Koppers Holdings Inc. (KOP) Earnings Call Transcript & Summary

[Audio Gap] paper and packaging sectors at Bank of America and having the pleasure of hosting a fireside chat with Koppers. And we have with us this morning, Jimmi Sue Smith, CFO; and Quynh McGuire, Vice President of Investor Relations. [Operator Instructions] So Koppers reports in 3 segments: Performance Chemicals or PC, where Koppers sells wood treatment protection chemicals, e.g. wood preservatives, mainly for residential applications like decking; Railroad and Utility Products and Services or RUPS, where Koppers sells treated and untreated wood products to railroads such as crossties and also sells utility poles. And the third segment is Carbon Materials and Chemicals or CMC, where Koppers is a leader in coal tar distillation, manufacturing a number of products, including carbon pitch used to make aluminum anodes, [indiscernible] used in wood treatment and as carbon black feedstock and naphthalene, which Koppers turns into phthalic anhydride for use as a plastic plasticizer and polyester resins. [Operator Instructions]. But with that, I'll start it off.

So how should we think about Q4 '24 working capital inflow and outflow?

I think you should think about it as being an inflow, and that's really Koppers' traditional arc of cash flow is that we tend to build working capital in the first and second quarters of the year. We're a little heavier in terms of sales in the second and third quarter because of weather and the related impact on construction projects. So we tend to build the first and second quarters and then see the working capital inflow come in, in the third and the fourth quarter. Last year, we saw a really heavy third quarter inflow and fourth quarter inflow too, but smaller. I think it's going to be a little more balanced this year.

More balanced during the fourth quarter.

Yes.

And how should we think about cash tax of '24 and anything you might want to say about '25 or as a percent of -- how we want to put it, but as a percent of EBITDA, it was mid- to high single digits in 2019, '20, then 10% in '21 and '22 and then 13.5% in '23. So there's a trend here.

Well, it's significantly impacted by where we're earning our money, right? So if we -- the more we earn in the U.S., the lower the tax rate. So in '20 and '21, we really saw a lot of our earnings concentrated in the Performance Chemicals business in the U.S. as the construction sector was so hot during that time, and that drove the rate down. I think you can think about kind of that '23 rate as being more of a going rate as the earnings are more balanced between the U.S. and the foreign locations.

Got it. And then maintenance CapEx, I think you've last said, at least by my notes, kind of in the $55 million range. Is that still a good number?

It is. It's still a good number for just baseline business.

Perfect. And then 2021, 2023 CapEx range from about $105 million to $125 million. Your '24 CapEx is $80 million to $85 million and '25, you gave guidance of $65 million to $70 million. So what was driving the higher CapEx in those earlier years?

Yes, sure. So we laid out like a 5-year plan, 2021 to 2025. And that plan took us from $200 million of EBITDA to what we expect to be $300 million in 2025, that plan was an organic growth plan based off of us doing investments in capital projects. And so we really focused on those investments in '21, '22 and '23. This year, it's really the baseline maintenance CapEx and a couple of those projects tailing off. And then you'll see in 2025, we kind of have just maintenance CapEx as we sort of digest everything that we've done, reset where we are and move forward into what we will eventually be talking about next year, which will be our 2025 plan, which will take us through 2030.

And were there any -- in those earlier years when you were -- the spending was higher, were there any bigger projects that you can point out?

Sure. There was the expansion of our rail-tie treating facility down in North Little Rock. There were multiple expansions of peeling and drying capacity in our utility pole business because what we were seeing at that time was there was a tremendous demand for poles and treating capacity wasn't the bottleneck. The bottleneck was getting peeled and dried wood in. So we invested in several kilns and peelers near our operations to facilitate getting the wood in that we needed. We also did what we call [ Project Skyfall ], which is an enhanced carbon products project in our European carbon materials and chemicals business. And so those are sort of the biggest projects that we did. And now we're kind of sitting back and starting to see those projects kick in and bring the EBITDA benefits of them.

And that CMC was that in Nyborg?

Nyborg, Yes.

And what was it for again?

It's enhanced carbon products. So it's heat treating, the pitch that we make. It makes it a little more pure. And it -- so we can sell it to a couple of different applications above and beyond carbon pitch for anodes, a little bit better profit margin on those. But the -- and this is not in our projections, and we're not -- we've said this is a couple of years off, but the holy grail of that is ultimately coating for lithium batteries for EVs. What we find is that our coating. If you think about your iPhone, right, and like when you first get it, it will stay charged for like 5 days. And then as it goes on, like you get to the point where you can't keep it charged for a day. And contrary to what I really did always believe, which was that Apple did that, so I buy a new phone. Apparently, it is the actual feature of the battery that over time, it just like it can't go to 100% anymore, right? And so what our testing shows is that if you coat the battery with our material, you can maintain the ability to get closer to that 100% charge and hold it for longer. And so we believe it significantly outperforms. That's very early stages. It's like we have it out to customers, people have trialed it, but it's not -- we don't have that in our projections, but that would be the lottery ticket on that project.

Totally.

But it was a -- that project paid for itself just in one, getting more pitch out of the tar that we distill, right? So you sort of -- the traditional cut when you distill coal tar is 50% pitch, 30% creosote, the rest is like a distillate. And that by treating it through this enhanced treatment, you can move that pitch cut up and get -- so you get more higher-value product out.

Interesting. Thank you for that. So you've laid out some pretty meaningful EBITDA growth targets and have moved a long way to realizing those goals. In your 2023 Investor Day, you said Koppers' new strategy is to shift to focus on margin over volume. Could you elaborate how you have and will achieve margin expansion? Is it through pushing price? Are you willing to give up volumes to do that? Is it through some fundamental change in how you change and how you contract your business or focused on raw material procurement, plan and SG&A operating costs, probably all of the above, but what are the big pieces?

Yes. So all of the above. But I do think price is -- would probably come to sort of like the tail off of the ability to push price. And I think that's not just us, it's probably everybody. As inflation moderates, there's a lot of just fatigue from that. So I don't think that's going to be the main driver. I do think cost structure is going to be big, and that is a little bit pocketed inside of our businesses in terms of we have individual segments and geographies where the cost structures have kind of gotten out of line, and we've been very focused on those, and we've talked about that a lot. One of the -- an example of that would be North American Carbon Materials and Chemicals. As we have less coal tar to distill in North America, the cost structure of that plant is probably not where it needs to be anymore. So we have to focus on some pockets, right, like specific rail-tie treating plants. There's a couple of areas that we have to focus on from a cost reduction standpoint. And then I think the other thing is contract structure and how we do business. And Leroy has talked about this on our calls that we want to be good partners to our customers, and we want to do anything to make them happy. And so when they don't buy ties for a period of time and then all of a sudden, they show up with all these ties, sure, we'll run over time at our sorter and we'll do all this. We can't keep doing that stuff for free, right? We have to get paid for it. So I think the main focus will be on cost control as well as continuing to treat our customers well, but making sure that we're being treated fairly also.

Got it. Makes sense. So you haven't done a transformational acquisition since you acquired Osmose in 2014. You've done a number of bolt-ons, Cox in 2018, Brown Wood in 2024. What do you see as your future or are you wholly focused right now on the 2025 EBITDA target of $300 million before you do any material inorganic M&A?

Yes. So today, we are very focused on 2025, for sure, right? It's right over the line. But we also have been doing a lot of work in the background on what does the strategy look like from '25 to 2030, right? And we're going to do an Investor Day next year where we will unveil that strategy. But in terms of transformational acquisitions, nothing on the horizon, but I always say -- and that's not our focus today, right? We're focused on reaping the benefits of the capital investments that we've made over the last couple of years. But I always preface that by saying, never say never because some of that you can't time. Like you don't know when something is going to come up like is it a really good fit for your portfolio or really makes sense for you. So I never would want to say never and then shock people by doing something. Like we're not planning on doing anything. But if the right thing came along, we'd always think about it.

Makes sense. Thank you. Maybe we'll go into each of the segments a little bit, starting with Performance Chemicals. So your 2024 Performance Chemicals EBITDA guidance of up $16 million to $18 million versus 2023 looks to be driven by a combination of spread expansion from lower raw material costs, favorable timing, if that is different from lower raw material costs, lower logistics and copper hedging gains. Can you provide a sense of the copper hedging gains, EBITDA tailwind? And is this sustainable in 2025? Or is sort of like, yes, you got it, it's great, but...

Yes. So no, I don't think 25% margins or what we've seen over the last couple of quarters is sustainable. We think of that business or have historically thought of that business as being more of an 18% margin business. And then we will get these spikes where maybe we get like a 25% and then we get a 13%. And that's really driven by some of the copper hedging where the accounting timing doesn't line up with -- like the cash side doesn't line up with the recognition of the revenue. But with in general, steady state, we have thought about that as an 18% margin business. So I think that's the way to.

Okay. So we should think about maybe what you're doing in 2024, that's sort of -- a lot of that is a copper hedging and some other timing.

There's some favorable timing in that. Yes.

On the Q3 earnings call, you said that a couple of years ago, Koppers was able to renew some contracts at much higher prices, picking up market share as well. But with typical PC contract durations of 2 to 3 years, competitors were taking some of your business by offering lower prices. So 2 to 3 years in the pandemic, when there was elevated demand to add homes, I understand the ability to push price, right? So everything was happening then. But why were you also able to gain market share that's now being taken away? I mean?

Yes. So there are a couple of things that happened there. There were some favorable consolidation that happened in the industry. So customers that we supplied were sole-sourced suppliers who acquired other treaters in the space that were supplied by our competitors, and they just brought them over to us. So we were beneficiaries of that as well as we had some competitors who stumbled a little bit during the pandemic. We had our challenges as well in terms of supply chain challenges and getting raw materials in, but we were very transparent with our customers. We stayed very close to them on it, and we kind of like did allocations and we're very transparent about it. So we were able to benefit off of some other mistakes during that time. Now what we're seeing is we push price probably as hard as we could in the last contract cycle, and we're seeing our competitors being very, very aggressive. And so we're going to have to compete in that landscape. I think the other thing that has happened -- and certainly, we think about it in our business, right? Like we don't want to be sole source to anybody anymore, not after what happened during the pandemic. So I think we're seeing customers that are good customers that remain good customers, but are saying, you can't do all of it. We've got to move a piece of it on to somebody else, so we have some diversification. So I think we're seeing a little bit of that as well.

Okay. And was it Arxada or Viance or some of the smaller competitors that were -- that have been acting this way?

Most of the large...

Okay. And when should we expect this to be reflected in PC sales and EBITDA, if not already. I mean is it in there? Or is it starting -- is it going to leak in over the next 4 quarters?

I think it's going to start leaking in, in the fourth quarter, and then I think we'll really -- we'll see the impacts in 2025 because kind of the new contracts are starting at the beginning of the year.

Okay. Turning to RUPS. So your guidance -- EBITDA guidance here is up $9 million to $10 million versus 2023, but so far, Q1 was up 2% year-over-year and then Q2 and Q3 were flat year-over-year, which leaves Q4 to do a lot of heavy lifting.

Snowfall.

What is the driver of the implied strong Q4 '24 EBITDA guidance? And is Wood Brown (sic) Brown Wood doing a lot of that heavy lifting?

So we certainly -- the impact of Brown Wood is reflected in the guidance. We purchased that April 1. So as we're continuing to bring that business on and to absorb it, we're seeing the impact of that. One of the things that we've talked about all year is the utility market being soft. There was some oversupply in the chain, and we were kind of trying to figure out when that was going to reverse. We're still trying to figure out when that's necessarily going to reverse. We saw some -- we had some pretty big storms at the end of September and early October. So that certainly helped take some of the oversupply out of the market. But that reversal is one of the drivers. The other one is some of the cost structure things that we've talked about and getting things right in -- getting the cost structure right in some of our RUPS plants, and we have seen some good progress on that in terms of lowering overtime, rightsizing the workforce really looking hard at our repair and maintenance activities and focusing more on preventative maintenance and trying to bring down some of those costs. So we've seen a lot of benefit from that, too.

Got it. And when you say rightsizing, it was suggesting is that sort of like looking at number of employees you need in the business? Is that what the code word was?

Well, we do that all the time in the operating locations, right? And we have made some adjustments at various plants throughout the year.

Got it. So it looks like year-to-date volumes and prices are up and fixed cost absorption has been favorable on the heels of that. So sort of for the year-to-date, is that all being nullified or almost nullified by the higher raw material and operating costs? Is that what's going on?

So there's a little bit of that. There's also some -- we had some contractually higher prices in 2023 that we don't have in 2024, as we continue to work with some of our Class 1 customers on getting their contract structures to work for us. So that's the other piece of it. So there's a little bit of price and then there's a little bit of higher raw material and operating costs.

And you already touched on this. But on the Q2 earnings call, you told us that you did go to your customers and say, look, we can't keep doing free stuff for you, which I'm not sure [indiscernible] later. But how is that going? Is there a pushback? Or is there like wait a minute, what's going on here?

No, it's going -- it seems to be going fine, right? Like I mean that's a delicate conversation to have, but it's not an aggressive or a confrontational discussion at this point. It's just a factual discussion like we've always done everything you guys needed, and we're happy to continue to do it, but we can't do it unless we get paid for it.

Got it. Moving on to Carbon Materials and Chemicals , CMC. There, your '24 EBITDA guidance is down $9 million to $11 million versus 2023. It looks like carbon pitch prices have been down high teens year-over-year. Is that correct? And what has been driving this lower -- is it lower end market demand driving competitive pricing?

So it is just a soft industrial demand, right, is driving that. So there's just not as much demand in the market. And that business, when we talk about this a lot, the way we -- the way it's structured is that loosely the raw material prices are driven by the finished good prices, but on a lag. And so what we'll see is when we are in a booming market and business is good and volumes are up, we will see really high profits in that business, and we'll see expanding margins because sales prices are going up and raw material prices haven't quite caught up. And we had that a few years ago, we made like $100 million in this business a few years ago, and we said at that time. that's not going to continue, right? Like it will turn, and it has. And so as demand gets soft, volumes go down, prices start to come down, raw material costs are still catching up and are kind of trailing. So that always compresses the margins in this business. And that's where we've been. We're kind of like in the trough of that cycle. That has been compounded by our North American facility and the cost structure there and the fact that there's just less and less coal tar available in North America, and we need to get the cost structure right in that facility to be right with processing that amount of tar.

Okay. So it looks like -- on the back of that, it looks like coal tar prices have been down maybe 20% year-over-year. Is this offsetting the lower, CTP, coal tar pitch prices? Or is this just a lead lag thing?

Yes. It's mainly a lead lag. So we talk about this business being -- when it's on the up cycle, we'll see margins -- we see 15% margins, 15%, 16%. And when it's in the trough, we'll see margins that are like -- we like -- we would like them to always be double digits, so close to 10%. I think we were at 9% last quarter, so we're coming back to that. But we had a couple of like really abysmal ones like 3 and 5, and that's the combination of being in the trough and having the challenges in North America as well.

Okay. And how should we think about this segment in 2025 versus 2024. Presumably, you look through the lead lag. Is that how we should think about it? Or are there other pressures? Or what are the -- maybe what are the puts and takes that we should have in the back of our mind as we think about '25.

So we haven't really given guidance by segment for 2025. But I think when you think about the cycle here, we're kind of at the trough. We may start to come out of it, but we don't see that as being an upswing in 2025. I think it will be more back half where we might see some improvement there, significant improvement -- slow recovery.

Fair enough. All right. Are there any questions from the audience? All right. Well, with that, thank you very much.

Thank you. Thanks, Roger.

I appreciate your time. Thank you for coming.

Thank you.