Urethane Blog
Olin Epoxy Comments from Investors Call
February 1, 2021
Scott Sutton
Yes. Thanks, Steve, and hello to everyone.
Look, I’ll kick off my comments by saying just how proud I am of our entire Olin team for bucking traditional stale paradigms. Our fourth quarter results demonstrate the team’s resolve and leadership. Olin people are masters of the ECU and we are prioritizing value first above all else across the entire ECU, not just in one or two products. That means we don’t sell excessive volumes into poor quality markets. Instead, we withdraw supply and we generate purposeful activations on both sides of the ECU up and down our derivative chains, resulting in margin improvements on both sides of the ECU.
Slide number 12 in the appendix demonstrates this activity and effect. In fact, maybe the most important slide we have ever published is Slide number 12. Our model also rejects the notion that this business must be deeply cyclical and will always have its co-products moving in opposite value directions, thus generating mediocre ECU returns over the cycle.
It is not cyclical and is quite steady when Olin does not push excess volume and chase the poor quality side of the ECU down across an inflection point on Slide number 12 into an oversupplied swamp of poor pricing.
Now, turning your attention to Slide number 3, Olin’s quarterly ECU profit contribution index chart, even though the global Chlor Alkali market configuration is in the poorest state for Olin. In other words, when strong back integrated PVC production, which Olin does not directly participating in pushes out lots of co-produced caustic into a weak caustic demand environment really the emphasis being on the weak caustic demand point here. We still sequentially lifted our ECU PCI, by lifting margins across flooring, EDC, and virtually every flooring derivative while simultaneously not allowing Olin caustic to decline in price as much as industry indices would have anticipated.
The ECU PCI shows our commitment to quality and our adjusted EBITDA improvement shows the results of that commitment. I will also comment here that our fourth quarter adjusted EBITDA result is pure as there are no non-recurring items included.
And speaking of quality and moving into Slides 4 and 5, Winchester delivered the best quarterly performance in the businesses 155 year history, with even better quarters expected throughout 2021. The Olin Winchester team relishes its commitment to support both the U.S. Warfighter and the more than 55 million of us who enjoy shooting sports. These themes are woven into the fabric of America and we expect that elevated shooting sport participation is here to stay. U.S. military modernization initiatives are expected to create additional opportunities for Winchester as well.
So, you know wrapping up my opening comments with Slide number 6, our first half quarterly average EBITDA should be better than the fourth quarter of 2020 across every business. Note that we do have a number of turnarounds in the second quarter to contend with. And we expect a 10% improvement in the ECU PCI across the first half.
Here are some key points specifically for the first quarter. Point number one, Epoxy will be the star of the ship and is expected to surpass our prior quarterly EBITDA record as the team lifts the permanent earnings foundation of that business to match the value of our product offerings.
Pat Dawson
Yes, Mike. This is Pat, I think on Epoxy, when you start out and you look at the demand side of things, we’ve seen sequential improvement in our demand since June month-on-month and certainly quarter-on-quarter. So the demand, quite frankly, where we sit today, and you got to remember, demand is really driven a lot around industrial coatings, automotive, electronics, wind energy. Quite frankly, we’re back in a lot of those segments to pre-COVID demand levels. So we’re sitting here, what, almost in February and demand looks good. The other thing that has been encouraging on demand is the fact that China has been very robust. And I think the demand of Epoxy in China is probably as good as we’ve seen it for a while. But, Mike going back less than 24 months ago, when we had our Investors Day, we were showing then that the overall industry supply demand fundamentals for epichlorohydrin, which is a major raw material going into making epoxy resin.
Along with epoxy resins, we’re already in the mid-80 type industry operating rates. So this is nothing new. It’s just simply been the industry getting tighter. And now coming out of COVID, we see things very tight. It’s given us pricing traction that started, quite frankly, back in September, October and has only built in momentum through the end of the year. And we see that momentum continuing here in the new year and right through the first quarter. So there’s increases out there, there is public and the public domain that had been announced. We’re seeing good traction on that and we see the fundamental is very good.
Kevin McCarthy
Okay, that’s helpful, Scott. And then, a second question, if I may on Epoxy. Clearly, there’s a tremendous amount of pricing strength in recent months. And I was wondering if you could help us understand how much of that is due to Olin’s change in strategy around the ECU profit contribution index, relative to exogenous market dynamics, such as various competitor outages in Asia, any color around that would be really appreciated.
Scott Sutton
Yes. I think Pat will provide some color here. I mean, I would just preface it by saying in our Epoxy business, it certainly is part of our strategy to — first and foremost, lift value across the whole ECU first and Epoxy is a significant part of that. But then, Epoxy has its own landscape fundamentals that Pat is exercising a lot of activities around. So Pat?
Pat Dawson
Yes. Kevin, I would say, first of all, we’re very active around upgrading where we decide to place epoxy resin into our targeted applications and customers around the globe to drive the best returns to the ECU. Because, I think a little bit of a different mindset change is that, I’ve got to compete and make sure that I can get enough chlorine to put into the epoxy chain. And so, if I’m not improving my returns to the ECU internally Damian will take that ECU and place it somewhere else. So that puts a different perspective and a different color on our sense of urgency and the sharpness of which we evaluate where we’re going to place that epoxy, like I say into our targeted applications.
Also, Kevin, we’ve talked a number of times about the fundamentals of Epoxy and the fundamentals of epichlorohydrin, which is a key raw material. And since the reinvestment, economics haven’t been there in the industry for epi or a lot of the base, liquid epoxy type resin business, there hasn’t been any capacity at it. So, if you work off of this, discussion we had less than 24 months ago at the investors presentation, I think you’re just seeing the normal occurrence of a market that hasn’t been invested in from an additional capacity standpoint.
I think the other thing, Kevin that you’re seeing a little bit more color around China, if you recall, a few years ago, they were really cracking down hard on environmental regulations enforcing those regulations, which I think was great. I mean, that was good for the industry, is good for China. But I think that took some capacity out that may have not been so transparent. And that’s why you had probably the longest running arbitrage we’ve ever seen on the price of LER in China versus LER outside of China. That gives maybe a little color of what’s going on here.
Vincent Anderson
So you talked about Epoxy having to compete for chlorine internally, which is interesting. I don’t normally think of those as an asset light business. And so without seeing anything specific to Epoxy highlighted on Slide 15, I was just interested in getting some color in terms of how much more fixed cost you feel like you can get out of those to facilitate the kind of flexibility you’re talking about.
Scott Sutton
Yes. I mean, thanks a lot. I’ll just take a quick shot at this. Look, we have room out of the company to tight fixed cost. And that’s pretty widespread, what we haven’t really tried to do, at least for external purposes is to narrow that down to business by business, I would just sort of close that point by saying, look, we’re going to get $150 million to $200 million of gross productivity, which translates into that net 50 to 100. And there’s opportunities across all the businesses to do that.
Matthew Blair
I had a few questions on Epoxy. So it seemed propylene and benzene cost move up quite a bit in January. Of course, LER price has also soared about $0.27, because you just walked through the moving parts here and all things equal, would you expect to see unit margin profitability increase in epoxy in Q4 versus — sorry, Q1 versus Q4?
Scott Sutton
I think Pat will give you a little color on that. It’ll probably just sort of cut to the chase and get to the answer on that without too many moving parts.
Pat Dawson
Yes. Matthew, short answer is yes, we are going to expand margin in Q1 versus Q4. And that’s a short answer.
Matthew Blair
Sounds good. And then, Pat, you previously touched on strong demand end markets in Epoxy like wind and autos, I think the price gains are just pretty remarkable given the aerospace is likely still a big drag. So could you talk about, how much of a headwind is aerospace today? And I guess how much upside down the road it would present if aerospace normalized?
Pat Dawson
Well, Matthew, I think you have to also show oil and gas into that aerospace as well. So, while we’ve seen that recovery that I talked about in our demand, I mentioned earlier, which, we’re pretty much back to where we were last year at this time. Without aerospace to your point and without oil and gas, and also without the full recovery in a lot of industrial coatings. And so, you guys cover all the big coating houses. And so I think there’s more upside here to the demand.
The other point I did mention is that we really saw a lot of customers and their customers, customers, take inventories down really to low levels at the end of last year, which is not uncommon. But we think inventories are pretty low levels here going into the new year as well. I think that bodes well for ongoing traction that we have seen late last year and that we’re seeing here in Q1.
Roger Spitz
Perfect. I’m wondering back on the Epoxy, with the Hexion furnace force majeure in Europe, how much is that driving the spike in this — at the LER versus say, perhaps less Chinese import pressure into Europe because of stronger demand in China and stronger demand overall? Thank you.
Pat Dawson
Yes, Roger. This is Pat. I would say that force majeure that you referenced is more of a minor issue compared to the bigger issue I mentioned earlier around overall demand and demand out of China.
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