Elementis plc (ELM) Earnings Call Transcript & Summary

Good morning or good afternoon all, and welcome to today's Elementis 2021 Interim Results Call. My name is Adam, and I'll be the operator on this call. [Operator Instructions] I would now hand you over to James Curran to begin. So James. Please go ahead, we you're ready.

Good morning, everyone. Welcome to the Elementis 2021 Interim Results Presentation. I'm James Curran, Director of Investor Relations at Elementis. And as usual, please take note of the cautionary statements on Slide 2, and we will run through the slide and then open up to Q&A. With that, I'll hand over to Elementis' CEO, Paul Waterman.

Thanks, James. Thank you for taking the time to join us today. In terms of the agenda, I'll start with the highlights of business segment performance. Ralph will review the group financials, and then I'll take you through our outlook and priorities. Following this, we will take your questions. On Slide 5 are the key messages for this morning. Industrial demand has improved throughout the first half, and this has driven growth in our Coatings, Talc and Chromium businesses. The impact of COVID-19 will, however, linger. While vaccines are reducing serious illness, their availability is limited in many countries. And where they are fully available, it's taking a while to vaccinate young adults, thus enabling spread of variants. As a result, we expect it will take longer than 2021 to achieve the full economic recovery. The significant increase in global demand has triggered material supply chain challenges and cost inflation. Raw material shortages have occurred due to weather events and issues with suppliers. Logistics availability has reduced due to shipping container imbalances, limited port availability and, in the U.S.A., limited trucking capacity. As a result, we're experiencing cost inflation unlike any we've seen in many years. In the face of these external challenges, we continue to make significant progress implementing our innovation, growth and efficiency strategy, which will ensure that we're well positioned to take full advantage of the multiyear recovery. And last, the recovery we are now experiencing will enable a further reduction of our financial leverage by year-end. I'll start with safety on Slide 6. At Elementis, we continue to put the health and safety of our employees first. In the first 6 months of 2021, we had 5 recordable injuries, 2 lost time accidents and no reportable spills. We also reached some noticeable milestones. 20 of our sites worked safely with no reportable injury this year. Our new plant in India saw over 800,000 hours of injury-free construction. That represents over 90 years of combined worker hours, a great achievement. Going forward, we'll continue to invest in training our people and maintaining our assets to further improve safety performance. To that end, we held our first ever safety week campaign involving all Elementis' staff, focused on promoting safety and awareness to strengthen our safety culture and to support our journey to 0 injuries. Turning to our headline financial performance on the next slide. In the first half, we've seen a strong performance recovery. Our sales rose 17% on the prior year to $452 million driven by strength across industrial end markets and currency tailwinds. Volumes improved in areas such as auto, construction and home improvement, benefiting our Coatings, Talc and Chromium businesses. While this is encouraging, some areas will take longer to fully recover. Constraints on social interaction in many countries has slowed recovery of our Personal Care business and the semiconductor shortage has limited the global auto recovery. As a result, we expect demand recovery to continue beyond 2021. Operating profit rose 29% to $54 million, with revenue growth offsetting increased costs, some of which was expected. Earnings per share increased by 57%, and net debt reduced by $38 million to $415 million, broadly in line with where we finished at the end of 2020, and 8% lower than this time last year. Turning to the supply side on Slide 8. Disruptions have been ever present since the onset of COVID-19, but they've been inconsistent, impacting different suppliers at different times for different reasons. In the first half of 2021, these disruptions have become more widespread as 3 key challenges emerged. First, a surge of demand recovery in the first quarter required fast action to increase production at a number of our most important sites. In response, we hired extra workers, increased batch sizes and extended production runs. Orders have been prioritized, and we've had to be flexible. Second, we've experienced raw material shortages. The Texas deep freeze in February resulted in shortages of propylene derivatives, forcing us to airship the material from an alternative supplier in Asia. In India, due to their COVID-19 lockdown, we were able to secure a key ingredient, castor, and shifted to an alternative supplier from China. We've also experienced cost inflation across a number of raw materials and have responded by rapidly qualifying alternative suppliers and taking price increases. And third, there have been a variety of logistics challenges due to limited container availability, congestion at key ports and driver shortages. As a result, costs have increased significantly. Freight rates have risen almost fivefold. We responded by using airfreight and overlaying transportation where possible, booking shipping far in advance and implementing surcharges. The Elementis global supply chain has responded well, and the resilience is clear in our performance. However, with the path of the virus uncertain, we expect that these supply chain challenges are likely to continue for the foreseeable future. Turning to the next slide. I'm pleased to say that we've continued to implement our innovation, growth and efficiency strategy. On innovation, we launched 12 new products across Coatings and Personal Care and are on track for over 20 launches in 2021. New products now account for 13% of sales as opposed to 11% a year ago. We made progress on our open innovation partnerships with AQDOT and NXTLEVVEL with products currently being rolled out to customers. And to support future growth and innovation, we opened 2 new Personal Care labs in China and Brazil. In terms of growth, we closed $25 million of new business. This exceeded our targets and was $5 million ahead of last year driven by wins across Coatings, Talc and Personal Care. As a result, we've increased our 2021 new business ambition from $30 million to over $35 million. Our Coatings business grew 15%, with our technology growth platforms increased sales by 34% on the prior year. Industrial Talc rose 22%, supported by demand recovery and growth outside of Europe. Across the company, we continue to grow in Asia with recent infrastructure and personnel investments contributing to 15% sales growth with every segment expanded. On efficiency, we continue to make progress. The closure of Charleston with capacity consolidation in St. Louis is now complete, on time and on budget. The AP actives plant in India is on course for Q3, start-up has been planned. In Asia, we have successfully transitioned from SAP to JD Edwards. This will further simplify our global ERP system, making it more cost efficient over the long term. These actions and others that Ralph will share with you underpin our objective to deliver $10 million of cost savings in 2021, which will offset the reversal of $10 million of temporary costs savings from 2020. Now we'll take the performance of our businesses by segment. Starting with Personal Care on Slide 11. Revenue fell 5% on a constant currency basis as COVID-19-related social distancing measures continue to negatively impact category demand for color cosmetics and antiperspirant deodorants, our 2 key end markets. Adjusted operating profit declined 8% to $19 million, with lower volumes and mix, partially offset by tight cost management. Looking at Personal Care in more detail on Slide 12. Today, where our business has scaled is positioned to grow by leveraging favorable long-term trends, such as the move towards natural ingredients, skin care and increasing demand in Asia. These drivers remain valid and I'm confident the business continues to have clear long-term growth opportunities. However, in the short run, our businesses continue to be impacted by COVID-19 as more people work from home, travel less and have more limited social interactions. Retail sales of cosmetics and antiperspirant deodorants remain materially below 2019 levels. While we've started to see signs of improvement in retail demand, which is encouraging, the pace of recovery will ultimately remain linked to COVID-19 developments and consumer behavior. Turning to Slide 13. We continue to make strategic progress to ensure we are well positioned for the full reopening of our societies and demand recovery. In skin care, our aim is to deliver $10 million of incremental sales over the medium term. In the first half, we grew 13% driven in part by 2 new skin care product launches. As customers increasingly look for natural products, our skin care products continue to build momentum. Our new business pipeline is at $11 million, up from $8 million at the end of 2020. In addition, despite the severe COVID-19 outbreak, our new AP actives plant remains on track for a Q3 start-up, which is a great result. This will build on our global leadership position as we have the most advantaged and resilient global supply chain while providing better access to faster-growing Asian markets. And with the closed water system, it's a very environmentally friendly plant. Our innovation in AP actives also continues to improve. In the first half, we launched 6 new products, including our order capture technologies in partnership with AQDOT, which is receiving positive customer feedback. We've also continued to strengthen our presence in Asia. Revenues grew 15% in the first half. To support future growth, in January, we opened a new lab in Shanghai. We've continued to invest in local sales, marketing and technical expertise, doubling our head count in the region. Turning to Coatings on Slide 14. Sales increased 15% on a constant currency basis due to improved demand, particularly across industrial coatings, and $10 million of new business wins driven by our technology growth platforms. The energy business, which is now reported as part of Coatings, was flat on the prior year at around $15 million of sales as oilfield activity remains depressed. However, profitability of this business met expectations following the Charleston plant closure. Adjusted operating profit rose 48% to $33 million with increased volumes, improved price mix and fixed cost savings more than offsetting accelerating raw material inflation in the first half. Looking at Coatings top line performance in more detail on the next slide. By sector, global performance was particularly strong in industrial coatings as activities picked up in areas such as automotive, marine and protective. Decorative performance increased behind resilient demand and continued share gains for our premium technology. By region, in the Americas, demand remained robust, supported by increased construction activity and continued new business gains. In Asia, demand for our waterborne industrial additives was strong, coupled with new business wins across our defoaming and wetting agents. In Europe, decor demand was buoyant, and in industrial coatings, our castor wax-based [indiscernible] products, targeting adhesives and sealants segments, continued to gain market share. And across our global key accounts, which represent the biggest coatings companies in the world, we grew 18% with good growth in every account. To drive further growth in Coatings, we're focused on making strategic progress in 4 key areas. First, we are accelerating our innovation and improving our product quality. In the first half, we launched 3 new products and are on course to deliver over 10 new products in 2021. These new products are focused on our technology growth platforms, which grew 34% in the first half driven by $10 million of new business wins. For the full year, we expect to deliver at least $15 million of new business. We've continued to invest in Southeast Asia to increase local sales and technology resources. In the first half, we grew revenue 30%. However, we expect to make a lot more progress going forward. And finally, our global key account management program continues to strengthen our relationships with our most important customers. Our focus on driving innovation has significantly increased the number of joint development projects. Today, we have 10 projects running, more than double where we were 3 years ago. Our enhanced digital capabilities have made it easier to work together as well. And we are now a global technology partner for 3 of the largest companies in the world, up from 0, 5 years ago. In summary, our Coatings business has continued to make strategic progress through the global pandemic. As recovery continues, we are well positioned for future growth. Moving on the Talc on Slide 17. Sales rose 14% on a constant currency basis to $77 million driven by demand recovery in industrial end markets, such as automotive and coatings, $6 million of new business wins and continued geographic expansion in the Americas and Asia. Operating profit rose by $2 million with margins stable on prior year as improved volumes were partially offset by temporary weather-related production cost increases in the first quarter. For the second half, we anticipate a much improved margin performance driven by continued demand improvement, pricing actions and cost efficiency initiatives. Looking at Talc in more detail. Industrial talc sales rose 22% on a constant currency basis, with good growth across all major segments. In long-life plastics applications, where talc helps to reduce vehicle weight, sales rose 25%, driven by the rebound in global automotive production, $2 million of new business wins and continued share gains in Asia and the Americas. In Coatings, where Talc is used primarily in decorative applications, sales grew 11% driven by new business gains at our global key account customers. In other diversified applications, sales rose 32% driven by our technical ceramics, which benefited from automotive production recovery and continued share gains in Asia. As a reminder, industrial talc is over 85% of our sales and has a strong track record over the last decade, having grown on average 8% per year. Looking forward, we see further opportunities for growth. Turning to Slide 19. There are 3 areas of strategic focus. First, with over 80% of our business historically in Europe, there is significant opportunity to globalize. In the first half, we increased our market share in both Asia and the Americas, gaining $6 million of new business and growing 19% and 60%, respectively. Second, underpinning our growth ambitions are 3 platforms. In long-life plastics, our global market share is under 10%, and we're continuing to grow into global production networks, our multinational partners, while also winning business with regional players. In Coatings, we grew our account sales at our global key accounts by 11%, leveraging Elementis' strong market presence in the coatings additives market. And in technical ceramics, the development of high-grade ceramics for advanced gasoline particulate filters is an attractive opportunity, and we're in partnership with a global market leader on this, targeting a 2022 launch. Third, our delivery of $20 million to $25 million of revenue synergies by 2023 remains on track. Leveraging Elementis' global network, scale and surface chemistry innovation capabilities, we've won new customers in new geographies and are developing products such as pre-dispersed and bacteria-free talc that combine our market-leading positions in Talc and specialty chemicals. And moving to Chromium on Slide 20. Revenue rose 16% to $90 million, with strong volumes partially offset a weaker year-on-year pricing and supply chain bottlenecks. Demand from users in areas such as automotive parts, industrial machinery plating and leather tanning all rose as volumes continue to recover from the weak levels seen in 2020. Average pricing was down in the prior year. But as a reminder, the impact of COVID-19 on Chromium pricing was not felt until the second quarter last year. Chromium was also negatively impacted by supply chain bottlenecks related to the challenges that I covered earlier in the presentation. Operating margins rose from 4% to 5%, with improved volumes and cost absorption offset by lower pricing versus first half 2020. Before moving on, it's worth expanding a bit on the business dynamics. First, as I mentioned, average pricing was down in the prior year period. Our North American margins continue to be remarkably stable, where our business maintains significant competitive advantages. We're the only producer in North America and utilize a highly valued proprietary delivery system that materially reduces our customers' product handling, operational and safety risks. This has resulted in a very high and resilient market share. Second, the volume recovery, which started late last year, has continued driven by automotive, construction and metal plating applications. And there remains room for further mix and demand improvement as higher margin aerospace and refractory applications remain weak and full auto recovery is currently being held back by semiconductor shortages. This volume recovery, combined with supply chain challenges at a number of our competitors, has pushed global utilization levels up from 75% in 2020 to around 80% in the first half. As a result, current market prices have started to sequentially increase. If these improvements sustained, then this will benefit us more in 2022 as fixed term contracts roll over. With that said, I'll now hand over to Ralph to cover the financials.

Thanks, Paul. Turning to group revenue on Slide 23. Revenue rose 17% on a reported basis. Now 5% was from currency tailwinds as we benefited from relative weakness of the dollar against the euro and the renminbi. Underlying growth was 12% driven by strong demand across industrial end markets. Pricing was up modestly overall by 1%, and I would expect this to pick up in the second half as the impact of existing and planned price actions are felt. Looking at group adjusted operating profit on Slide 24, this rose by 29% on a reported basis and 21% on an underlying basis, with strong revenue growth partially offset by cost increases. As previously communicated, $10 million of temporary cost savings in 2020 are reversing in '21 as demand starts to normalize. Offsetting this is the delivery of $10 million of supply chain savings. And finally, on cost inflation, as Paul has mentioned, in addition to normal cost inflation, we're currently seeing significant impact in raw materials and logistics costs throughout our supply chain. Let's take a look at this in a bit more detail. This year, we are currently seeing mid- to high-single-digit inflation and input costs across the group. Given the inflation picked up as the first half went on, we see roughly 2/3 of this impact falling in the second half of the year. The areas such as packaging, where the price of steel has doubled since March, or propylene derivatives where production outages have impacted supply, prices have moved up. Now to manage this, we've taken several steps. Across disruptive supply chains, we rapidly qualified alternative suppliers. Given our products are specialty in nature, you can't switch raw materials at the drop of a hat. It takes time and both our sellers and our customers need to be comfortable. However, where it has been possible, we've acted with speed. We've also increased the amount of our spend under global procurement, thus ensuring we leverage our band scale across multiple sites. And finally, we responded with price increases. We made several increases in the first half and are responding with additional measures in the third quarter as the impact of inflation accelerates. Given the niche specialty nature of our product range, we're very confident of price rises being able to cover input cost changes. Equally, executing these can mean something of a lag and realization that will temporarily impact our second half margins. While we have seen some quite deep pockets of inflation, we are also aiming to deliver a further $10 million of underlying savings in 2021. This ambition is underpinned by progress in 3 areas. First, in December 2020, we announced the closure of our Charleston plant and consolidation capacity at St. Louis. As a result, we have a lower fixed cost base and are more efficient across our North American organic operations, with around $5 million of savings primarily benefiting our Coatings business in 2021. Second, in procurement, we have increased our strategic purchasing, better leveraging our scope and scale and revisited pockets of spend where it is cheaper to make than buy. This has delivered around $3 million of savings in 2021 and will be our focus going forward. And finally, our global process engineers are driving continuous improvements throughout our value chains in areas such as raw material recycling and increased automation. These steps will lower both our environmental impact and cost to serve and will deliver around $3 million of savings in 2021. Turning to CapEx. Our spend this year is $45 million to $50 million driven by 2 important projects. I've discussed the Charleston/St. Louis consolidation is an important savings driver this year and requires around $10 million of spend. Our second major project is the new India plant, again with around $10 million of spend this year. This plant will provide a highly cost-efficient production base and is an important driver of our aim to deliver an additional $10 million of supply chain savings by 2023. We also have 7 productivity projects currently in progress, representing around $5 million of CapEx and with an average payback of less than 2 years. Beyond 2021, we expect CapEx spend around $45 million per annum, with the majority of spend still focused on growth and productivity investments. Now turning to cash flow, we saw a resilient performance, and there are a few points to highlight. First, on working capital. We saw an outflow in line with our typical seasonality and strong demand recovery. Second, we had $24 million of CapEx spend, which is roughly half of our anticipated spend for the whole of '21. And finally, as previously discussed, we had a $20 million cash outflow in the first half in relation to EU state aid. But we are confident of ultimately being successful on appeal and having the cash returned, it was an additional one-off cash headwind in the first half. Despite this, our net debt of $415 million was broadly flat on the 2020 year-end position and $38 million below the prior year period, representing a leverage ratio of just under 3x, which we're on track to further reduce by the year-end. Staying on leverage, Elementis is a highly cash-generative business, and as the graph shows, we have a long track record of healthy cash conversion and cash generation. This performance, combined with improved trading 12-month volumes and a normal H1-H2 working capital phasing means we're confident of continuing to reduce leverage by the year-end. Turning to Slide 30. Our capital allocation priorities are unchanged. First, we will invest organically to grow our business. Capital expenditure will be approximately 5% of sales, and we're focused on growth and productivity opportunities. Second, debt reduction continues to be a major priority. We see a clear path to get to under 1.5x leverage, while simultaneously investing in growth. Third, on shareholder returns, we suspended dividend payments during 2020. Whilst regretful, this was clearly the right thing to do given the COVID-related demand uncertainties. We recognize the value of dividends to our shareholders and intend to reinstate payments when significant progress has been made on reducing financial leverage from its current position. I will now hand back to Paul to wrap up.

Thanks, Ralph. Starting with the outlook and priorities. We've had a good start to the year, and the business has encouraging momentum. For the second half, we expect a normal level of seasonality in the business. Underlying demand is anticipated to continue to improve, and we focus on our strategy implementation and self-help actions to optimize performance. However, inflation is clearly accelerating. And while we are very confident in our ability to protect and improve margins, there is a time lag between input costs going up and our ability to recover them. As a result, our full year guidance is unchanged, and we continue to expect an improved level of financial performance and a reduction in leverage. As you can see on this slide, there's tremendous self-help that comes with delivering on our innovation, growth and efficiency strategy, and we'll continue to be laser-focused on this. Turning to our medium-term ambitions. While there has been an encouraging demand rebound, we see a multiyear performance improvement opportunity at Elementis, and the pathway to delivery of our margin targets is very clear. First, we'll continue to pursue the $100 million of revenue opportunities that we see across our Personal Care, Coatings and Talc businesses. As we leverage our new products, [indiscernible], we'll continue to deliver over $30 million of new business annually behind our growth initiatives. Second, we'll continue to deliver improved efficiency. We are on track for $10 million in 2021 and expect another $10 million by 2023. In addition, the continuous improvement capability we've put in place will support further progress on incremental efficiency in the coming years. Third, every one of our businesses suffered due to the pandemic. While we've seen some good signs of recovery in the first half, there is more to come over the next few years. Taken together, this gives us confidence in the future. And with that said, Ralph and I will be happy to take your questions.

[Operator Instructions] Our first question today comes from Nicola Tang, Exane BNP Paribas.

Thank you for the presentation and also for the breakdown of raw materials, I found that pretty helpful. I think you mentioned it a little bit in your remarks, but could you talk about in which areas you're seeing the highest level of inflation? And sort of remind us of how much raw material account for within your cost of goods sold, and therefore, how much of a price hike you need to get through in order to offset that mid- to high-single-digit inflation? And then perhaps you could talk a little bit about within the 1% price increase that you saw in H1, could you break out how much within what you saw in specialty products versus Chromium, given I think, Ralph, you mentioned 7 price increases in H1. I was surprised that the pricing side wasn't just a bit higher.

Thanks, Nicola. I'm kind of going to take the front end of this question and then pass it to Ralph to give you the details on it. I think what we've seen, like a number of companies, is some rapidly accelerating cost inflation particularly in the second quarter, and overall, it's kind of mid- to high-single digit range. The point I want to make before handing to Ralph is, we've already actioned price increases. We're putting them in the market. Customers never like price increases, but they're accepting them well. The issue we have to contend with, I think, is a bit of a lag. It takes 60 to 90 days to get the price increases implemented. And obviously, we continue to monitor for cost changes. We don't see any decline, actually. So these are needed, we're executing them and doing it in a way that is going to -- we protect our margins, and we think, over time, enhance them. But Ralph, do you want to give Nicola some detail?

Sure. Nicola, I mean, to answer your question, roughly speaking, we have around $300 million of spend in raw materials and logistics freight. We're seeing a sort of mid- to high-single-digit increase in those costs, around about 1/3 in the first half, 2/3 in the second half, most acute really in the Coatings business where we're seeing sort of high single digits. The areas where we're seeing most increase, I would say, in packaging, something like 25%. So steel, I think, is up a couple of hundred percent since March. C2/C4 derivatives, so things like polyethylene glycol, hit by the U.S. freeze and acrylic monomer is up around 20%. And then plant vegetable oil ingredients, things like castor wax and palm oil, up 10% to 15%. On the 1% sort of price rise in the first half of the year, I mean, it was actually a mixture. You're quite right to point that out. It's a mixture of pricing decrease in chromium as first half '20 cycled onto first half '21. What we are though seeing though in chromium is, if you look at sort of second half '20 prices, it's beginning now to be on the turn, but there is a negative pricing on chromium, offset by, overall, a stronger price effect in the specialty area of the business. But I would just sort of -- perhaps just close the comment by saying, we do see these cost inflation and our pricing response overall likely to be a net positive for the business over the next period of time. So as we get the price rises through, it should benefit us overall. There will be a slight lag in the second half of the year.

Our next question comes from Sebastian Bray of Berenberg.

I would have 3, please. The first is on CapEx. There are currently 2 larger projects, which are being built this year. The Indian antiperspirants plant and the St. Louis refit. What is the -- what are the projects that are going to emerge in 2022 that will take place of these 2, if CapEx remains at $45 million to $50 million per annum? I'll pause there.

Okay. We're not used to get just 1 question from you Sebastian. In terms of -- you're right, Galaxy and [ Olympus ] were the 2 macro projects that we're executing in 2021 and, frankly, both going really well in spite of the pandemic. As we look at '22 and '23, there aren't any shortages, frankly, of projects. And I would -- but they're not sort of as big, let's say, as Galaxy or Olympus. They are projects that support growth, continued growth of our Talc and our Coatings business. So we're at a point, I think, where there are certain types of production capacity that we need to expand. We are actually looking closely also at our Personal Care business for some expansion of [indiscernible] our capacity, for example. But then the other category that is just as exciting for us, our productivity projects, and Ralph called out some that we're executing this year. But frankly, with the continuous improvement capability that we put in and the high grading that we have done of our operations, we are identifying a number of productivity projects. And these are kind of 2-year payback kind of projects that just reduce cost, debottleneck plants, obviously, at the same time, improve safety. And the sustainability of focus, I guess, the third thing I'd say. We've got 60, 65 projects, they are very sustainability-driven. And we're finding like a lot of companies that cost efficiency and sustainability are 2 sides of the same coin. And so there are things that we continue to invest in. So that's kind of the shape of how we see '22, '23.

That is helpful. My second question is on the mineral contribution to Talc revenues. My understanding is, for the annualized production of nickel is around 1,000 tonnes and Elementis receives close to half of the LME price, if I were to mark-to-market on this versus the previous year, it looks as if there's $4 million or $5 million of incremental operating profit that can come from that business on its own. Is that the right type of calculation to make? And is there anything in terms of pricing lag or contracts or levels of production that would mean that this is an oversimplification?

Yes. Ralph, do you want to take that one?

Yes. I mean depending on sort of particular volumes of sales, I wouldn't say it's quite as high as you've got there, Sebastian. I mean just as a reminder, it's only around about 2% of group earnings, is under 10% of Talc earnings. What I can say is that the uptick in the nickel price is something we are able to take advantage of this year. I think it's up to just over $19,000 a tonne at the moment. So we are capturing all the value available from that, but it's really a very minor part of the group earnings.

That's understood. And final one on Chromium. If the chart -- if we just do a line along the industry utilization chart that you have shown is correct. And it looks as if utilization could, by the end of the year, be heading back into the levels it was in 2016 when margins at the EBIT level were in the mid-20s, I assume that your own assumption internally is that margins don't go back that high. But what is the reason for this? What has changed structurally in this market that would mean a similar level of utilization does not mean a similar level of margins that you had in 2016?

I mean, look, what we're sort of seeing on Chromium is spot pricing is starting to sequentially improve. Right now, that is less a function of demand than it is some of the supply bottlenecks that the industry is dealing with. But demand is better, no doubt about it, and we expect that it will further improve in 2022. And as that occurs, the global capacity utilization will start to tighten up. Right now, we think it's about 80%. Rule of thumb, obviously, Sebastian, as you get into sort of mid- to high 80s then pricing really starts to move. We are, I think, feeling like we ought to be a little bit careful because it's a question of how fast that happens. But we do think, on a multiyear basis, that capacity utilization does tighten up in this recovery and margins do materially improve because of this pricing benefit. And the other thing I would say is, we haven't -- I don't believe, gotten anywhere near a full demand recovery in 2021. Given the impact on -- for example, on auto of the semiconductor shortage, we have some segments, refractory, aerospace, very healthy margin segments that are still very, very weak. So we see more demand improvement coming in 2022 and beyond. And that's kind of how we're thinking about it, Sebastian. Oh, I'm sorry. The other thing to -- I'd be remiss if I didn't mention 40%, 50% of our business is term contracts. So it's tied up for 6 months, 12 months. It's always been like that. And as these contracts roll over, obviously, the pricing benefits are quite positive for us.

Our next question comes from Navina Rajan of Morgan Stanley.

Just a few questions from me. Apologies if I missed it, but I don't believe that the state aid impact, do you have any idea of when you'll get that back? I know that you've appealed it, but do you have any sort of idea on when that sort of will come back? Just a few on the divisions. On Talc, can you give some color on what the temporary-related-weather costs relate to? I think in the margin, agreed year-on-year, but then sequentially, the decline was quite a lot from the H2 level. So just some color on that, given that, that volumes would have recovered quite significantly and the operational leverage from that. And then just on AP active, I think 6 new product launches sounds like quite a good amount. Maybe just some color on where those are? Are they in -- for FMCGs? Are they more indie brands? And what you sort of expect in terms of volume contribution from that? And also just adding on to that on AP actives, have you seen sort of any positive from the price hikes by your peer in India? That would be great.

Okay. Ralph, do you want to take the first two, and I'll take the AP actives one?

Yes. On the -- Navina, thanks for your questions. I mean on the EU state aid, there's a couple of avenues of appeal going on. I think the U.K. government itself is appealing. I think our best advice is that, that is likely to be heard first. And then there's also individual company appeals going on as a sort of second line of defense if necessary. I wouldn't expect either those avenues to conclude during the course of this year. So you're probably looking at '22 at the earliest on that, but we are confident in getting that $20 million back based on the expert advice we've got. On the question about Talc, I mean the operating leverage was a little bit limited in the first half of the year. I mean typically, we have some seasonality anyway. Last year, I think the operating margin split was something like 10% in the first half, 14% in the second half. We were constrained in the first part of the year by really extreme cold and very wet conditions that affected our finished production, and that limited -- that increased our costs effectively in the first half of the year. We also had some increased freight distribution costs. We are expecting a much improved performance in Talc in the second half of the year. The normal sort of second half margin improvement should come through with our growth in Talc having 14% underlying sales growth, 18% operating profit growth, we should see pretty strong performance, I think, overall in Talc in '21 versus '20. Do you want to take the AP question?

Yes. Yes. So Navina, in terms of the new product launch, I think what we're actually finding is that there's quite an opportunity for customization that creates value for customers as well as for us, Elementis. And so a variety of products that we have launched recently that provide benefits to both parties. Unilever, we converted a product to a powder version for sticks and creams. It was quite important to them. Church and Dwight was looking for a customization of a product into sort of a very super fine, it's called a microdry product. It lowers their manufacturing costs quite significantly and it's actually higher margin for us. Customizing products for -- let's see what I got here on my list. Customizing projects for Revlon as well, different performance specification that they were looking for. And I think, obviously, the big launch that we have is REACH 701L, which is really a liquid version of Reach 9000. It improves efficiency by about 50% versus traditional products and lowers manufacturing costs by 20%. So we're able to provide a pretty significant amount of innovation. I can say we're the leader. I actually think we're the only in the category. So this is actually going quite well for us. On India, in spite of COVID-19 and monsoon season, et cetera, we are on track for a third quarter start-up. This is a really important repositioning of our global supply chain. We're going to have to qualify products. That will probably take 12 to 15 months, but as we ramp up and make 70%, 80% of our products in India, that's going to make us the lowest cost producer in the world. So we're quite excited about the level of efficiency that that's going to create and, obviously, advantage. And as far as the category is concerned, we're seeing some signs of life in the last 60 days, but there's quite a ways to go until we get to the kind of consumer demand levels of 2019. You asked about [indiscernible] price hikes?

Yes.

It's a little early on that. Most of the price negotiations for the bulk of the category are in early fourth quarter. But we do see prices very increasing given the fact that the inputs have went up pretty substantially as well as some of the same logistics challenges that we see in other parts of the business are certainly impacting us in AP actives. Ultimately, that will be helpful to us.

Our next question comes from Martin Evans of HSBC.

Just on the cost savings side of the equation, Slide 26 and 33, you're saying the cost savings of $10 million are underpinned for this year. It's really the components of this -- these figures, the $10 million for this year and maybe another $10 million by 2023. Obviously, the Charleston closure and the St. Louis capacity consolidation are fairly quantifiable, but the component parts of the other cost savings, you talked about procurement, strategic purchasing, you talked about continuous improvement, global process excellence, some 50 projects in progress. And so maybe just to give us some comfort that these cost savings are relatively secure. You could help us understand what that really means in real terms, maybe 1 or 2 examples. Because companies continuously talk about global process excellence, and I don't think we really know what it means. So it will be very helpful. Because, obviously, if you strip out the Charleston $5 million savings, there's another $15 million in total over time that we need to feel fairly confident will come through to the P&L.

Yes. I'll start, and Ralph can join in. I mean, look, the 2021, I mean if you're sitting in July of 2021, and you don't know where your $10 million is, then you're in deep trouble, and when we do, frankly. The [ Olympus ] project, the Charleston/St. Louis consolidation is a big driver of that. In addition, as I said a little earlier, we are seeing very good cost savings on continuous improvement that we're validating. That's coming out. As I -- we do call out procurement, and I would just say that procurement is kind of we've always done it, which is quite good, but there's an awful lot of opportunity to continually improve. I think as we look forward to '22, '23 and then -- and the next $10 million that we're going for, in my mind, that's the minimum. We're going to be quite aggressive in this space. I think the productivity projects that I referenced in the CapEx question, we've got a number of projects that in sourcing product, let's say, where we've used third parties, changing, shifting where we are making products and expanding capacity. So the point is that there's quite a lot of cost savings in optimizing your network, and we're seeing some big, big opportunities there. The second thing I would say is on procurement. We've been high grading the capability of that organization. And really what we're in the throes of doing, I think, it's pretty significantly enhancing the tools and the globalization of how we execute procurement. We think that we can -- although we're not BASF, we still have quite a lot of leverage in terms of if all the disparate pieces of Elementis that are working together in the procurement space. We think that's going to materially accelerate what we're able to do on the procurement side. Last thing I'd say is on [ CI ]. It's very early innings. We never had this capability. We have all these sites around the world. Getting them to work together and taking that great thing that you do in 1 place and spreading it around the world immediately, [ CI ] has its early innings. We have a long way to go in terms of what we can do there. So -- and that's sort of leaving any manufacturing network optimization off the table, frankly, at this very moment. But there's quite a good runway, and we're going to be pursuing these kinds of things to get that next $10 million, and frankly, hopefully, exceed that target. Ralph, I've probably forgotten some things here, what would you add?

I think just on the process excellence point as you called that out, Martin, I mean $1 million or $2 million of savings around our -- sort of our minimal supply chain or in the specialty area goes a long way per year, and we've got a consistent continuous improvement target. So for example, we've put more temperature controls in our Talc business. We've switched in our China organic [ pay ] plant from solvent to waterborne [indiscernible] inputs. We've started to recycle [ targeting ] more in New Martinsville. We're recycling waste at the hectorite plant. And in Chromium, we've had a strong manufacturing cost efficiency program going on. So -- when you add up relatively small individual savings together, they can make quite a significant difference. And these are not one-offs. These are part of a program year-after-year improvement across our piece. And having now got a global supply chain in place and individual leaders of continuous improvement in each of those sort of value stacks, that's really, of course, it's paying off if you can take those improvements from 1 part of the business to the other. So they're absolutely laid into this business and really, really important contributor to our performance.

I think we can take one more. If there's another one.

Our final question today comes from Andrew Stott of UBS.

I had a couple of questions. So first one was on operational leverage. Given the scale of the revenue, I was slightly underwhelmed by how much is dropping through to EBIT. Let me explain. So you've got basically $12 million improvement in EBIT, $55 million improvement in sales. So it's an 18% drop through. Your gross margin is double that. And I thought the answer was raw materials, but it's not because, Ralph, you said earlier that you're down 1%, which is $4 million cost increase of $7 million, so that's only $3 million. So your drop-through is 23%. So -- sorry, lots of numbers I've thrown at you. But the simple question is, why are you only dropping through at 23% when your gross margin is 36%? I've got a follow-up question, but maybe we'll tackle that first.

Yes. I mean, I think some of the components, which are not [ meeting ] the obvious on Chromium, the pricing is down. So that's a net effect. You've clearly got the raw material inflation, which is a lag, negative lag effect impact in the first half, and it will be, we think, a negative lag effect in the second half, even though, overall, the pricing should benefit it. We've also got some normal annual inflation impacts as well. But primarily -- and the other point, Andrew, is that, in Personal Care, the relative weakness in the cosmetics level of demand, that's the highest level margin part of our business. So the relative mix effect of that is having an effect on the drop-through. And then I talked about the talc operating leverage in the first half of the year with that weather-related issue. That clearly is something which should improve in the second half of the year, and that's impacted the first half performance. I mean overall, though, we're very confident about our margins. You saw we were at 10.9% in first half last year, around 12% first half this year. We definitely see that 17% medium-term target as achievable. So we are confident of continuing to make progress on that. And I think the raw material costs and pricing response, overall, is going to be a net positive for us over the period of time. But we have seen some margin compression in the first half of the year, as I mentioned. And that really has affected the drop-through.

Okay. That's clear. So the second question was really your guidance commentary. You're talking about the seasonality effect. But I would have thought this year is not a normal year at all. You've got Personal Care, through the chart you've shown yourselves, dramatically improving through the year so far. So one assumes that Personal Care is actually seasonally biased towards the second half of this year. Chromium improving through the half as well. I'm just struggling to understand why you're calling out seasonality.

Yes, Andrew, I'll start, Ralph can chime in. I mean, I think -- yes, you're right, we have traditionally experienced seasonality first half versus second. Obviously, Coating is the biggest business for us, always has a stronger first half. So that's kind of has an influence in our thinking. And then in Personal Care, I mean, Andrew, it is not clear to me based on what I'm seeing and experiencing in this pandemic that we can bank on all coming back as fast as we might like. It changes by the week. It's changed since we started writing this presentation, frankly. Yesterday, the U.S. just put mask mandates in place. I don't have to tell you, that's not helpful for us. That, I think, influences our thinking. And on the inflation issue I talked about earlier, I mean we're in action, and we feel confident based on what we see so far that we're going to -- we'll take the short-term margin hit, but we'll get the pricing in and it will be probably a net positive longer term. But what we really don't know is that it's all going to abate in the third or fourth quarter. There's no evidence of that yet either. So we can be accused of being slightly careful, but it feels like the thing to do. Ralph, anything you want to add?

Maybe I can just follow up, sorry. So the question was a bit clumsy. Are you really trying to say that coatings is starting to slow? I suppose that was really the question.

Oh, that was the question?

It was disguised.

I mean not hugely, Andrew. We have good momentum in our Coatings business and its multiyear momentum actually. We've got growth platforms that we feel really good about. We're selling quite a lot of new business as we pointed out in the presentation. I think the -- but the highest amount of cost pressure in Elementis is in the Coatings business, and that's where we have to do the heavy lifting on price recovery. But that's a different challenge, I think, than how we see the competitiveness of the business and the growth opportunity in the intermediate term. Thanks very much, everybody, for joining us today and speak to you soon.

Ladies and gentlemen, this concludes today's call. Thank you very much for joining. You may now disconnect your lines.