Urethane Blog
Epoxy Comments from Olin Investors Call
May 4, 2021
Scott Sutton
Yes. Thanks, Steve, and hello to everyone. Look, I’m super proud of the Olin team for their passion, results and for their optimism for our future. Because of their optimism and success, I had the opportunity to pull forward our value creation formula story. First of all, Olin is on track to deliver more than $1.8 billion of adjusted EBITDA this year. One proof point to that track is that second quarter adjusted EBITDA is expected to exceed first quarter adjusted EBITDA, excluding Uri onetime impacts, even though we have significant turnarounds in the second quarter. The third quarter adjusted EBITDA should also exceed the second quarter. So it is time to start projecting toward a higher adjusted EBITDA of $2.5 billion and above in future years, the emphasis really being on the above. For clarity, 2022 is expected to be a positive stepping stone toward that direction. Some key activities to bridge that gap to $2.5 billion are shown on Slide number 4. But maybe Slide number 5 tells a more comprehensive story to that $2.5 billion and above.
Olin is quickly moving through four phases of evolution. We have already discussed the first two with you on prior earnings calls, and we are currently in Phase 2, the leading phase as we enhance our unique model of optimizing value first across the whole ECU. Think of leading as solving the ECU co-production conundrum by setting our participation to the weak side of the ECU, anticipating potential value inflection points and then activating to achieve a desired response. Shortly, we’ll be looking to take our innovative model and apply it across multiple millions of tons of similar molecules and parlay the model into a much larger business. All kinds of commercial strategies will be employed in this Phase 2 of parlaying including bartering, sophisticated trading and differentiated alliances to better serve customers. Simultaneously, Olin will be preparing for Phase 4, structuring as we look to take proceeds from our cash flow machine and invest them in a smart way to expand our beneficial footprint. Please don’t miss our internal equity price target in the lower corner of that slide.
Okay. Let me pull back to today a bit and fill in some key activities and results. Slide number 6 shows that in the first quarter, we matched our market participation to the weak side of the ECU.
In other words, we sold less caustic, which not only allowed us to hold up caustic value relative to the fourth quarter but more importantly, allowed us to significantly expand value throughout our chlorine and chlorine derivatives chain. I think the lift in the ECU PCI shown on Slide number 7 clearly shows the positive results. That value impact was also significantly expanded by the innovative actions taken by our epoxy team, as shown on Slide number 8. Olin is the world’s leader in epoxy and our wins continue to stack up as we place our offering with key customers and into key applications. Look, I would also like to highlight the updates made to our Olin ESG scorecard in the appendix slides. We are generally delivering to many of the commitments made in our sustainability report that we still have a lot of work to get fully on track here. Again, this demonstrates the team’s comprehensive passion for Olin’s broader contribution.
So before opening this call up to Q&A, let me wrap it all up into contemporary value on Slide number 9. Our team’s shared success in leading and running toward parlaying is forecasted to generate roughly $1.1 billion of levered free cash flow this year, which at the current stock price represents a yield of roughly 16%, really attractive, considering we’re just in the early stages of our push for shareholder value delivery.
Alex Yefremov
Scott, you were talking about epoxy margins moving towards 30% in the medium to long term. If margins are this high, I assume part of this equation is the price. How do you think competitors and industry in general would respond to this? What level of reinvestment economics are we in this position ad you just see more capacity amount?
Scott Sutton
I’ll turn it over to Pat here in just a moment. We probably won’t go into the competitor action there. But I would just start Pat’s comments by saying that we actually have a long way to go to get to that 30% adjusted EBITDA, but it’s totally within our scope and range. So Pat?
Pat Dawson
Alex, I would say why not 30% because I think if you look at the performance properties of epoxy and the fact that there’s really not any clear substitutes for epoxy in terms of its performance and the value that it brings to customers, it should be able to command these kind of returns. I think also, you look at our leadership position and the space that we occupy, vis-a-vis competitors that’s more of an upstream, midstream space and the way we can monetize our Epicor hydrant in the form of liquid epoxy resin, I think those leadership positions are very strong. I think also, we have a number of opportunities to parlay that you see on Slide 8. That upstream position into opportunities that, quite frankly, are already in motion, whether we have the option to toll produce, the option to make versus buy, the option to produce more if we can get the value for that. I think we have a lot of optionality there. So that’s the way we look at it. And we’re really working to accelerate those parlaying activities as we move early into the game here towards that 30%.
Alex Yefremov
And just as a follow-up, Scott, you mentioned you expect third quarter EBITDA to continue improving sequentially. We had a lot of disruptions in the US Gulf Coast, as you well know. How do you expect ECU PCI to behave in the back half? Do you think we’ll start coming down at some point in the third to fourth quarter from Q2 level?
Scott Sutton
Well, I mean, I would say our improved EBITDA performance is going to be a reflection of an improved ECU PCI as well. But what I would say, there are going to be points in our future that perhaps we exist through a quarter where we have to make some adjustments in how we’re set up as we’re running our model and that can lead to potential declines in the ECU PCI. But they’re going to be short lived because what they do is position us for the next phase of growth that we have in that ECU PCI and in our EBITDA.
Kevin McCarthy
Scott, as I listen to the commentary and having read the slides, it seems to me that when we hear about alliances tolling agreements, bartering, et cetera, that you’re going to be looking for, what I would call, capital light solutions to growth as opposed to building, let’s say, new greenfield or brownfield capacity. Is that correct or am I overreading into the signals here?
Scott Sutton
No, I mean, that’s correct. I mean, we do have a next path to growth that is capital light. And in fact, we are already engaging in those activities. You heard when Pat had answered an earlier question that we’re doing things why tolling some of our shares upstream materials into liquid epoxy resin, for example, so that we can service our customer base. And there’s just a lot of opportunities to do that across our complete portfolio. So those are the things that we can pull forward the fastest to support growth. There’s other things we can do beyond that. I don’t really see greenfield expansion as part of our future. There could be limited brownfield expansion, depending on the alliance opportunity that we might have. But yes, it’s a low capital near term growth strategy that will complement with that Phase 4 structure.
Matthew Blair
And then I was hoping you could share any more details on just other chlorine derivatives that were especially strong in the quarter other than EDC, which has some pretty pretty transparent pricing. On our sources, it looks like HCL pricing was up more than 100% quarter-over-quarter. But could you just offer any more commentary on what you’re seeing on that chlorine envelope?
Scott Sutton
Well, I mean that chlorine envelope is most of our company. So I’m going to let Damian make a comment or two on something and then, Pat, might want to add on to as epoxy comments being a key chlorine derivative for us?
Damian Gumpel
Matt, I’ll refer you to a couple of slides. I’ll refer you to Slide 17. The appendix showing our heat map and then refer you to a slide also at the back, Slide 21. And both of those, when you put those together, you see pretty widespread interest in Olin, chlorine and chlorine derivative for very broad spectrum of end uses, you see a continued momentum and request from customers for Olin’s ability to supply. I’ll go back to the Scott’s comments, or questions at the beginning, he, about are we seeing things — question around maybe market share. I will just tell you that our customer forecasts are still for volume throughout the rest of the year that are higher than our forecasted ability to supply them. So that should give you an indication as to the robustness of the chlorine side, which of course, as going to my earlier comments, is still relatively stronger than the caustic side. So we’ll continue to manage the ECU around that. But across [CCO], ACL, bleach versus chlorine, it’s all those three legs in the heat map. And I’ll pass it over to you, Pat.
Pat Dawson
Matthew, I’d say from a epoxy standpoint, we do sell some of our upstream products into wastewater treatment and municipalities for water treatment. We’ve seen that really continue to improve on demand. And some from an epoxy and resin standpoint, you look at civil engineering, construction, automotive, even though there’s been semi chip shortage, we’ve seen improvement coming back there. Appliances, electronics, we’re starting to see maybe a little bit of life again, and oil and gas, which uses fusion bonded epoxy for pipelines and everything like that, machinery is coated with epoxy. So I think it’s back to what Scott said, we’ve seen good month over month improvement. But we think we’re still very much in the early innings of this demand recovery. We think there’s more coming based on some of these end use markets I just mentioned.
Eric Petrie
And then maybe a question for Pat. How much epoxy goes into higher value versus the low margin end markets, where do you want to get that down to? And then is there a difference in profitability between regions currently?
Pat Dawson
I think, if you look on Slide 8, we talk about where we’re increasing our supply and the high margin performance coatings, I mentioned civil engineering earlier, formulated type systems. And certainly that value over volume orientation that we have is putting more into those types of areas and applications. And there’s places where you have low margins in industrial coatings, wind energy, it’s been an area that’s been growing but we’ve pulled back from some of the low end of that business. And then some of our upstream base stocks, we’re definitely doing less business here because the value is not there. I think geographically speaking, one of our leadership advantages that we have is we have a lot of flexibility as to how we flex product between the regions. And that’s a pretty dynamic process that we use all the time around our activation. So I wouldn’t say anyone geographies, I don’t pay attention to that so much strategically as I do where the opportunities come up to create more value to juice up our return to the ECU.
Steve Byrne
With respect to this 30% EBITDA target in epoxy and the shifts more downstream and less of the upstream commodity sales. Do you have the commercial relationships in those downstream resins and/or the production capacity to move more of the feedstock material into those downstream products or will this require some acquisitions?
Pat Dawson
First of all, let me just course correct you here a little bit. Really, our sweet spot is in the up and the midstream part of the epoxy value chain. We don’t go nearly as far down in that chain as to say the questions that you were asking. We certainly have all the right channels to market in place today to monetize and to really exert our leadership in up and midstream. So I would just say just a little correction in how we view that chain and where our strengths are.
Steve Byrne
So you can get to 30% EBITDA margins by selling epi and cumene and BPA and so forth and not move downstream?
Pat Dawson
No, Steve, that’s — again, part of the equation is the strength and you have upstream, but that midstream, we have many channels as to how we monetize the epichlorohydrin and the bisphenol A. So that’s where we have a lot of channels, a lot of optionality, a lot of optionality to parlay. So that’s pretty broad reaching as you move down into that midstream.
Steve Byrne
And then just curious about the margin on epi. If you look about your broad platform of chlorine containing derivatives, where would you put epi in the ranking of all of those chlorine containing products? I mean if you look at the margin difference between your two segments, I’m just curious where that epi would fall in the ranking.
Pat Dawson
I don’t think we’re going to get into the rankings of epi versus derivatives of where we put that epi. Epi, make no mistake, is a strategic pillar to our upstream and it’s a strategic pillar as to how we parlay down through the midstream into those various end use markets where we’re prioritizing our value over volume. And I think the other thing to keep in mind, Steve, is when we had our investors presentation back in February 19th, one of the headlines on my slides read that epi and LER supply demand projected to be tight by 2021. And so we’re just entering this phase of what we’ve been saying for the last two years of what we saw coming in this sweet spot of ours around this up in the midstream and parlaying these things that we talked about on Slide 8. So I think those kind of fundamentals bode well for our ability to get to this 30% EBITDA in epoxy.
Angel Castillo
And then on the epoxy margins, you noted that you expect them to improve sequentially in the second quarter. I was just curious, does that contemplate, I guess, the meaningful pickup in benzene prices? And/or as you think about where raw materials are moving, how should we think about that within your guidance?
Todd Slater
We feel very confident in the fact that we’ve had good pricing momentum. We’ve seen that pricing momentum continue here in April. There’s publicly announced increases out there for May that are also getting good traction. So we feel very good about the sequential improvement in our margins and the sequential improvement in improved returns to the ECU.
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