Element Solutions Inc (ESI) Earnings Call Transcript & Summary

Welcome back to our next session with Element Solutions. It would be my pleasure to introduce Ben Gliklich. He's been with Element Solutions for 11 years and CEO for 6 -- the last 6 years. Previously, he was in investment banking. I've been a student of corporate leadership for a long time, and Ben has engaged in quite a few activities at ESI that I have found to be very novel and innovative and also really what's driving margin expansion at the company. A lot of things going there that I really admire. So look forward to this discussion. Rock is going to lead our Q&A.

Thanks, Steve, and thank you, Ben, for being here. Really appreciate it. I would love to just go over Element Solutions' recent performance over the past few quarters and how it's been able to command a premium over kind of legacy electronics and industrial market drivers.

Absolutely. And thanks for those kind remarks, Steve, and thanks for having me. Looking forward to spending this time with you guys. Yes, our business has outperformed our end market drivers over the past several years on the way up from what was a difficult trough during which we also outperformed. When you look at 2024 as the most recent results came out last week, we grew our electronics business in the high single digits against a backdrop of, we call it, mediocre, but in reality, we're way off of peak, closer to trough. So PCB square meters were up in the mid-single digits. Smartphone units were up in the mid-single digits. MSI was roughly flat. Our semiconductor business was up in the teens against that MSI number. Our circuitry business was up in the double digits in that backdrop. How have we done that? We've done that by penetrating the fast-growing niches within the electronics ecosystem that have been vastly outperforming. And so we penetrate those markets like AI and high-performance compute and electric vehicles through targeted innovation, strong commercial risk and delivering a differentiated product outcome to those markets. And we've done a very good job against that.

Awesome. I think in a recent presentation, maybe over the summer of last year, you guys have cited semiconductor assembly as ESI's largest near-term market outperformance opportunity. I was just wondering kind of how you size the opportunities now as well as in the other segments within the company.

Sure. Yes. So what you're referring to is what we called our electronics roadshow, and we spent a bit of time in the middle of last year with investors. You guys hosted a wonderful event at our site in Piscataway, where we took the investment community through our electronics business in a bit more detail and tried to give clarity around what the drivers were, end market drivers attached to each of the slices of our business and how much we thought we could outperform and then explain why. And as you rightly recall, our semi assembly business had both the fastest unit growth 10-ish percent and the greatest opportunity for us to outperform another 10-ish percent. The drivers of that are multifold, but broadly defined into 2 categories: advanced packaging and power electronics, right? Advanced packaging is an emerging market where to get more computing power into similar sized spaces. As we've seen sizing or scaling down, breaking down, we're stacking chips in different architectures. We're packaging them in innovative ways, and our materials play a critical role in that packaging. And so that's a market that's been growing very, very strong, and that's a market where we have a differentiated value proposition. The other area is power electronics, where we have really exceptional technology for materials that are used to build power semiconductors and to put those power semiconductors into power modules. And the EV market has been one that we have been penetrating very successfully with the leading new entrants and also with many of the incumbents in the automotive space. So it's been a great growth driver for us over the past several years and one that we expect to continue. That having been said, that's not the only exciting area in our electronics portfolio, and it's certainly not the only area where we see opportunities for outperformance. In fact, in each of the niches that we outlined, we expect to be able to outgrow those markets significantly over the medium term.

Understood. Last quarter, one figure that you guys had called out during the earnings call was, I think it was 14% 5-year CAGR for sales of semiconductor subsegment. That being said, I think it was a relatively smaller business back in 2019, roughly 9% of fiscal year '19 revenue, now closer to just under 15%. Just wondering, as that business scales and grows, what a more normalized CAGR may be?

Sure. So our semiconductor business has been very strong, right? You pointed out a 14% CAGR over 5 years. Now if you look at 2019 MSI, compared to 2024 MSI, it's about 7% higher. So that's 7% growth total over 5 years, and we've been compounding at 14% per year. So you get a sense for the magnitude of outperformance. That's driven by the 2 things I just went through, semi assembly and then some of what we're doing in wafer-level packaging, which also plays into advanced packaging, wafer plating technologies where we have really good capabilities and have been growing our share. We still see a path for double-digit growth in our semiconductor business. I said in the early days of Element Solutions that we thought our semiconductor business could double and here it has. And we see a pathway for that growth to continue. Yes, laws of scale make it a little bit more challenging, but the markets in which we're participating, where we have really valuable differentiated capability are outgrowing MSI or outgrowing the semiconductor market. And so there's no reason for that level of performance -- of outperformance to slow. And at the same time, we're emerging from trough in the semiconductor industry in some areas, specifically in legacy nodes. So we should have a market tailwind for the foreseeable future as well.

Understood. I guess given some potentially a weaker ex-China EV growth in the near term, how would you see that impacting the semiconductor business, particularly for power modules?

Yes. So our power electronics portfolio had been highly concentrated if you go back a couple of years. And we've made really strong inroads over the past several years in the 2 areas where we were underpenetrated. The first was the Chinese EV market, where it was a race to market. It was let's get product out quickly, and there was less focus on technology and performance. And as that market has settled down a bit and the clear winners have been established, they're beginning to look to performance as a differentiator and they're starting to adapt our technology. And so we've had really strong share gain opportunities from technological execution and commercial execution with the local Chinese -- with the leading Chinese EV OEMs. And at the same time, we've been working very hard with the Western OEMs that have longer product development cycles to make sure they understand our capability and spec us in for the products that they're working on. Now the nature of that industry is that they're working on products that are 3, 4, 5 years out, but we've got really good visibility to gaining share in those platforms, as they come online. And so we're not reliant on EV unit growth. We can grow through share gain. And we've demonstrated that, and I expect that, that will continue.

Understood. I guess just you had mentioned earlier on the MSI and the other kind of indicator growth for 2024 and ESI's outperformance of that. I just guess looking to 2025, we see potentially some weaker -- incrementally weaker consumer growth for consumer electronics, kind of a little more moderated than it has been previously. Just wondering how this is reflected in your channels and more broadly, what your expectations are for electronics in 2025.

So our general expectations for 2025 end markets are similar to what we saw in 2024, right? So the industrial market seeing persisting weakness. The broader electronics market should see similar levels of growth, call that mid-single digits. And then the markets where we're outperforming -- that are driving our outperformance will continue to be strong, high-performance computing, advanced packaging markets and so forth. So our going-in assumption is a continuation of the trends from 2024. With regard to that observation about channels and so forth, the nature of our business is a short-cycle business, right? So the major smartphone OEMs don't know how many units they're going to sell this year. And so how would their supply chain know what volumes they're going to be supporting this year. And so our guidance is really based on third-party expectations, and that's what I just articulated. Smartphone unit growth in the low to mid-single digits, printed circuit board volume growth in the mid-single digits. MSI is expected to be mid- to high single digit, again, coming off a trough. That's what's considered in our guidance. And in the first 2 months of the year, again, short-cycle business, that's roughly what we're seeing.

Switching gears a bit. Could you walk us through the decision to sell Macdermid Graphics Solutions? And what are the steps remaining to close this transaction?

Yes. So we've always said that we're not emotional about any of our businesses. In some of our businesses, we don't call them noncore, but they're less core, which is to say that supply chains are more independent. The operations are more stand-alone, and there's no commercial overlap. And our graphics business fit that bill. We also said we would never put a, for sale, sign on any of our businesses. The way you get the best price for your house is not by putting a for sale sign on it, it's by waiting for your neighbor to have twins and need to expand. And so we were waiting for someone to be proactive around that business. We expected someone would. The graphics business was less of a market leader than our other businesses. It was also a little bit slower growing from an end market perspective, a little bit lower margin and a little bit more capital intensive. So it was naturally the one within our portfolio that we would be more willing to part with and a strategic buyer showed up and met our price expectations. And so we agreed to divest of that business. It puts us in a great position as we enter 2025 with a balance sheet -- with more balance sheet capacity than we've ever had, with a faster growing -- faster underlying growth rate for our businesses, better margins, better returns on capital. What's left between now and closing, my team laugh -- gets a little frustrated when I say is just we're waiting for the check to clear. The major hurdles have been crossed and it should be closing any day now.

Good to hear. I know you've mentioned you're not, I guess, necessarily broadcasting it for sale sign any of your remaining businesses. But just as we think through your industrials portfolio and as your market exposure shifts more towards electronics, would you say that there is opportunity for more less core businesses to be divested?

So again, we've said we're not emotional about any of our businesses. But depending on the size and cash flow characteristics of that business and difficulty of separating businesses, you get a different level of premium expectation. And so making it worth our while, the bar gets higher and higher as the scale and difficulty of separation gets higher. What we do is focus on running our business as well, right? And we are -- that's where this leadership team spends its time. Operational excellence, and then deploying the very strong cash flows that these businesses generate behind them to compound intrinsic value per share. And so we're not spending a minute thinking about separating and soliciting interest for pieces of our portfolio. Those things occur naturally as and when they do. And the way to maximize value is to run our businesses really well, and that's where we spend our time.

Sure. I guess just given the graphics business sale and the shift towards electronics, do you think that warrants a higher multiple for Element Solutions? And how long does that really take to occur?

You should ask the audience that question. What we say is that investors determine the multiple, and we work on what gets multiplied, right? And so our job is to grow earnings sustainably over the long term. And again, that's where we spend our time. Now we believe -- we'd like to believe that as we outperform our markets and compound earnings and demonstrate prudent capital allocation that, that accrues to multiple. And as the underlying growth rate accelerates and the performance accelerates, that also accrues to multiple. And so you would think with a faster-growing, higher-margin business with incremental -- incrementally more capital allocation opportunities to compound earnings that, that would speak to a higher multiple. But again, we don't spend a lot of time thinking about the multiple. We spend all of our time working on what gets multiplied.

And just as you briefly touched on capital allocation and perhaps relevant as you guys approach your ex-dividend date, just wondering if you could give a broad overview of your capital allocation strategy as well as us if we share buybacks you anticipate in 2025 and beyond.

Yes. Yes. So we've got a reasonably simple framework around capital allocation, right, which is we want to invest behind our businesses. And so we're investing in things we deeply understand. our business being one of them. The types of things we would consider acquiring are businesses that make our company better. They enhance our value proposition to our customers. They create opportunities for our people that are better inside of our company than outside of our company. So that means there's some synergies and that meet our returns criteria. And our returns criteria is very simply looking at the cash-on-cash return of an investment versus our own shares. So the baseline is the free cash flow yield of our shares, and we compare any external capital allocation opportunity to that. Pro forma for the sale of graphics, our leverage will be under 2.5x, which gives us just shy of $1 billion of capacity beneath our leverage -- our targeted leverage ceiling of 3.5x. So what should you expect from us? You should expect us to pursue attractive bolt-on M&A that fits that criteria and to buy back our shares, if that's not -- as that passes muster from a returns perspective and as sort of the fallback alternative. I think we have capacity to do both of those things this year in addition to retiring some debt. Just our net debt is low, but we still have some -- we can repay some gross debt, which is probably the prudent thing to do. But quantifying buybacks versus M&A is very much dependent on what the market serves up to us from here forward.

And just in terms of bolt-on M&A, do you see any clear either gaps or areas you can grow in terms of geographically or business lines?

Yes. So we're where we participate in the niche markets, we are in a strong position. And so there aren't any gaps in our portfolio insofar as there's nothing that we don't have that customers would like to see us have in order to buy what we currently do have. So there's nothing missing, I would say. But surely, there are things in and around our business that fit, that our customers would like for us to offer to them, where the technologies are complementary, where our technical capability, where our commercial organization could support bringing those businesses -- those applications to market. And so when we look for M&A, we look for things like that and for further consolidation opportunities. And there's not a lot of very large scale that fits that criteria, but there's a very long list of attractive tuck-ins that do fit that criteria. Actionability is also uncertain. So a lot of these businesses are in family hands. They're very high-quality businesses that generate a lot of cash. And so the ability to action any number of them in any given year is pretty variable.

Shifting gears a bit to your full year guidance for 2025. Just wondering what really drives the most variance there in terms of both electronics versus industrial as well as revenue versus margin?

Yes. So on the revenue line, the single biggest variable over the past several years has been currency. Even through significant market volatility, currency has swung around and has been a persistent headwind for 5 years. Just more recently, as an example, at the end of September, currency was a $10 million tailwind to 2025. In early January, it was a $20 million headwind. So there was a $30 million swing just in a few months from FX. That's bigger than our guidance range, right? Our guidance range is $520 million to $540 million. So FX is the single biggest variable. When you take FX out, how do you get to the high end versus what's baked into the low end? We talked about consumer electronics weakness. Expectations entering the year have been wrong in the past several years. They've been wrong to the upside. So in other words, people were overly optimistic entering the year. Notwithstanding that fact, last year, we exceeded our guidance organically by $10 million to EBITDA despite the fact that our end markets were materially worse than folks expected entering the year. But should there be a great new handset, for example, that could drive an accelerated replacement cycle and bring smartphone units towards the long-term trend, you would say, of $1.4 billion, $1.5 billion, that would be a material headwind -- excuse me, a material tailwind to earnings in 2025. The auto market has been softer in the West. Should there be something around interest rates or some recovery in the consumer that drives auto units higher, that would be a material tailwind as well. The fast-growing niches are going to grow really nicely. That's pretty well baked in. The way things go to the lower end is if we see industrial economy in the West weakening further or handsets weaken further, that's how you get there. Our SKU when you -- when we give guidance in a short-cycle business is to have a level of conservatism. And so that's been our track record.

And just on the, I guess, the raw material side of this for 2025. Obviously, you guys have kind of, I guess, 2 groups of that metals versus non-metals, metals of which get passed through. But just wondering kind of what have you seen in recent periods for both of these groups for raw material costs? And what do you expect to see?

Yes. So there's been a divergence actually in those 2 categories. Metal prices have increased a bit over the past year. And so that's had an optical impact on margins. Our ex-metal margins, however, are back towards what they were at peak on a full year basis. The non-metal raw materials have seen nice deflation over the past several years. You look at our Industrial business, for example, Industrial Solutions, which is the biggest part of the Industrial & Specialty segment, it saw organic revenue down about 2%, and it grew EBITDA in the mid-single digits. The reason for that was raw material deflation and some productivity we've driven through the business. We'll get the carryover benefit in the first half of what were sequentially declining raw material prices in 2024. And so we should see incremental margin opportunity at least in the first half. And given broader industrial dynamics and some of the capacity, that's been brought online in that supply chain in Asia, we could see incremental raw material deflation, which would be a tailwind to margin from here. Margins have also benefited from mix, where the higher end, faster-growing electronics, products and applications are also higher margin for us. And so we've got a very good story around margin trajectory from mix, from raw material deflation. And should we get a little bit of a tailwind in terms of units, particularly in the industrial business, we'll get incremental facility absorption, which will be an added benefit to margin.

Understood. Just shifting gears a bit here. ESI recently announced the launch of Shadow Plus, advanced direct metallization technology for high-density applications. I was wondering how do you envision this impacting ESI's competitive position in the electronics segment?

Going into the products. That's good research. So Shadow Plus is the latest generation direct metallization application technology we have. When you think about the legacy way of metalizing a printed circuit board, it was done through a copper electroplating process. So many process steps heavy energy intensity, you're plating copper, so there's copper in the waste stream, a lot of water discharged as well. That still has more than 80% market share of -- that is the technology used for about 80% of metallization globally. The remaining 20% is a technology called direct metallization, which replaces copper with conductive carbon. And we're the pioneers in that market with a very strong position. Conductive carbon does not require the same level of electricity, does not have the same waste stream, has much less water discharge. So it's sustainably very favorable to the incumbent technology, but it's a different technology. And so supply chains have been a little bit reluctant to try something new. Again, our solutions are about 3% of the cost of a printed circuit board, right? So this isn't an area where suppliers are digging in for value engineering. But if it doesn't work, the whole electronic assembly fails. So people are change averse in the supply chain. We've been innovating, building our moat, advancing ahead of new entrants that are trying to get into this direct metallization space, and Shadow Plus is truly a breakthrough. And so we are rolling it out. We are working not just with our customers, but with OEM -- electronics OEMs who are very sustainably oriented to say, hey, this has the same performance attributes with much less environmental applications. And by the way, Shadow Plus is an even better solution from an electronics and connectivity perspective, consider specifying it for your supply chain. And that's -- the holy grail here is not to have 100% market share in the direct metallization market. It's to move the 20% of the market that is currently direct metallization to 50%, displacing all of the incumbents in the copper electroplating space with our best-in-class technology. We've been working at that for many years, and it feels like Shadow Plus could be an inflection point. What does that mean for us? It would vastly improve our market share in the printed circuit board metallization market because we're the market leader there.

And just sticking on the technology theme here, I'm wondering if there are any other emerging technologies that may drive outsized market gains for either segment that we haven't spoken about?

The answer is -- the short answer is yes. The longer answer is that our business is not one comprised of blockbuster products. So it's not like we bring one new product to market, and it represents hundreds of millions of dollars of opportunity. Part of the beauty of the business is how fragmented, diversified, not just our businesses, but the applications and the spaces where we're playing. That having been said, we do have a few exceptions to that. So you look at Argomax and what we do in power electronics, where we have a superior technology that is delivering performance for end customers. ActiveCopper and Kuprion is the next one of those to come, where right now, we're really working on the supply chain and getting it qualified by customers, but it's going to deliver an incredibly powerful value proposition, not just to our customers, but to the OEMs and the customers' customers in the form of better thermal management and power attributes. We have a few other examples of that, not quite to that scale that we're working on, particularly in the semi assembly market. But I think Shadow Plus fits that model as well, where we're bringing something that's differentiated from a technical perspective that drives a lot of value through the supply chain to the OEM. And the way we win is we get OEMs to specify our products. And that gives our supply chains fewer alternatives, which allows for us to capture some of that value and incremental margin.

And just on Kuprion, you had stated on the last earnings call that you expect Kuprion to contribute some company revenue in 2025 and EBITDA contribution in 2026. You just mentioned now working on supply chain. Just wondering kind of more specifically what's involved there and what might speed up or delay that process?

So with Kuprion, with ActiveCopper, what we're doing is we're bringing a new material science to market. And when we bought that business, we knew that this was a product or a technology that worked, and we could make the product at a lab scale and it could be applied in a lab scale. But scaling a new materials technology into high-volume manufacturing in our sites and also in the customer sites, where they're making hundreds of thousands of units in an assembly line, right, in ongoing production, that's a challenge. And so we've been spending the -- over the past several quarters, we've said, for the next year or so, you're going to hear us talk about supply chain. And supply chain means scaling our production, not making it at the lab scale, but making it at a sort of medium-sized plant and then in a large plant and scaling our customers' application technology. So they're not making it in samples, but they're making it in high-volume manufacturing. And we're working very hard at that. We've got dedicated resources and significant investment going behind that, and we're making progress.

Awesome. How would you assess the potential impact of Trump tariffs on your business?

So If you go back to the original -- the first Trump administration when we lived through these tariffs and many of those tariffs, by the way, particularly the tariffs in Asia persisted through the Biden administration, our answer was the same as it is today, which is that we source, manufacture and sell locally. This is a remarkably local business, right? It's why we have 55 manufacturing sites all over the world close to customers. And so tariffs don't have a direct impact to our cost structure, but they may have an impact to our customers and our customers' customers, who are making printed circuit boards and sending them overseas, assembling devices and sending them overseas. And we saw some demand volatility. But ultimately, the original set of tariffs were passed on to the consumers. The tariff threat or risk has gone -- has several permutations -- new permutations where we saw for a minute a risk of tariffs with Mexico. And there is quite a bit more cross-border trade for our business with Mexico. But again, we have 55 manufacturing sites. We can move production to adjust for tariffs, and we can pass on our price increases because, again, our business represents a tiny fraction, right, of our end customers' cost and is completely integral to product performance and their production. And so where we see cost increases, as we lived through during the supply chain inflation over the past several years, we're able to pass on price. And I would expect us to do the same, should we see any impact from tariffs in our cost structure, though I expect it would be modest in any of the permutations that we've had to consider thus far and going forward.

Understood. Happy to open up to the broader audience for any questions. All right. Well, maybe a few minutes...

There's one over there. Sure. So the question was with regard to competition, what are we seeing in the market and who are our competitors? The electronic materials market is a very big market. But where we play, the small niches, we tend to be market leaders. The other thing about our business that's different than the other players in the electronics materials space is that we tend to focus on applications that are very adjacent and complementary. So basically, anywhere the electron goes in a circuit pathway is something that we speak to. So whether that's the circuit pathways on the printed circuit board, the circuit pathways on the silicon or the materials that connect the silicon, the die into the package and the package onto the circuit board. And because of that, we don't have any competitors across the breadth of what we do. We have competitors in specific niche applications. So in printed circuit board chemistry, DuPont is a competitor, a business called Atotech, which is now part of MKS Instruments is a competitor. Whereas in our assembly business, we compete with a company called Heraeus, which is a German Mittelstand company, a company called Senju, which is a Japanese company. And our semiconductor business on the wafer-level packaging side, we see BASF in that market. We see Moses Lake Industries, which is part of Tama, another Japanese concern. We see DuPont from time to time. And then in the semiconductor packaging business -- or the semi assembly business, it's a completely different set of competitors. That's what used to be called Hitachi, which is now Resonac and Henkel. Why that is important to understand is that now as we're moving into this advanced packaging ecosystem, where it used to be a consistent innovation drive towards smaller transistors, now it's package design. You had a standard approach, let's get smaller. Now you have a completely custom approach around architectures where not only the OSATs, which used to be the packaging shops, but now the foundries like TSMC and Intel are working on their own package designs. And even the hyperscalers have their own chip designs, whether that's Facebook and Amazon and Google and so forth. They have heterogeneous approaches, which means they have different pain points, which require different material solutions. So the material suppliers have a bigger seat at the table. And we're the only company in the market that isn't trying to sell a specific product but can speak at the systems level because all of the places the electron goes, we have a product to solve -- or to supply. And so that gives us a really different value proposition to these supply chains than we had before and drives mind share, market share and technology road map exchanges our way. We're only in the early innings of that.

Ben, when we toured your R&D facilities up in Connecticut a few years ago, you had this process where you were developing the ability to apply circuitry on a flexible polymer that conceivably would have some opportunity with the OEMs in the auto industry. Is that gone anywhere? Is that something that still under development?

That is what we call our films and smart surface solutions business, which is a small business within our circuitry segment today. And the idea there is if you can print electronics on the back of a display, you can remove the cabling that today is connecting a screen to circuitry that's somewhere else in the car. That cabling is metal and it's very heavy. And when weight matters to range in electric vehicles, it's got a big value proposition. We've had some really interesting breakthroughs in that market, and we are working with major OEMs to get that to a production quality perspective where it meets that industry's needs. I would say that we've made inroads, but it hasn't scaled as quickly as we thought, it could, but there's a lot of opportunity associated with it. It's just a longer gestational technology than the going-in assumption, as most technologies are. But we're continuing to work on it, and we see opportunity.

All right. Well, it looks like we're just about running out of time. So I appreciate your time, Ben. And everyone, please join me in thanking him.