Huntsman (HUN) Q2 2018 Results – Earnings Call Transcript

Peter R. Huntsman – Huntsman Corp.

Thank you very much, Ivan. Good morning, everyone. Thank you for taking the time to join us this morning.

Let’s turn to slide number 3. Adjusted EBITDA for our Urethanes division for the second quarter was $269 million. Our MDI Urethanes business, which includes our propylene oxide, polyols, and systems businesses, recorded adjusted EBITDA of $246 million. This compares with $165 million of a year ago and $245 million for the previous quarter.

Our MDI Urethanes business delivered 9% volume growth year-over-year. We grew our differentiated portfolio 13% year-over-year. Because of our ongoing portfolio shift downstream, we grew our component MDI 2% year-over-year. Demand remains strong and we continue to operate at a high rate of capacity, selling what we are able to produce.

Let’s turn to slide number 4. Fully consistent with our strategy, we continue to see robust growth in our downstream specialty and formulation businesses as we shift more MDI from components to systems. In the second quarter, we saw 13% year-over-year growth in volume within our differentiated systems business. As you know, on April 23, we completed the acquisition of Demilec, a downstream spray foam manufacturer in a high growth market. Excluding Demilec, we grew 10% year-over-year in our downstream business.

Looking at growth regionally in the quarter, our Americas volumes increased 21%. Our recent acquisition of Demilec added about 5% to these volumes. The strong Americas volumes were primarily driven by our composite wood products, insulation and adhesive product sectors. With the continued startup of our new Chinese MDI capacity, we are shipping less MDI from the U.S. to China, helping to feed our growing North American customer base.

Demand remains strong for our MDI in this region, driven by construction, housing and continued substitution for other materials. Asia volumes increased 8% versus the prior year. Growth in this region is being helped by strong automotive demand for MDI systems in high-growth and large-scale infrastructure projects, such as district central heating insulation. The ACE and footwear markets in this region also continued to be significant contributors to our growth. Our new China facility continues to progress through the start-up phase and we expect it to be fully operational by the end of the year. We will bring on this new capacity as demand dictates.

In the European markets, operating problems at a third-party raw material supplier impacted our second quarter production volumes. These outages are fully resolved. We believe that these production outages in the quarter impacted our EBITDA by approximately $20 million. Underlying demand fundamentals remain positive in the European region and the market is growing, specifically in automotive and ACE, as well as differentiated insulation systems. We expect to see growth in this region moving forward.

Over the past three quarters, we have pointed out what we believe is a short-term spike in commodity component MDI prices in Asia and Europe. We believe that these margins softened another $25 million in the second quarter. Barring any unforeseen industry outages, we expect the remaining spike in margins to be eliminated by the end of the year. Industry capacity utilization will remain balanced for the foreseeable future. This balance does not anticipate any supply disruptions.

Our outlook on global demand growth has not changed as we anticipate future growth at about 6% in the coming years. This demand growth translates to roughly 400,000 tons annually, which is the equivalency of a new world-scale plant being built every year. Assuming all the debottlenecks and brownfield capacity additions that have been announced to date come on exactly on time and at full capacity, we believe the capacity will be growing at about 5% through 2022. Therefore, industry supply/demand dynamics will remain tight for the foreseeable future, as we have good visibility and do not see any new greenfield capacity entering the market for several years to come.

Let’s turn to slide number 5. It is important to remember that about 75% of our MDI is in differentiated systems. Margins in our differentiated businesses are fairly stable and behave differently than margins in our component MDI business, which is more volatile. We’ve been transparent in calling out the temporary spike of component MDI margin we experienced within the China and European regions.

While there has been expected volatility with this declining portion of our Urethanes portfolio, we see margins within our expanding portfolio of variance and differentiated systems being stable and steady. While there are times when we could generate higher earnings in the short-term by selling component MDI, we are focused on what we can control and on long-term growth and steady earnings.

Our long-term strategy to keep moving more of our business into the stable and higher-margin derivatives and formulation applications is delivering the intended consequences of high-quality growth and a more stable core Urethanes business. Our business will be impacted by the occasional volatility in component MDI, but this is an increasingly smaller piece of our overall MDI Urethanes business. Our differentiated systems provide value-added solutions and technology to our customers.

In addition to organic growth in our existing downstream businesses, we will keep looking for value-creating and accretive bolt-on acquisitions that allow us to pull through more volume of component MDI into growing specialized and high-margin formulations. These acquisitions will give us entry into new markets and an opportunity to leverage our global platform to grow the existing business. We have a proven track record of downstream urethane bolt-ons acquisitions that provide significant synergies through MDI pull-through and global scale-up.

Looking forward to the third quarter, we expect our MDI Urethanes business to experience good volume growth over last year with another solid quarter. Urethanes EBITDA will be modestly down from both the third quarter last year and the recent second quarter of this year because of the declining component fly-up that we’ve already discussed.

Kevin W. McCarthy – Vertical Research Partners LLC

Yes. Good morning. Thank you and good morning. A few questions on MDI. Can you comment on how your assets are running thus far in the third quarter? Whether or not there was any spillover from the Rotterdam issue that you mentioned? And whether you have any planned outages in that business in the back half of the year?

Peter R. Huntsman – Huntsman Corp.

We don’t have any outages that I would consider to be material that should impact our earnings. I would just note in the second quarter the outages that we had were, for the most part, due to third-party operations and so forth. And this is something that will affect our MDI facilities as we are highly dependent on third-parties being able to supply our hydrogen and our oxygen and raw materials and so forth.

But having said that, I think as we look at our Geismar facility, our MDI facility in North America, that is running strong at the present time. I don’t foresee any issues there. Rotterdam continues to run well and our Chinese facility continues to come up as we had planned for it to come up. And I think we said, over the course of the last couple of quarters, we see that facility being capable of operating at full capacity by the end of 2018. And we will put those pounds into the market as it prudently needed.

And just as a reminder, we used to have a fairly material section of our Geismar production that used to go to Asia to feed our growing Chinese appetite there. And obviously, as we have those pounds now coming back into North America, this is a concern that we posted a couple of quarters ago that we have quite a few of those pounds coming back into North America. I think it’s fairly safe to say at this point, those pounds have come back to North America, they’ve come into the market and we feel that they’ve been placed effectively and efficiently in the market. And so I think that we really see regional production matching regional demand.

Kevin W. McCarthy – Vertical Research Partners LLC

That’s helpful. And then, Peter, as a follow-up, I realize you’re only a bit more than three months into the integration of Demilec, but perhaps you could provide an update into how that’s going and how your ambitions are progressing with regard to growth and cross-selling there?

Peter R. Huntsman – Huntsman Corp.

Well, we initially – I think it was a quarter ago, when we announced the acquisition, we talked about being at a run rate of close to $40 million on an annualized basis by the end of the year. We continue to be pushing towards that and I think that we will meet that by the end of the year. Again, that is an improvement in the business as we look at the cost improvements that should come in the business, the integration should come in the business. I think our priority in 2019, going into 2020 will certainly be how do we globalize that business, and we’ve already taken steps introducing the products and the know-how and so forth in Europe and in Asia. That’s not going to be an overnight success, but we feel very confident, if I had this acquisition to do all over again, I certainly would do it. And we are achieving the objectives that we set out. And so, I think it’s gone very well thus far.

Michael J. Sison – KeyBanc Capital Markets, Inc.

The volume growth in differentiated MDI continues to look really good. If you think about the MDI demand, it’s growing better than the market. Do you think that is sustainable over the next couple quarters? And maybe give us a little more color what’s driving that growth?

Peter R. Huntsman – Huntsman Corp.

Well, I would say that it is sustainable. There’s no one particular area where – I’d say that if you kind of look at it on a regional basis is that where we’re seeing a lot of the growth. It’s largely in the U.S. where we’re seeing strong construction in the U.S. and certainly benefiting from that. As we look at the downstream construction appetites, and we talk to those companies, I don’t see in 2018 and 2019, as we look at the basic raw materials are going to OSB in the construction industry, I don’t get a sense that there’s a great deal of inventory neither on our end nor on the contractors ends that are making the OSB and making a lot of the paneling and boards and insulation and so forth.

The demand right now in the construction field feels quite healthy in the Americas. I would also just note that a lot of the growth that we’re seeing is also in product substitution. And as we continue to make inroads into the replacement of formaldehydes, the replacement of expandable polystyrene, and existing insulation materials, not all this is just GDP growth. I think as a rule of thumb – and again, I don’t want to apply this just to any one particular quarter, but I’ve always kind of thought that as a rule of thumb, about half the growth that you see in demand in MDI is GDP-related and half of it is kind of product substitution-related. And I see that driver and I see that engine of product substitution remaining quite strong.

Michael J. Sison – KeyBanc Capital Markets, Inc.

Okay, great. And a quick follow-up on the differentiated side of the business, as the short-term spike in margins or pricing, whatever you want to call it, fades in the second half of the year, would you expect the margins there to maybe expand or just stay stable?

Peter R. Huntsman – Huntsman Corp.

I think that they’re probably looking to expand. I think that we’re facing with higher crude prices and so forth, we’re facing a lot of raw material pressures. And so, any expansion that we’re making, I think that it’s important just to note that when we talk about those expansions, we’re making them in the face of raw material price increases. As I look at our Advanced Materials group, year-over-year, quarter-over-quarter, we’ve absorbed about $5 million or $6 million in Advanced Materials, about the same amount in Textile Effects. So, the fact that we’re looking in the third quarter of either kind of flat of a year ago or slightly up from a year ago, in reality, we’ve boosted margins $5 million, $6 million just to offset the cost of raw material. So that would certainly denote that there continues to be strong demand in those areas when you’re able to take that large of raw material price increases.

Jeffrey J. Zekauskas – JPMorgan Securities LLC

Thanks very much. I think in your prepared remarks, you said that your third quarter Polyurethanes EBITDA as best as you could tell would be below the $245 million that you reported last year. Can you talk about the sequential degradation in EBITDA? And I suppose the fourth quarter would be weaker still on a sequential basis for seasonal reasons, or is that not correct?

Peter R. Huntsman – Huntsman Corp.

Well, I think that what we’re really trying to point out in EBITDA when we talked about our MDI is the effects of the fly-up that we site. I’d ask you, Jeff, to go to slide number 5. I think it’s a very interesting slide. And if I had to pick out one slide in the deck, well, they’re all great slides…

Jeffrey J. Zekauskas – JPMorgan Securities LLC

Yeah.

Peter R. Huntsman – Huntsman Corp.

… slide 5, I think we tried to break out to kind of show the market, because there were some press reports a month or so ago that I think gave kind of a misleading guide that MDI prices were collapsing in Europe or in China and so forth, and we tried to break out on this slide number 5 the – you can see the impact. It’s about 30 – that red line, depending on region, depending on the blend, depending on the application, that red line is anywhere from 30% to 40% of our business in the regions and so forth. And the solid dark line is kind of the all of our other margins. And if you look globally and you look at that solid dark line there, it’s a very steady foundation to the business. And when you look at what we’re talking about on that short-term spike margins, look at Asia and look at Europe. And Asia largely has come back down to, I’d say, to normalized margins. As a matter of fact, as I look at Asia component commodity prices today, if anything, Asian prices are inching up a little bit, and as I look at that spike that we saw about a year ago this time, again, really just getting back to normal. And so, when we talk about being equal to or down from a year ago in Polyurethanes, I just want to make sure that it’s not the overall business, it’s not the foundation of the business, it’s not the overall strength of the business, it really is just that spike that’s being moderated. And that’s what we’re going to see. It’s the last of that fly-up spike.

Aleksey Yefremov – Nomura Instinet

Good morning. Thank you. Peter, I just wanted to go back to slide 5. In Europe, it shows an increase in margin at least in July. And if we look at sort of independent price services, they’ve talked about a price decline. Is it a correct way to read that that you’ve actually in your system in both components and systems saw a margin and price increase?

Peter R. Huntsman – Huntsman Corp.

Yeah. So as we look at the business right now, we’re seeing decent to strong demand in Europe. And also, mind you, in the second quarter, we did suffer a bit of outage in our own facility in Rotterdam, so thinking we were short materials. And the MDI right now, it feels tight in Europe. Also, there’ll be a little bit in those numbers when you look at that increase, a little bit of that’s going to be around product mix as well. We saw very good automotive demand. And our footwear, our ACE business, coatings and elastomers, adhesives business was strong. And so, some of that upward trend is going be supply/demand related. Some of that’s going be the mix of the products where we’re seeing particularly strong demand in the second quarter.

Aleksey Yefremov – Nomura Instinet

Got it. Thank you. And then on the systems pricing, as you sign new contracts in systems or you extend existing contracts, are your margins generally higher than what they were before or your average margin? So, what’s just the direction of that systems margins?

Peter R. Huntsman – Huntsman Corp.

I think we have an opportunity to make it a little bit higher than before. And Alex, as we look at the business, I think what we really want to see in MDI is sustainability. And if we have an opportunity to go in and lock in short-term price for a longer-term, but longer-term that’s going to force the customer to look for competing products or something like that, we don’t want to be in that situation.

So, we want to be selling value. You want to be selling your cost. You want to be selling your service. You want to be selling your effect. And all of those come together to make a price. But I think, by and large, as we look at the strength of MDI, we probably have more of an opportunity to gradually move up margins on these systems as they’re being renegotiated than not.

Arun Viswanathan – RBC Capital Markets LLC

Great. Thanks. Good morning. Just a question on MDI going back to the issue around Europe and Asia. Would you expect a similar impact from some recent force majeures in the industry that you saw versus last year, or is this a much more minor issue? Thanks.

Peter R. Huntsman – Huntsman Corp.

I want to make sure I understand the question. You’re talking about the impact of force majeures on the industry and the impact that’s having on pricing?

Arun Viswanathan – RBC Capital Markets LLC

That’s right.

Peter R. Huntsman – Huntsman Corp.

Okay. Yeah. The force majeures, certainly when you’re operating at around – I think the overall industry’s probably operating around 90% globally capacity utilization, probably a little bit tighter in North America, fairly tight in Europe and less so in Asia. And when you look at – this is largely – mind you that MDI is largely a regional supply and demand. MDI is a tough product to put on a boat and oftentimes, depending on the grades, have to be shipped cryogenically, has to be stored cryogenically. You don’t see massive MDI volumes moving around the world, especially in the downstream differentiated higher grades of MDI.

So, when you see a facility that is 400,000 or 500,000 tons of capacity go down in a particular region, that 400,000 or 500,000 ton facility can account for several percentage points, and often that region can go from the low-90s up to the mid-90s or even the high 90% capacity utilization. So, I think it’s a regional issue. It’s a timing issue. It’s a seasonal issue. And what impact that has on the market and so forth, I think, is probably – I mean it certainly is there. And it’s certainly is there, particularly the component side of the business. I think of our downstream systems end of the business, as you can see, again, going back on slide number 5, you don’t see a great deal of volatility in margins on that downstream differentiated end where we’re focused.

And so, I would say that on a margin side on the majority of our business, those force majeures and so forth we’re seeing globally don’t have near the impact of just focusing on the downstream steadiness and the margin where we want to grow the business.

Arun Viswanathan – RBC Capital Markets LLC

Great. And then, you noted earlier that kind of upstream capacity expansion isn’t really something in your best interests. What options do you have to expand downstream in MDI and Polyurethanes? I mean, obviously, you have the buy options and you proved that with Demilec. Are there further options like that in the imminent future? And then, furthermore, are there options organically to increase your downstream exposure? Thanks.

Peter R. Huntsman – Huntsman Corp.

Frankly, I would see that being a good mix between organic growth and looking at our downstream growth. And as we look at one of our bigger areas of our downstream opportunity and our elastomers and so forth, we have opportunities where we bought an asset in North America and now we’re taking that know-how to Asia and we’re taking that know-how around the world.

And so, oftentimes, we’ll see – for instance, with Demilec, we bought an asset, we bought manufacturing facilities and then we’ll take that and organically grow the business. So, the growth that I see taking place downstream in MDI is going to be a combination of growing and acquiring new technologies, customers, know-how and applications and then growing that in a – buying a regional player and then globalizing as quickly as possible. And so, I wouldn’t want to sit here and say that the majority of our growth is going to come organically or is going to come through acquisition. I think it’s going to be a combination of the two.

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