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

Hello, everyone, and welcome to the Crédit Suisse 34th Annual Basic Material Conference. I'm very pleased to introduce Corning Painter and Lorin Crenshaw, Wendy Wilson, respectively, CEO, CFO and Investor Relations Officer for Orion Engineered Carbons. And before we proceed with Q&A, Corning will run us through some slides that have been prepared, and then we'll exchange on the industry and on the company. Corning, the floor is yours. Corning, I think you are on mute.

There we go. Even now when you've done a year of Zoom, these things can still happen to you. So first of all, thank you very much, Pierre, for the introduction and for the little cue there and thank you for everybody who's participating in today's presentation. I'm just going to go through a couple of slides very briefly. As always, we'll be making forward-looking statements. So I encourage people to review this slide and information on our web page about important risk factors. So just hitting a few key points for Orion, starting right at the top. So we are focused on high-margin, specialized, differentiated Carbon Blacks. I'll show you that's over 3/4 of our EBITDA at this point. We are right now investing a lot of cash into our plants, both for environmental improvement controls, which are EPA-mandated for us and the whole industry, but also for growth. And as a result, there's not a lot of free cash flow this year, and our cash flow next year again will be largely reinvested. But when we hit '23 and the requirements for the EPA drop down, we'll see a big change in our free cash flow. We'll talk a little bit more about that. We're a participant in some very resilient end markets. We saw that as we worked our way through last year. We're focused on driving economic profit and return on invested assets. Those are key important things in terms of centers for management and, obviously, they align with our shareholders. We'll talk a little bit more about sustainability, but we see that as a key value opportunity for us in this industry. We are leaders in innovation, and that really goes with that focus on specialized Carbon Blacks, and we've got very strong financial standing. And again, that was proven last year. So just to give a sense for the company. If you look at these 2 doughnut charts, the light blue is Specialty Carbon Black, the darker blue is Rubber Carbon Black and some of that darker blue, as I'll show you, is really differentiated Carbon Black as well. But a key point is 25% of our volume, only about 25%, 27% of our volume is Specialty Carbon Black, but that corresponds with about 40% of our revenue and over half of our EBITDA. And while this is for 2020, and 2020 was a sort of unique year, '21 numbers aren't going to look that different from this in terms of proportion of our overall sales. So we're a very Specialty-orientated company. As we look at our global map, you could see, number one, it's a distributed company. Rubber Carbon Black does not travel very far in an economic way, so we've got production around the world. But a few key points that might not jump off this slide. Number one, in North America, we, in some ways, lag in our specialty business there. And so that little lab icon that you can see located in what should be looking like New Jersey, that is -- just get the pointer going -- that's relatively new. We opened that just before the COVID struck. And also in Asia, although we have one facility in China right now, probably about 40% of the world's tires are made in China. So we're really very underrepresented there, and we don't participate very much in the tire industry, and we don't have production in Southeast Asia. So just in terms of our weighting, that's something to understand. Now if we look at our overall Specialty business, a couple of things, I think, jump off the page. Number one, as I said earlier, the Americas remains an opportunity for us. Our business there, really, there's no good reason for that to be so much smaller than it is in EMEA. I see that as an opportunity. That's why we opened that applications lab. We increased the number of people we have who are, like, sales engineers who understand the customers' process and can help them to qualify and use our product. Another point I'd make is that if you look at the overall GP per ton, it's been relatively stable over the years. We've improved it recently, and we've made that improvement despite the fact our input costs have gone up. Our input cost is heavily linked to heavy heating oil. Obviously, those costs have gone up quite a bit in the last 12 to 18 months. And despite that, we've still been able to show that -- the profitability increasing, which has just shown we've been able to push through those prices. And if I look on to the Rubber Carbon Black from a geography point of view, again, maybe one key point is that we're a little bit underrepresented in Asia, as I talked about before. We do have an expansion project, a greenfield facility going into China. That will be largely focused on Specialty Carbon Black, but we will do some Rubber Carbon Black out of that area. You could see the profit trend here has been trending up until we hit the 2020 with COVID-19. I look forward to that improving again and significantly as we go into 2022. We'll talk more about that, no doubt. And let me now just give a little sense of how we see ourselves positioned in terms of specialty and differentiated Carbon Blacks. So perhaps the most straightforward part of the story is here on the left-hand side where we're looking at Specialty Carbon Black. And as I said, 27% of our volume, 55% of our EBITDA. You understand why we focus on it. it is many different end applications. So even within a car, we obviously have a black car, so there's the coatings, but there's also engineered plastics, think about the dashboard. There are sealants, think of around the window. There's fibers potentially, man-made fibers that could be black going into the upholstery, a wide range of Carbon Blacks that go into a car. Everything from that to, obviously, things like inks and so forth. And then at a less differentiated side of the Specialty business, making Carbon Blacks that, for example, go into black pipe applications like that. If we move to the right-hand side of the slide, you come to Rubber Carbon Black. To be clear, Rubber Carbon Black on a global basis is about 90% of what's made, right? So we're heavily overweighted into Specialty Carbon Black. Within the Rubber Carbon Black, most of it is what's called ASTM black grades. So American Society of Testing Materials (sic) [ American Society for Testing and Materials ] has defined a variety of characteristics from N100 all the way up to N990, specific sort of morphology and structures of the Carbon Black. So when you're producing one of those, you're not producing to your own specification. We try to focus much more on what we're going to call technical tire grades and MRG. Here, we're making potentially an Orion-defined specification or potentially we picked out a few of the more difficult to make, more differentiated ASTM grades and put our focus on that. Altogether, our EBITDA from the dark black box, it's about 3/4 of the EBITDA in the company focused on these more differentiated areas. So what's open to us in terms of growth? Well, one is simply capacity expansions. So we are wrapping up this year an expansion of a new line in Ravenna, Italy that'll largely be focused on Specialty. We'll also be doing a step in our multiyear, multistep debottlenecking of our Gas Black oxidized products. We'll be completing that this year. Then next year, we'll be working hard to complete the project that we announced in China that I mentioned earlier. That'll be a greenfield facility, about 65,000, 70,000, 80,000 tons of Carbon Black coming out from that. That remains a growth opportunity for us for years to come. We could work in that area. Another opportunity for us is shifting pricing towards reinvestment level. So if you look at North America, in particular, there continues to be an onshoring of tire capacity, but no new Carbon Black capacity. And that just sets up a supply-and-demand scenario that's very favorable for this industry. At the same time, the industry is pouring money into these EPA investments. Our returns got to be earned on that capital, and the table is set, I would say, to be able to achieve that, being a team that's very focused on differentiated products, obviously, getting a high return on our R&D spend. And we've done a number of works that improved our work processes and focused on accelerating key projects in that area so we can win and get qualifications with our customers. And the final thing I'd point out here is just sustainability. We see sustainability as both a threat and an opportunity for this industry. We are very active in working with recycling tires and, let's say, creating a circular economy around old tires that I think is of great interest to the tire industry, but also looking at the biological oils and other ways that we can favorably input our CO2 footprint as we move forward. So I will stop it there and turn us over for Q&A. Pierre, if you would like to kick us off on that.

Yes. Well, thank you very much. Thank you, Corning, for this interesting introduction for those on the audience that's familiar with your exciting business. Maybe if you don't mind, Corning, we could go through a few questions on the industry dynamics and the impact on Orion and then turn to a bit more specific question. I think if you could comment a bit on the current market environment, how you see supply and demand across your main line of businesses that you described to us, and to a certain extent, also how you see that affecting your pricing negotiation going into 2022.

Okay. Well, this year is playing out largely as we thought it would. We always thought that the first half conditions would be a bit stronger than the second half conditions. And I think we see that broadly playing out in the economy at this point. Perhaps at this point, the chip shortage and that impact on automotive production is a little bit larger and more prolonged than we had expected earlier on, but all in all, on track of what we've seen. I see a huge opportunity for us and for the whole industry for next year in terms of where market pricing is going to go because I think we'll continue to see in this environment strengthened manufacturing, right? We're not restaurants. We're not particularly related to restaurants other than maybe carryout dishes. And in general, I think we've seen manufacturing do very well, including the last labor statistics here in the U.S., and that's really a driver for us. We also see things like the shortage in chips and so forth that we're experiencing this year. I think that just maps over to deferred demand. In fact, all of the friction you hear about today with shipping and so forth, what it speaks to is a strong underlying demand and economy that's out there, and that's currently frustrated. I see that then as deferred demand, not destroyed demand. And what we don't perhaps have this year, we'll just see that sliding over into next year. And frankly, there's a shortage of some of these materials at the moment. We see a significant request for spot requirements so forth coming in. So you put all those together, and I think we see very positive. I think with COVID D, it's unfortunate, but the one thing I'd say is what's everyone's favorite way, mode of transportation right now, right? It remains a car and is going to remain a car for better or for worse for a while. And that's very strong demand for us and the tire replacement being so important for our business. Another thing you can think about what could affect market pricing and how that's going to work as well. Couldn't somebody import low-cost product from, I don't know, Russia or somewhere else? And it is true that Russia does make more Carbon Black than they use, but the Russian overcapacity is really balanced with Europe, right? Europe does not make enough Carbon Black for the European tire manufacturers. Those 2 together are in balance. It's been like that for a long time. To ship something across seas right now, we all know that is very difficult. It's expensive. You got to get containers. You got to get the booking on the ship. The ship's got to sail. There's a lot of blank sailings right now. And then finally, you need an end customer who's willing to live with those uncertainties. So I personally don't see the whole import story having a big impact on '22, really quite the opposite. And then on top of everything else, we've got to continue to see more and more on-sourcing -- onshoring, excuse me, of tire production. Just recently, I think Pirelli made an announcement about expanding their activities in Mexico, but there's been many others beyond that. So that is demand not so much maybe for '22, but '22 and beyond, right? It sets the overall tone. And then finally, everybody has invested a lot of money on these EPA controls, and you've got to get a return on that capital. And I think thinking about return on capital, not margin, that is a key thought process that this industry needs to turn to. The world turns on return on capital, not on margins, and we've all got to go out and get that. So you put that out there, there's pressure because of these internal costs and there's market forces that I think are just supply and demand related that are going to push pricing higher for next year. I was a little bit of an evangelist there, but you can tell, I'm always interacting with our sales teams. But I mean like that's how it is. That's just -- I think it's a really positive year for us.

No, no. It seems to be -- and look, you mentioned one of the issues, though, being supply chain disruption. And could you comment, I think, vis-a-vis your customers, their own supply chain disruption, how does it impact you? Is it delay, as you indicate, of turnovers that you can achieve? And then subsequently, maybe if you could comment on potential own supply chain disruption that you would have yourselves on your own supply side.

Yes. I think that the current supply chain issues are largely deferring demand. I really don't think it destroys end customer demand. So I don't see a mechanism for that. You don't see indications of that. Automobile sales are slow not because car lots are filling up with autos, it's because I think there aren't enough autos on the car lot. And you could say the same thing with building supplies and many other factors of the economy. So I think that remains strong for us. Our own situation is really fine. We source our raw materials locally. So getting the raw material in the front door really hasn't proven to be a particular challenge for us in this time frame, cost notwithstanding. In terms of shipping for us, well, most of our Rubber Carbon Black is shipped domestically, so truck or rail. That's been really pretty stable for us. The high-end Specialty Carbon Blacks, we manufacture these in a variety of different countries and basically every country exports so, right, who is making it. So Asia is both an importer and exporter as is North America, as is Europe. And that's an area where it's difficult. I would warn everyone that peak shipping season is coming and the holiday season is coming. And I think shipping is going to get worse before it gets better. But what that really requires of us and other people is that you plan ahead, you book ahead and you develop your relationships with the shippers and you do what it takes to get yourself on that. So I think it's manageable. It's certainly unfortunate right now. But I think, ultimately, it's just pushing demand into next year.

Maybe moving on to what is obviously a big end market for you on the auto side. Can you maybe comment on how the negative impact for your business of potential auto slowdown in terms of production is somewhat compensated by the increased demand for replacement tire? This is something that I think some people have been writing about, maybe if you could provide your own perspective on that.

Right. So yes, I think the question here is, to the extent automotive production slows down, what does that mean for us in terms of replacement tires? Replacement tires being a much larger part of the overall demand than OE production. And if you think about it yourself, right, you end up replacing your tires 2 or 3 times on a car, right, before you're through with that car. So even at a time like this where OE production may slow down a little bit, there's a number of drivers for replacement tires. Number one is just auto inspections. And in many states, they inspect your tires and you have no choice. You just got to upgrade them. So if you're stuck with your car longer than you wanted, well, you may still have to do that. Another element is damage to those tires. So if you get a flat tire, you still got to replace it. And the fact that you're driving an older car with older tires means there's a bit more of that. And then finally, I think there's just a general sense that when people are sticking with their car for a longer period of time, just all elements of maintenance go up, right? Maintenance cost goes up with time, tires being a part of that. And if we look at some of the most recent data, you can see that OE tire sales are down, right, not our sales, but our customer sales are down, but their replacement are up. And I make that comparison, I make it against 2019. So compared to 2019, replacement being up, OE being down, and I think it shows that kind of natural hedge that's in there. So what does that mean to us? So it's a little bit of a headwind on some of our Specialty areas. But at the same time, I'd say most of our Specialty distributors and customers in that area have very low inventories of some of the higher-grade Carbon Blacks that we make. The other thing that impacts us is there's less MRG, so mechanical rubber goods. This is Carbon Black that goes into some of the premium rubber in a car. So if you think about that weather seal around the frame of your door, that really sort of like a strip of very soft rubber. Your car can be 10 years old and it's still very soft pliable rubber. That's high-end material. The Carbon Black that goes into that is also very high-end. We're going to see an impact of mix with us with that greater strength in the tire side and a little bit of weakness in the MRG just because that's really heavily linked to OE production.

Maybe keeping on the theme of auto. Obviously, a lot of noise about shift from internal combustion engine to electric vehicles. How should we think about that for your business in the long term?

Yes. So we see that as a net positive, and the big thing in that is the drive for greater use of lithium-ion batteries. Lithium-ion batteries in the electrodes use conductive carbon, right? And we're a participant in that now with our Acetylene Black products. I think as that continues to grow, that segment, EVs, continues to grow, we're going to see strong demand for conductive Carbon Blacks for sure. If we just think about it from a tire perspective, though, there's, I think, a net positive that comes with this. Number one, that EVs are simply heavier, so there's more tire wear from that. And they also have higher torque. An electric car has got higher torque so there's greater acceleration. If you ever look at a Prius, it starts from a stop 100% on electricity. And only when it's up to a running speed does the engine kick in, and that's because the acceleration is just more efficient with electric motor versus internal combustion. That efficiency is part of what gives like a Tesla the thrill of driving it, but that also means higher wear. So that's really the plus side on that. MRG is a little bit harder to score. I think MRG will be a slight negative, that there's going to be less in the form of, let's say, hoses and belts in the car going forward. There are going to be some increasing uses of MRG around dampening in some areas like that. So the story isn't totally written there, but I suspect the MRG will be slightly negative. But all in all, if you put the whole picture together, we see EVs as a big positive.

Maybe moving on to more specific question around your company itself. You mentioned during your presentation the significant investment that are being made. Could you remind us when you would finish with EPA work in the U.S. and a little update on all that?

Right. So our last plant is due to come on stream in December of 2023. So currently, we're just finishing up the turnaround for installing advanced air emission controls in our Ivanhoe, Louisiana facility. Next, we'll do basically the same work, SOx, NOx for our plant in Texas. And then finally, we'll be doing one in Ohio. That will be focused just on the NOx phrase. And because of the overall timing of this, although it's due on stream at the end of 2023, we are looking at accelerating that. And I would expect our spending for 2023 to drop from, let's say, about $75 million a year to $25 million, right? So we'll see a significant drop off in that. And we'll have also at that same time largely closed out the project that -- the new plant in China. So that's part of how we get to that greater cash flow for 2023.

Understood. And in this context, how do you think about capital allocation policies today and I guess, in the context of this greater cash flow generation trend in the industry?

Well, first of all -- yes. Sorry, there's a little time delay there. So first of all, let me just say, I think capital allocation right up there with safety, it's just one of the key roles of the CEO. And it's also important that there's a number of stakeholders. So myself, Lorin, Wendy, we spend a lot of time when we're talking to shareholders to also gain their perspectives and to understand what their interests are. And I think once we hit 2023, we'll be in a position where we can strike more of a balance between investing for profitable growth, which I think everyone is very interested in, but also returning cash to shareholders. And that can be in the form of dividends, buybacks, combination. We've got options on that. But I feel strongly that ultimately, a company should get to a point where we have a structured return of cash to our shareholders. To be clear on all of this, though, when we do come back with returning some of that cash, it's not going to be on the same magnitude of what we were doing before. It'll be a smaller, let's say, dividend/buyback program than what we were doing in the past. And if we were going to look back to, let's say, 2015 through 2020, but just including with that all the EPA spend, we spent about $640 million between EPA, dividends and paying down debt after we originally carved out of Evonik. $640 million. And there's a lot more, let's say, EBITDA-generating things we can do with that cash than what we've done before. And as I said, things like connectivity are an exciting opportunity for us in -- as well as in many other areas. So I think we're going to be able to be in a position to have a balance between growth and returning cash to shareholders.

And you mentioned about, on top of this return of capital to shareholders, the growth, and you gave an example. Can you elaborate a bit more maybe on your expansion, growth projects and what we can expect from Orion going forward?

Right. So we've mentioned that we were -- had a project running on our oxidized Gas Black. This is important because it's a high-value product, but also important because we've been sold out of this on and off for years and years. And so to really give customers the confidence to continue to formulate this into the new products, we need to get out of allocation on that. We are just in the fourth quarter of this year. We're going to be doing a turnaround. That will take another step towards debottlenecking that, and we'll be continuing that for some time forward. We expect this year to also complete the project in Ravenna, and we'll be starting that up. So we'll be qualifying that in the first quarter of next year. And then about a year after that, we'll be bringing on the new plant in Huaibei. So all in all, 3 projects. We're going to see one step-up for us in '22. We're going to see another one step-up for us in '23. And that's what I mean we're -- we've hit the point where we can have a sustained driver for growth in this company as well.

On the topic of growth, I mean, you put up a page in the presentation about your 6 long-term growth drivers. And I think, one, the growth driver was on sustainability, which, if I recall, you described both as a strength but also a business opportunity. Can you elaborate a bit on this? And how do you see your opportunity? Maybe also tell us a bit about your bio-based carbon products, which I think in the past you mentioned, and so we understand a bit more what Orion is trying to do there.

Right. Thanks for that question. So we've done a lot in ESG, and we've made a number of improvements in our governance, and we've refreshed our Board and so forth. But as we look at what's most material to us, I really think it's around the questions around CO2, and this is an opportunity. But if you were to ignore it, I'd say it's ultimately a threat as well. And so that's really where we're putting a lot of focus there. So there's 2 areas that we've talked about recently and made some announcements. One is where we do biologically-based Carbon Black. So if you have a sustainably farmed and produced biological oil, obviously, your CO2 footprint looks a little bit different as you're using that material. Near term, I do not see this as a big impact on our financials. Yes, there is great interest in this material, and people qualifying it, but it is going to cost more than traditional Carbon Blacks. And I think it's initially going to be in demonstrator products, maybe one line of tires from 1 or 2 vendors, that kind of approach for someone who is really trying to test the market, see what end customers are really willing to do for a sustainable product. But meanwhile, they and we learn and get better at producing said materials. The other area where there's a lot of interest, and if you were going to look at some documents that the tire industry has put out, signed off by the CEOs of the 10 biggest tire companies, one of their key priorities is end-of-life tires. And end-of-life tires today are mainly consumed in cement kilns. They're burned for fuel value. I think everyone recognizes that at some point, the acceptance of that may change, right? And we need a better solution. So we're very involved also in actually an EU-funded project right now where we're taking end-of-life tires with our partners in this project. It is led by Michelin, running a process on them. That generates an oil coming out of the processing of these old tires, which we then use to make Carbon Blacks from it. And so in that way, creating kind of a circular system for it. Again, I don't expect huge sales of that to be a profit driver or a catalyst, let's say, in 2022 for us, but I will say there's a lot of interest in this. And I think these sort of activities set us up for long-term success as a company.

And so you mentioned this project is with Michelin. That's something you're working on with other manufacturer and in other region or for now it's mostly a Europe initiative, you would say?

Well, that one specific project, BlackCycle, has a certain defined set of partners who are a part of it, but I would say nothing in that prevents us working with reclaimed oil from tires and working with other customers, same thing with a biological. I think there's broad interest in the industry around developing sustainable solutions. And again, no one really knows where end customer demand is going to be today, but you can see trends towards CO2 taxes, greater regulation, this sort of thing. The time to make your move and be prepared for that is not when that legislation is about to get passed, right? It's now. And I think there's broad interest in that. And I would say globally, right, from tire customers around the world. And we talk more about tires because it's a more condensed industry group than others. But obviously, I think there's opportunities here in Specialty as well. And in Specialty, I'd say, the whole EV, right, it drives some of the connectivity opportunities for us that we see in Specialty, not just batteries but also, let's say, high-voltage cables, connectivity. It's great to say you're going to do all this with green energy, but you need to get said energy from an offshore wind farm, 2-year terrestrial uses of the energy.

It's a good transition maybe to the next question I wanted to ask you, which is actually on your Specialty Black business, which as you explained to us is about 1/4 of the volume but an area you want to grow. Can you briefly tell us a bit about -- I think we have only a few minutes, but tell us briefly about what you see as the opportunities in Specialty Black? Is it mostly around EV or high voltage, as mentioned?

Well, so I'd say if you're going to pick a theme, connectivity is the biggest one, Pierre, and it's lithium-ion batteries for sure and getting into the electrode pace for that. But it's connectivity in general also. I'd say high-voltage cable, static electric discharge, there's just an electrification going on of the economy right now versus, let's say, heating through other means. And that creates demand and an opportunity for us. But if we look at the rest of the segments we're in, I am keen on micro segmentation, right? You can't think about inks. If you think about inks as a whole, you'd say, inks are dead. Digital, everything, blah, blah, blah. But there are segments within inks that are really hot, food-grade ink. I don't recommend you go out there and you eat it, but there is such a thing. And so there are little specialty areas in every section where there's opportunities for growth. And just because you're good at one part of Specialty doesn't mean anything, you're going to be good for this other, right? You have to have the best product, the best material for each one of these little segmentations. Even coatings. Do you mean automotive, architectural, marine, protective, whatever. You've done automotive. Well, did you mean refinish? Think about that. All those refinish shops, that's really quite challenging how they get the color to perfectly match and then how -- what's their technology to be able to blend it versus what can be done at a larger factory, water-based, solvent-based. All these little micro segments matter. And if you pay attention to them, you can find growth opportunities. Hence, some of our expansion in that area right now.

I think we soon going to have to conclude this exchange. I thank you very much for taking the time and let you say some final words.

Well, so Pierre, once again, I'd just like to thank you for the opportunity to be here today. Who would have guessed we'd still be doing this virtually a year later. But here we are, and I appreciate your time and the time of everybody who's watching this. Thank you all very much.

Thank you.