Orion S.A. (OEC) Earnings Call Transcript & Summary

Good afternoon, everyone, and thank you for joining. We're pleased to host Orion Engineered Carbons today, one of the leading global producers of Carbon Black. With us today, we have CEO, Corning Painter, CFO, Lorin Crenshaw; and Head of Investor Relations, Wendy Wilson. I would like to pass it over to Corning for some introductory remarks, after which, we'll open it up to a fireside chat. As a reminder, if you have any questions you would like to ask anonymously, please feel free to e-mail me at kieran.debrun@csg.com. With that, I'll hand it over to Corning.

So first of all, I appreciate the opportunity to be here today, the chance to talk about Orion Engineered Carbons. Appreciate everyone who's listening in for this part of the investor session. For those of you who are new to this story, Orion Engineered Carbons makes Carbon Black. So the majority of Carbon Black in the world goes into rubber applications, primarily into the tire space, probably about 93% of the Carbon Black made on this planet is used in that way. And one of the things that's different about Orion is about 25% of our Carbon Black goes into the specialty market, so heavily overweighted there. And a significantly higher portion of our sales and our profitability comes from the specialty market as well. But nonetheless, we play in both spaces. It's been very interesting year in this year with the pandemic and so forth. Like many companies, we were significantly impacted during the time period where there was a lockdown and people really required to stay at home. But as we showed in our last earnings release, we saw a significant rebound as soon as people who are no longer on lockdown and we saw a driving pickup. And with that, demand, particularly for rubber Carbon Black, going into the automotive section make a really significant rebound for us. So with that brief introduction, why don't I turn that back over to you, Kieran.

Great. Thank you. I guess to kick it off, we'll continue to go on that kind of thought. Can you give us a sense of the overall order trends that you've been seeing across your Carbon Black's portfolio? Now we can delve into both specialty and Rubber Carbon Blacks, but maybe on the Specialty Carbon Black side, if you can give us a regional breakdown of how you've seen orders start to rebound, that would be really helpful.

Okay. Yes. So it was really quite dramatic when we did our Q1 report. And in that, we shared some of the volume that we were seeing in April. And at that point, we saw a very significant downturn in Rubber Carbon Black. So to say in North America, Europe, maybe 60% down in volume. And we saw at that time, let's say, overall, let's say, a mid-30s sort of range in Specialty Carbon Black. And then when we reported in our last earnings release, we included volumes from July. And you can see those online. But in that case, Rubber Carbon Black was 93% of a year ago. So really quite a significant rebound. And in the Specialty Carbon Black, we were in the 24-ish range in terms of a rebound. So what we saw first was, of course, a dive in China, in particular, as COVID-19 struck in that area. And then a more rapid recovery first in China as they came out. And then that followed by really Europe first, followed quickly by North America in terms of making a move significantly down. And the two of those making a recovery now at this point as we move through the pandemic.

And I guess, in terms of the Specialty Carbon Black's portfolio, were there any key end market areas of strength that you're seeing recover more rapidly. And specifically, I'm focusing on the polymers or the coatings demand for Specialty Blacks? And any color you have around what you've seen in 3Q and how you're thinking towards the end of the year?

Yes. So I can speak to some specific end markets that do have done particularly well in this time frame. But the thing I would leave with investors is just a sense of the overall portfolio because there's many separate markets that we supply in the Specialty area, that's part of the attractiveness of that business. And I would say, overall, tracking pretty well in terms of trend lines to things like purchasing managers index, manufacturing in measurements of industrial activities such as that. But particular areas that have done very well in this area would be things like food-grade Carbon Black. Believe it or not, there is such a thing. It's not that I recommend you go out and eat Carbon Black, but if you think about the Carbon Black that's going to go into those black dishes for carryout, which can be microwaved and so forth, so that's actually fairly special stuff. The Carbon Black, it's used in food-grade inks for food labeling. That would be an area, for example, that has done well in this time frame. So we have certain marketplaces that have done well. I'd say, in addition to that, anything related to do it yourself. So in terms of coatings, particularly coatings used for a happy homeowner sort of paints the tinting, those sort of applications, garden-based activities. That kind of activities have been quite strong for us. But if I were going to balance it out across all of them, I'd nonetheless come back to, let's say, PMI being an indicator of activity.

Great. And then I guess when we think about the Rubber Carbon Black side, you mentioned you were seeing a rebound, especially in higher demand as we went into 3Q. Any color, obviously, on the demand that you've seen in July and August, but also how you're thinking about returning to a more, let's say, normalized miles driven environment as we go into maybe 2021 versus 2019? Any thoughts on how that progresses, that would be helpful.

Sure. Well, in our Q1 earnings release, we put in one slide, trying to give some guidance on how we sought the business would be recovering. And at that point, we find -- that we felt one of the leading signs of the overall economy recovery would be the replacement tire market, both for consumers as well as trucking tires as well, and that really played out. We've seen a very strong rebound on that. Basically, as soon as people are no longer in, let's say, the shelter in place, stay at home kind of guideline, we saw miles come up. And you can track that yourselves by looking at some of the tire producers. Michelin, Goodyear, do a good job of laying out volumes. You can look at Apple Mobility, that's a very popular one right now. You can get traffic congestion measures. There's a number of indicators out there that show how that's behaving. I think it's very clear that people feel comfortable traveling in their car, and that people now prefer that to mass transit. I'm not saying that's necessarily good for the world and everything else, but I think we see a time frame in which that remains very popular. And clearly, we've seen that in the volumes that we've reported and some of those metrics that I was just citing.

Great. One of the things that I find really interesting about your portfolio is the amount of EBITDA. I think, over 75% of your EBITDA is driven by Specialty and technical products. I'd be really interested to hear more about how your portfolio has evolved towards those Specialty and technical grades over the last few years, and really how that differentiates you versus some of your other peers in the space.

Sure. Thanks for that question. So as I said earlier, the majority of the Carbon Black in this world is really made in the tire market. Now even within the tire market, there's more commoditized activities and more differentiated. And the whole strategy of Orion is trying to go where there's higher margins where we can add greater value. So in terms of Specialty, it's all those markets that we've been talking about, and it's a desire to be able to play where there's higher value-add and therefore, higher profitability for us as well as for our customers in the use of our products. And we've got a good position in that space. But in terms of growth, there's opportunities of new markets, for example, conductivity, particularly lithium-ion batteries, for example, getting Carbon Blacks into the electrodes, the cathode and the anode in that space, for example. If we think about the tire space, the ASTM, American Society for Testing and Materials, long ago, set up a number of sort of standard Carbon Black descriptions, morphology, a structure of those Carbon Blacks going from N100 to N990. And some of those are a little bit more difficult to make, a little more tricky, and we tend to aim at those spaces. But beyond that, to define our own morphology, our own structures, which are going to give that tire something special. Maybe it's higher fuel efficiency for the tire, maybe it's higher wear, things where we're bringing some differentiated advantage to the customer. And our whole business and our production slate is geared for that. Our reactors, I think, tend to be a little bit smaller than our competitors so that we can go from Specialty grade, Specialty grade, to Specialty grade versus having a really large diameter reactor where you're just winding out lot. It doesn't mean one strategy is necessarily all right or all wrong, right? There's a lot of volume in some of those standard grades. It's just for Orion's sake, we're much more aimed at, let's say, playing in the differentiated spaces.

And then I guess along those lines, it's clear that innovation has formed a big part of your strategy and portfolio. Any insights or any products that you're particularly excited about or that you see forming a bigger part of your portfolio going forward? And how that plays into the end markets that you may be trying to expand into going forward, that would be helpful.

Okay. So we're constantly working on innovating and refreshing our current portfolio. And actually a time like this, when our customers are a little bit slower, it's an excellent time to be pushing new products into the market because, frankly, customers have got more capability, more time to be able to actually go and work than qualifying them. So we have products in the coating space, in the ink space and polymers. But probably what's I think most exciting right now is thinking about connectivity. So in the end of 2018, we bought a company that made Carbon Black via settling. Usually, we use it as a feedstock, big, heavy molecules, maybe 20 to 70 carbons stuck together, and that's where we're using to be our feedstock for making the Carbon Black. In the case of a settling, it's just 2 carbons. And in fact, they're triple bonded together. So there's like very little other material coming along for the ride, if you will. So you can get a very pure material. And that's attractive in some very interesting activities, including in lithium-ion batteries. So that's a place where there's obviously a more difficult qualification process to get in. I used to work in electronic chemicals. I'm very familiar with that story. Hard to get in, but once you're in, you're qualified, and you're in the formulation. And so that's an area of a lot of activity for us, including work on that plan and upgradings and quality systems to be very consistent and a very tight range in terms of morphology, and purities that we give to customers. And for that, we're really looking at the opportunity amongst some of the things that really the electrification of vehicles. And there's different formulas out there for how far that's going to go and how fast that's going to go, but that's a significant opportunity for Orion moving forward.

Okay. I guess along those lines, there has been a lot of dislocation due to COVID-19, and I think there's also been a lot of opportunities. Are you seeing any areas where you may be able to accelerate some market share gains or position yourself to grow faster as we recover from this from the pandemic and some of the demand shutdowns that we've seen going forward?

Well, certainly, if I take you back to the customer qualification process, it's been a great time. We had launched a number of products late in the last year. So we were so ready with material to be working with customers on and work with them to get the initial qualifications going. So I think in that sense, it's been a nice positioning opportunity for us. In terms of the industry as a whole, it's not that I would say there's dramatic shifts in it. I mean, I think in the end of the day, COVID-19 isn't going to have destroyed volume or earnings potential of this company. It's perhaps opened up a few niche markets, like I mentioned before. But by and large, I think we can expect continuity coming through this, that our end markets remain intact, are going to continue to deliver the kind of growth that they have in the past and that it's -- we're not immune to the global economy, but I don't see any dramatic shifts for us in the portfolio.

I guess when we think about maybe a little bit longer-term as we think about the fourth quarter and then we think about going into 2021, obviously, volumes and margins have been impacted this year that's pretty broad-based in our space. But when we think about the key variables that are really going to help in terms of just the volume rebound and the key puts and takes in terms of margins recovering, whether that's rod of raw materials, productivity initiatives, how should we think about kind of the cadence of those initiatives or the recovery as we go into 2021? And any actions that you can take to stabilize and rebuild the portfolio as things start to improve?

Right. So I think probably the most important thing in any specialty material business is during a slow period not to chase volume that isn't there, right, and destroy value with trashing your pricing. And I'd say the -- for someone who's relatively new to this industry, it was really positive to see how we went through this cycle in terms of pricing behavior. And I think, by and large, if you looked at our last earnings release, we had an EBITDA margin of about 17% for specialty, I think, really quite respectable. We did not see, especially in the differentiated areas, a huge amount of pricing pressure, that kind of thing. And effectively, almost none in the rubber space where it tends to be under a longer-term contract. So I think that's really the main thing right there doing well with that. We'll then go into a pricing cycle for next year for the rubber space. And really, the fundamental underlying drivers are still there for that for -- in the United States, tires even before the last election, were being on sourced into the United States, that's a trend only accelerating right now. With all that new tire capacity, there's no new Carbon Black capacity. So just a supply and demand occasion, that's something that's favorable for the pricing and the fact that the pricing here has got to get to return of capital pricing in order for people to be willing to make that investment. And frankly, the investments only gotten higher tighter air quality specifications. So I think from a rubber perspective, it's really just carrying on more of the same. From a specialty point of view, obviously, we're better with the fixed cost absorption of higher volume and loading. But that's something we really look to see come from our end markets versus doing something foolish in the name of share in that space. We took a fair amount of cost out this year, and some of that, though, was in temporary measures. We, to be honest, really only expect to have $3 million or so of that carry on for us in the next year. A lot of the things we did were in short-term nature in that regard.