per vehicle is almost all electronics uplift that's there, which will make sense as the decorative parts of the car are going to change a whole lot. Talk a little bit about the nonelectronics part of the plating business, decorative GDP business or industrial production driven business. So how do we think about the drivers of the nonelectronic side?

So we have an Industrial and Specialty segment. 70% of that is what we call Industrial Solutions, which is surface treatment for industrial applications. Auto is a big part of that, but we also have exposure into construction markets called sanitary products of faucets and things like that and then heavy equipment, machinery pipelines those types of end markets. It approximates GDP, but we should be able to do better. And the reason for that is there's more content, even decorative content in high-end electronics, in high end automotive. And there's an inflection underway around sustainability. And we have the certain capabilities and solutions that are eliminating hazardous materials from plating processes that will be enforced by reach imminently. And that will drive share towards our business in IS over the next several years. So we should outgrow our markets here as well.

Is most of the non-electronic plating decorative or protective that's there. So I think of heavy-duty machinery where it's playing a corrosion prevention role in instead of just looking shiny?

Yes. So we have both, right? So functional is corrosion protection or hardening, right? And decorative is plating chrome onto plastic or nickel onto plastic. And the split is 60-40, functional to decorative.

You still have a subsea fluids, hydraulic fluid business, you still have a printing consumables, the printing blankets business. What are the roles in the portfolio? And what's the outlook for them longer term?

So the other 30% of the INS segment is, as you pointed out, fluids used in deep offshore exploration and production and flexographic printing plates that are used in printing of flexible packaging. These are really nice, high-margin, sticky businesses, low capital intensity, strong cash flows. They're not driving revenue for the other 70-plus percent -- excuse me, 85-plus percent of the company, but they're attractive assets. We don't refer to them as noncore. We refer to them sometimes as a less core when we asked questions about that. And we like them as businesses. They have growth opportunities just like the rest of the business. And we intend to continue to run them. We're capitalists about it, which is not to say that is to say we're not entrenched. And we would be rational if someone were to want to own them more than us, but we wouldn't expect to pursue a divestment.

And then what would be the trends in those businesses over the, say, the next few quarters to the next couple of years given it's 15%. It's not completely immaterial.

The graphics business is coming off a lull because the trend towards online purchasing driven by COVID eliminated some of the new package designs that would have been introduced in a more supermarket forward on the shelf forward purchasing environment, that won't persist. And so that business has been coming off a low production. We've had very good customer wins. That business will grow nicely over the next couple of years. The offshore business operates with a lag to drilling and new umbilicals for offshore because -- or to the energy price because drilling activity lags often a quarter or 2 to a high stable energy price. This go around, it lagged even more given some regulatory and political issues, but we're starting to see drilling activity pick up, and that translates into new fills or new production coming online. So that has a tailwind as well.

Questions from the room. The question is whether the credits and incentives in the new inflation Reduction Act will impact Element Solutions?

So these are the secular trends we've been talking about, right? Increased demand for computing power in the United States supporting local champions in the semiconductor industry accrues to our benefit as a local supplier to those customers where we do have very good market positions. Sustainability and supporting infrastructure to enable next-generation vehicles is a tailwind for us because, again, we have more value on an electric vehicle than an internal combustion engine product. It's not a 1 quarter or 2 quarter sort of driver, but if anything, it gives us more conviction and confidence in that inflection in the underlying growth of our business and again, our ability to capture a disproportionate share of that as we are local because we are a leader in those markets.

Ben, you mentioned reach and environmental regulations tightening being a beneficiary in some of your reformulation. Do you have any negatives that might come out from the environmental side, you've been around a long time that there is a legacy company that's there.

So we're not formulating molecules. And so we have far less exposure than those that we're formulating and developing some of the molecules that are under environmental and regulatory scrutiny. We, on the other hand, are dedicating an intense amount of energy to developing solutions that improve our customers' environmental footprint. Our environmental footprint is modest because our manufacturing processes are formulation-driven, don't have significant discharge, what we make, we sell. Our customers have more energy-intensive and materials-intensive processes. And insofar as we can reduce the energy intensity, prove the waste treatment, we can win share in a way that differentiates ourselves, not just on the technical level, but in terms of liability for that company. So we've introduced technologies that are supporting less water and energy use in printed circuit board manufacturing, that are eliminating hazardous materials from plating processes, and that is driving a very significant reference towards our company. We talked about not wanting to be in the equipment business. The only equipment business we're in, we just entered, which is water treatment. And our competitors can't solve the waste treatment issues of our customers, the way that we can. And the waste treatment companies think about problems from a waste treatment perspective, not from a chemistry perspective. So we're sitting in this really attractive niche to solve the waste treatment issues from a chemical -- with a chemical mindset for our customers. And so we're adding value not just in terms of equipment sales, but converting the lines of our customers towards our chemistry. And in a business as sticky as ours, having that wedge to drive share is very powerful.

And I don't know if there's anything else you want to discuss, but just spend a little bit on your aspirations for that business in the water side. And are there any questions that we haven't asked during session.

We're not interested in becoming a big waste treatment company dealing with municipal waste and so forth. We're interested in becoming a company that helps solve our existing customer base's problems -- provide solutions across their whole manufacturing space. And that's been the focus, and we have a really strong traction there. We're both growing the waste treatment side of the business and winning more chemistry business because of that. So that is the goal, right? It's not to be a new vertical in waste treatment for customers that are outside of our existing universe. Any questions that haven't been asked. I think it's been a rather thorough discussion of the long-term trends, dynamics propelling the business and some of the...

Good. Good. So Ben will be around for a few minutes afterwards here. You probably have some additional meetings. Thank you all for coming, and I think we've got about 10 minutes before the next session.

Thank you so much -- Thank you, John. Thanks, everybody.