The Urethane Blog

Huntsman Urethane Comments From Investors’ Call

Peter R. Huntsman

Ivan, thank you very much. Good morning everyone. Thank you for joining us. Let’s turn to slides number 3 and 4. Adjusted EBITDA for our polyurethanes division in the second quarter was $146 million versus $218 million a year ago. As Ivan mentioned, our North American propylene oxide and MTBE businesses are now reported as discontinued operations. Therefore, our continuing operations for our polyurethane divisions are now nearly entirely comprised of MDI based formulated systems, elastomers, and MDI components. As a reminder and as we have called out in the past, in the third quarter of 2018, we were still experiencing exceptionally high margins in the component end of our MDI portfolio. These spiked margins including above normal operating rates, conditions accounted for approximately $45 million of the year-over-year variance.

MDI volumes in the quarter were up 3% as the business continued to benefit from the expansion of our Chinese facility that began to come online in the third quarter of 2018. Our downstream strategy continues to perform well. Our margins remain stable in the larger differentiated end of our polyurethanes portfolio. This stability is a result of our continuous drive downstream, ongoing material substitution, product innovations, benefits from bolt-on acquisitions, global scale up opportunities, and increasing regional diversification.

In the third quarter, our total differentiated systems volumes were about flat compared to last year, and our global component MDI grew 7% year-over-year due to the new capacity added at our Chinese facility. What we experienced in the third quarter within our polyurethanes division was a continuation of what we were saying at the end of the last quarter in most of our key end markets. However, in Europe, the economic headwinds did intensify somewhat in September. We believe that the destocking we reported impacting the first half of the year in polyurethanes is finished most specifically in China. However, customers are still cautious, and inventories continue to be managed aggressively low in about every region which we compete. Consistent with what we have said in our conference call in July visibility still remains challenging.

Looking at polyurethanes regionally; for the second quarter, our Americas volumes were down from the prior year. We experienced a short-term outage near the end of the quarter at our Geismar facility impacting volumes a bit and EBITDA by about $5 million. Our spray foam insulation business, Demilec that we acquired last year continues to be a bright spot for us and is growing at a low-double-digit rate. We continue to expand this business by leveraging our global footprint. We’re on track to achieve our expected synergies. Just to illustrate the global opportunities for our Demilec business, the system house that we opened this past September in Dubai is equipped to support Demilec growth in that region. Our growth in spray foam in the quarter was offset by weaker volumes in other high-volume markets such as OSB and furniture.

We are focused on growing our downstream business further in the Americas, and we’re progressing with a new splitter at our Geismar facility. This should be operational in 2021 and will cost approximately $175 million to build, which is above our preliminary estimate that we shared with you this past February. The increased costs are primarily due to higher material costs such as steel due to tariffs as well as very tight labor markets in the Gulf Coast. Despite these higher costs, the IRR on this project remains very attractive, well north of our 20% hurdle rate.

Turning to the Asia region of polyurethanes, our differentiated and component volumes were up even when excluding the benefits of our recent expansion. Volumes are being helped by insulation growth in large scale infrastructure projects and applications. The adhesives, coatings, and elastomers and footwear markets in Asia are also contributing as we gradually shift our China portfolio and the newly added capacity to be more downstream and differentiated. We believe that customer inventories were at very low levels in this region. While we’ve experienced real growth within this region, demand in China remains well below average and erratic. We believe this will remain unchanged until trade discussions have some form of resolution thereby helping customer confidence and visibility.

In Europe, our downstream margins are stable despite lower underlying demand. Our volumes in the region were marginally up but that was primarily a result of favorable comparisons due to outages that impacted our results in the same period over a year ago. The overall macroeconomic environment remains increasingly soft, and we do not expect it to improve in the near-term. The margins in our differentiated business remained stable despite the pressure on volumes and weaker industry conditions. Our long-term strategy of growing our downstream business through strategic investments like our splitter, our new system houses will continue to be supplemented with bolt-on acquisitions having strong synergies and compelling financial metrics. We believe that the positive long-term fundamentals for MDI remain intact as above GDP growth driven by product substitution will continue long into the future. However, for the short term, the demand headwinds are unlikely to change. On top of that the fourth quarter is typically softer than the second and third quarters. Putting it all together we would expect our fourth quarter results to look slightly better than our first quarter.

Kevin McCarthy

Good morning. Peter as you anticipate the influx of 1.6 billion in cash proceeds from the Indorama deal can you elaborate on how you’re thinking about organic growth investments versus M&A for example with regard to your splitter project. Notwithstanding the higher costs, it sounds like you’re looking at a return above 20% there, do you to see other projects or opportunities like that that could claim a substantial portion of the capital, and maybe you could just elaborate in general on your latest thoughts there?

Peter R. Huntsman

Well, thank you very much Kevin. I look at the splitter that we’re building in Geismar Louisiana to be something almost akin to an acquisition. We have a very similar splitter in Europe, we have one in Asia. With the completion of this facility in the Americas, we’re going to be very well positioned by producing crude MDI, splitting capacity, and downstream. I don’t see a lot of large CAPEX projects. So, if you were to give me $150 million right now and say go spend it internally, I I think I’d be rather hard pressed at the present time. I don’t see a lot of large scale projects like that and frankly I’m not a big believer in that. It seems that as you build virtually anything in the last decade in the U.S. Gulf Coast, costs just continuously are going up and I’ve never been a big proponent that this industry needs more capacity of just about any product. I think that we need greater diversity of technology and the ability to perhaps specialize the products we’re producing.

But frankly, I don’t see this company going headlong into spending a lot of CAPEX around building new capacities around the world. So, as I look at that threshold because of the risks of higher costs and uncertainty about making commitments today as to where markets will be two, three, four years down the road when you complete such projects, I think that they warrant a much higher IRR in general than M&A does, where you know what you’re getting upon closing, and you have a good outline of synergies, technologies, globalization, and you can have a plan of action on day one. That’s rather difficult to do when you’re planning a new MDI plant that won’t be coming into the market for upwards of four, five, six years.

So, I think that we’re going to be certainly leaning more towards M&A opportunities, and again I emphasize that on a cautionary note as I did in my script, and I would also say that we want to make sure that whilst — particularly while we’re in what I would consider to be a rather challenging economic conditions, we need to make sure we retain the strong balance sheet. We’ve got plenty of capital to continue to pay a competitive dividend, and we are very committed to share buyback program when the share price is at appropriate levels.

Laurence Alexander

Good morning, could you discuss a little bit for both advanced materials, and in polyurethanes how you are seeing the competitive dynamics shift in response to weak environment. That is are you seeing capacity curtailments, are you seeing changes in pricing behavior, extended outages, any other kind of indications of sort of how the market is reacting in this environment?

Peter R. Huntsman

I think, Laurence it really is a little bit of a mixed view. The further upstream that you are or the more commoditized the product and the application, I think the more competitive pricing and margin pressure that you’re seeing. Further on down the chain where you have a product that has been specked into a customer, where you have a multi-year commitment and where you’re selling in effect or performance rather than a commodity raw material that maybe has a little bit of work done to it. You know I think that we’re seeing far less of that, and so as I look at something like our advanced materials in aerospace, as I look at our downstream formulation, applications in MDI, polyurethanes and so forth, margins for the majority of the business — margins are holding up very well. It is volume that is hurting the bottom line, and I suspect that volume will obviously be coming back as the economy starts to stabilize or even if the economy doesn’t stabilize when you see a lot of the de-inventorying, destocking that is out there taking place. So, again I would say, and it’s always — I probably will get in trouble for saying something this broad, but I’d say that I’d like to think that two thirds of our business is more volume sensitive, meaning that I think margins are pretty stable by and large and we’re going to be more affected by volume, and maybe a third of our business you’re seeing more competitive factors that might be impacting to some degree or another margins. And so, it is again product by product, region by region, division by division. Those things will vary, but I think that obviously we would like to get more and more of our products into that two thirds category.

Laurence Alexander

And are you seeing any sort of significant curtailments of customer R&D cycles, innovation cycles, new product development in response to the soft environment or is that inconsistent?

Peter R. Huntsman

I have not, as a matter of fact I might be seeing and I don’t want to say that this is going to continue but for the time being I think that there’s — you take in the economy like Europe where you’re seeing virtually no growth in GDP perhaps even a bit of shrinkage right now in economies like Germany. So for product substitution, things around sustainability, things that have an environmental improvement and push I think that there’s actually more innovation in certain applications. I look in the footwear industry where a lot of the producers today are looking to have a single grade of material that goes into the soul of the running shoe versus four or five different elastomers and colors and so forth that go into the sole of a running shoe. You look at those sort of — it might sound rather drab but those are areas where we’re seeing where there’s increased reward, increased opportunity. And so I think right now I’ve not seen a decrease in the reward for innovation and the opportunity to replace product substitution. I would imagine 2020, I’ve not seen the budget yet, we’ve not completed for 2020 but I would imagine that the majority of our growth in 2020 will be through product substitution.

Robert Koort

Thanks very much. Peter you had commented I think that you’re seeing component MDI margins pressured. I guess your major competitor from Midland yesterday showed some charts that is Asia Pacific that seem to suggest maybe things have bottomed out there some, Peter, where do you see the incremental thing coming from in commodity MDI?

Peter R. Huntsman

Well given the number of competitors that we have in Midland I won’t even try to guess who that might be but I think that in earlier conversations I think last quarter we said that we thought that China was most aggressive in bottoming out its inventory. And I think that as we look at now and my earlier comments Bob I think that I said that we felt that China not just in MDI but perhaps in some of our other products but more particularly in MDI. That said the inventories that were very low and I think that we’re seeing — if anything I think we saw a little bit of growth that took place in the third quarter in MDI after you take out the effect of our new capacity there. And I think that’s probably the first quarter in the last three quarters or so where we have seen a return to growth in China. So I’m not here to say that China is off to the races and we are going to great guns there but I do think that it has more to do with the idea that we’re done with destocking on a large basis in China. I’d also just know Bob that as we look at a lot of the announced capacities that are coming into the MDI market that seemingly a lot of those likewise have been either delayed or has been outright cancelled and so I think that between lowering of the — kind of the destocking coming to an end here and perhaps some of the capacities either canceled or pushed out I’m probably quite bullish on MDI. So look out over the next 12 to 18 months. Again depending on the macroeconomic environment as well.

Robert Koort

I guess maybe combining that with you made comments that multiples are starting to come down but your own multiple I guess in a pro forma basis after the Indorama deal looks like it’s maybe 6 times 40 but that seems like a pretty large discount given that enthusiasm you expressed and maybe high grading of the portfolio, so how do you square that with pursuing acquisitions and the risks that come with that versus buying your own arguably discounted equity?

Peter R. Huntsman

Well I think that we need to continue to balance both of these very well. You know I look at what I see is our multiple — I think we’ve seen an expansion over the course since we’ve announced this deal and I think that the market will reward you a little bit when you announce it. I think it rewards you a bit more when you actually get it done and I think it rewards you quite a bit more when you redeploy the capital smartly. I mean it’s got to be done by a combination of both share buybacks as we have seen in the last quarter or two. I think we just last quarter we bought an $80 million worth of shares all under $20 a share and at the same time we also bought in our 50% partnership of our maleic anhydride business and simultaneous this last quarter we sold off $2 billion worth of — $2.1 billion worth of our business. So I think we’ve got Bob do all three of those things very smartly and I think that over time the market will reward you and the multiple will continue to improve.

Michael Sison

Hey, good morning. For polyurethane your pro forma numbers for fiscal 2018 was a little over $800 million and looks like you’ll be somewhere a little over 550 for this year on a pro forma basis. So just curious Peter when you think about at some point we exit the industrious session and things get better. Where can that polyurethane EBITDA go on a pro forma basis if times improve.

Peter R. Huntsman

Yeah and as we look at 2018 that obviously was a banner year in MDI and I think we also saw the benefit of a fly off and so forth. I would hope that as we look at the volumes coming back, able to take advantage of the margins that we have in place I would certainly hope that as we look at that kind of that $800 million sort of number that we saw for 2018 that we can certainly be building on that number. Again as I look at kind of the recession scenario if you will in this company I think when we look at the last major 2008-2009 recession we saw our earnings drop at about 50%. And I would say that if we were to repeat that same sort of a scenario you’re probably looking at somewhere between a 30% to 35% drop. What I’m saying is I think that we ought to be seeing less volatility, less falloff, and a more stable earnings platform. So I would hope that 800 million would be more of the norm. As we look at 2018 too I’d remind you that when you take out the spike that we’re probably looking at a margin of around 15% in the business. And as we look at our downstream business our margin is around 20%. And so as you look at moving more and more of that to that downstream portfolio that’s going to be essential to our growth, our expansion of margins, and more importantly the stability and the maintenance of those margins.

Michael Sison

Okay, great and then real quick I think you mentioned you don’t want to stretch your balance sheet but just curious a little bit of color there would you say it was a good opportunity, how far would you go in terms of the balance sheet, two times EBITDA, and then are there other opportunities outside of polyurethanes that are interesting for you to do some acquisitions?

Peter R. Huntsman

Well there certainly are plenty of opportunities outside of polyurethanes. I think that when you just look at what percentage of our business is polyurethanes, MDI, and you look at the downstream growth that is taking place in a lot of those areas most of those acquisitions that we’ve done to date we have been our customers. And so we’ll continue to focus in that area. Matter of fact if you look at over the last couple of years the bolt on acquisitions that we’ve done in our polyurethane business if I look at this kind of on an LTM basis we bought those businesses with today’s EBITDA of around four times EBITDA and we’re going to continue to look at those sort of opportunities. And as we find them in other ends of the businesses we certainly will be taking advantage of that as well. As we think about leverage levels and so forth, look we have thought if anybody who is listening to our calls last couple years knows that perhaps the most consistent basis is we want to have a strong balance sheet, we want to have a balance sheet where we can have access to the capital markets regardless of what’s going on in the macroeconomic environment. And we want to keep to the investment grade metrics and so those are just fundamentally. I don’t want to speculate as to what size of an acquisition and so forth or how it would be financed and what have you, just because at this point it’s hypothetical. But I would say that we would certainly put limits on what we would do when we look at that threshold of investment grade.

Michael Harrison

Hi, good morning. In the polyurethanes business you had the planned fire in Turkey, I believe there was also an outage in Rotterdam, and then I think you referenced about $5 million worth of drag from Geismar. But can you just walk through the overall EBITDA impact that you saw from outages in the quarter and let us know if there are any outages that we need to keep in mind for Q4 or I guess early 2020?

Peter R. Huntsman

Well as we look at the Q4 we certainly don’t see anything at this point. And between the second and third quarter we did see and that as we talked about last time that it took place in Rotterdam that was due to us third party supplier that went down they shut down a number of facilities that were in the Rotterdam area including ours. And Geismar we did see an outage there that affected the third quarter numbers as well. So when we look at the third quarter the total impact on that was right around $25 million between Rotterdam and Geismar.

The fire that we had in Turkey we don’t believe that that’s sort of impacting our EBITDA in any material way. We’ve been able to source materials from our other system houses throughout the European and Eastern European area. A few weeks before that incident took place we opened up a new facility in Dubai that’s going to be running very aggressively to supply the Turkish markets. I don’t see us losing any business or materially any margins because of that and we will certainly be — it is our intention at this time to rebuild that capacity.

Michael Harrison

Alright and then we are about a year since you started up the additional MDI capacity in China. Can you talk about how that facility has performed relative to your expectations and maybe give us an update on how you’re progressing on shifting that polyurethane’s business in China towards a more differentiated product slate?

Peter R. Huntsman

Well I think it’s fair to say that that I think that the product that has come out of there is very high quality. Reliability and operating rates have been very steady. The facility is sold out as of today and we have the ability to move those products downstream because of the splitting capacity that we have. And so I think that we will continue to shift our portfolio more and more downstream into formulated areas and so forth and that will be a multiyear effort. Right now we’re selling into the component market and we will be shifting out of the component market this weekend and building up more and more of our downstream opportunity. But again we have the splitting capacity in play to be able to do that without further investments.

John Roberts

And then just a follow up and I apologize if I asked this earlier before but is the propylene oxide cost and the ethylene cost in the historical results essentially equivalent to what you’re going to get with the Indorama contract post closing?

Peter R. Huntsman

The transfer economics that we’ve had in the past will continue going into the future. We will not have the benefit of PO manufacturing economics in the polyurethanes business but the poly — the propylene oxide we will not have the manufacturing benefit of the PO that is going to the MDI business. But the MDI in the past it’s been transferred into that business into the system houses and so forth that will remain the same economics or say virtue of all of our products across the board with in-house and we try to always transfer those at a market or a most favored nation sort of pricing. We don’t transfer them the cost.

John Roberts

Okay so the polyurethane segment this quarter doesn’t have any benefit in the manufacturing margin?

No, it is not.

Unidentified Analyst

Good morning Peter, this is Eric Ketrian [ph] on for P.J. Your polyurethanes volumes year-to-date has increased 5%. If I were to strip out the [indiscernible] plant start up what are your underlying volumes and then how do you see the industry demand finishing out 2019?

Peter R. Huntsman

Yeah, we’ve seen in our MDI volumes growth for year-to-date including the third quarter, we see that total and our internal growth has been about 7%. And I see that what we’ve seen by and large Europe is up about 5% or 6%, the Americas is flat, and I would say that Asia wages up 24% but a lot of that’s because of the new capacity that we’ve brought into the market. So, but I would say without that capacity it’s probably flat to up slightly.

Unidentified Analyst

Helpful and secondly could you just give an overall description of utilization rates by region and if you see ability to push pricing in any of the regions?

Peter R. Huntsman

Yeah, I would say that as we look at it globally I get a sense that the capacity utilization though I don’t see a lot of data that is published in this area but just anecdotally it feels like it’s around globally in the mid 80’s and I would say you know the Americas were sold out in the Americas. Europe you’re probably somewhere 90% maybe a few percentage points below that. And Asia I would say you’re probably somewhere in the mid 70’s to 80’s somewhere in that area. And so I think that there is some room for — I think that any monicum [ph] of GDP growth should be the catalyst when you’re operating in most of your regions economically around the world of between 90% and 100%. It should be an environment for potential price increases. And in the chemical industry hope always springs eternal