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Urethane Comments from Huntsman Investors’ Call

Huntsman Corporation (HUN) CEO Peter Huntsman on Q4 2019 Results – Earnings Call Transcript

Peter Huntsman

Good morning, everybody. Thank you, Ivan. Thank you everybody for taking the time to join us today. Let’s turn to slide number three and four. Adjusted EBITDA for our polyurethanes division in the fourth quarter was $122 million versus $141 million of a year ago. Consistent with last quarter, our results now exclude our North American propylene oxide and MTBE business that was sold together with our Chemical, Intermediates and Surfactant businesses to Indorama Ventures on January 3 of this year.

Our continuing operations for our polyurethane division are now nearly entirely comprised of MDI based formulated systems, elastomers and MDI components. MDI volumes in the quarter were up 6%, primarily due to higher volumes in China, resulting from our expansion that was running at less than full rates a year ago in the comparative period.

In addition, we saw some favorable comparison in certain product lines versus the fourth quarter of last year, as well as some market share gains. While our downstream margins remain relatively stable, consistent with our prior quarter, we continue to experience some pressure on polymeric and component margins.

In addition, volumes in certain markets remain depressed, which pressured overall profitability. Regardless of short-term challenges, we are committed to our strategy of investing in our downstream businesses, as well as product innovation. We are confident that the positive long-term trends for MDI urethanes around product substitution remain intact.

In the fourth quarter, our total global differentiated systems volumes increased 7% compared to last year and our global component MDI volumes grew 5% year-over-year, due to favorable comparisons and some new business wins, specifically in Asia and in the global scale-up of our spray foam business. Overall business conditions in the fourth quarter remained challenging, with global manufacturing conditions facing continued headwinds, particularly in Europe.

Looking at polyurethanes globally in the fourth quarter, our Americas volumes were up from the prior year, primarily due to growth in our insulation businesses and favorable comparisons to our composite wood products business. Softer volumes in our higher-margin ACE, or our adhesives, coatings and elastomers, and footwear businesses, were offset by higher volumes in lower-margin composite wood products businesses.

We continued with our project to build a new splitter in Geismar, Louisiana, which remains on track and is expected to be functional by the end of 2021. As a reminder, this investment will help us to support and further grow our downstream businesses in key markets in the Americas, such as automotive and elastomers.

Also, our recently announced acquisition of Icynene-Lapolla, remains on track to close in the first quarter of this year, could possibly close as early as this month. When this acquisition is completed, we will immediately start to integrate this business with Demilec, our existing spray polyurethane foam business that we acquired in 2018.

We expect the combined business to have EBITDA margins in excess of 20% once fully integrated and be a leader in this high-growth market. Additionally, our push to take our spray foam technologies in the international markets will continue to be another source of growth for this business.

We look forward to the prospects of this business for years to come due to the competitive advantages our spray foam has over alternative installation products. This is a perfect example of the size and type of acquisition, which we hope to do more of and not only in Polyurethanes.

Turning to the Asian region of Polyurethane, volumes were being helped primarily by insulation growth across several applications as well as growth into the adhesives, coatings and elastomer and footwear markets. While overall volumes are higher in the fourth quarter, the environment in the region remains very competitive and polymeric margins are under pressure.

Having brought on new capacity in August of 2018, we are focused on what we can control and taking our component and less differentiated polymeric system volumes in the more stable and high-margin downstream products.

We have made and continue to make significant inroads into Asian ACE and automotive markets. An example of this is our recently being awarded the seating business in the new Teslas being built in China.

In the near term, the situation around the coronavirus in China is having an immediate impact on our business in this region. Anything that we say today will likely be outdated by events in the next 24 hours. Some areas of China, we’ve seen cities and regions and post closures and restrictions of movements while other areas are reopening. Workforces are barely getting back to work while transportation and logistics are significantly challenged.

We are being forced to slow production at our MDI facility in Shanghai and our TPU plant in Jinshan. Short-term visibility is difficult, not knowing how long or how widespread the effects of this pandemic will remain.

However, we see this as a short-term matter and expect business to resume unimpaired once this matter is under control. We sit here today we expect to have a noticeable impact on our first quarter EBITDA, but hope that it will be contained to the first quarter. We shall see.

In Europe, our volumes in the region were slightly up but the overall macroeconomic environment remains increasingly soft, and we do not see any convincing signs in the near — for near-term improvement.

Margins are being impacted by an increasingly competitive environment in component and polymeric systems. Including polymeric systems, the margins of our differentiated business remain relatively stable despite the weaker conditions in the industrial and automotive markets.

Our overall strategy to grow our downstream urethane business through strategic investments like our splitter and new system houses will continue and will be complemented by attractive bolt-on acquisitions, having strong synergies and compelling financial metrics which is our recent announcement to acquire Icynene-Lapolla demonstrate.

We have a high degree of confidence that we will continue to find other similar attractive strategic opportunities that will further accelerate our move to a high-quality downstream business. Our urethanes portfolio was unique and a world-class franchise that will only get better as we further accelerate our downstream growth.

The positive long-term fundamentals for MDI remain intact, well above GDP growth. Driven by product substitution it will continue for the foreseeable future. For the short-term, the demand and margins in component and polymeric systems remain challenged specifically in Europe and Asia.

With very little visibility, we expect first quarter results in this segment to be down when compared to the prior year. With the year starting off on this weak note, we suspect that it will be difficult for us to improve much on last year’s results.

In performance amines, our polyurethane catalyst continues to show growth in the markets that are looking for low VOC solutions such as spray foam, automotive, and furniture. We intend to further invest in this business over the coming years in order to keep pace with market demand as well as support growth and product innovation with our existing customers.

Sean Douglas

Thank you, Peter. Turning now to slide 8. Fourth quarter adjusted EBITDA dropped by $25 million year-over-year. Strong volumes in our Polyurethanes segment offset weaker volumes in all other segments. Variable margins declined largely due to weaker margins in component MDI. We faced some translational-related foreign exchange headwinds as both the euro and the yuan most modestly weakened year-over-year.

Turning to slide 9, we concluded 2019 with another very strong free cash flow year. The fourth quarter was stronger than we had anticipated at the time of our last earnings call due to a larger working capital release and due to the timing of payment of certain taxes which have been passed into 2020.

Throughout 2019 we also enjoyed a onetime benefit of approximately $70 million from collecting past due foreign VAT taxes pertaining to years prior to 2019. As previously shared with you, given our portfolio of businesses post the sale of our Chemicals Intermediate and Surfactants business, we expect a normalized targeted free cash flow conversion rate of approximately 35%. This excludes the capital required for the construction of our new MDI splitter at Geismar, Louisiana which is expected to be completed by the end of 2021.

The total cost of the splitter is estimated to be approximately $175 million of which approximately $15 million was spent in 2019, $80 million which will be spent in 2020, and the remainder in 2021.

Taking into consideration this projected spending on the splitter plus the deferral of certain taxes into 2020 and payment of certain transaction expenses related to the sale of the business to Indorama that will pay out in 2020, we expect our free cash flow conversion 2020 to be between 20% and 25%. Including the new MDI splitter, we expect to spend between $300 million and $325 million in capital expenditures in 2020.

Peter Huntsman

As I mentioned earlier, we continue to expand our ability to convert more of our crude MDI in Geismar Louisiana to more valuable formulated systems. While not adding more MDI volume it does add more MDI value. Additionally, we opened another downstream system housed in Dubai to enhance our position in this region. As a reminder of our 30 MDI consuming system houses around the world, we have built 17 and acquired 13. We will continue to review internal expansion opportunities so long as they justify an attractive hurdle rate.

By and large, I am not a proponent of large capital projects that add excess volumes. I believe that our greatest focus is going to be on our M&A opportunities. At the same time that we were selling, our upstream Chemicals Intermediates and Surfactant businesses we also repurchased – or also purchased the remaining 50% of our maleic joint venture making us the largest and lowest-cost North American and European producer of maleic anhydride.

Perhaps the best example of our M&A strategy is the upcoming completion of our polyurethane spray foam acquisition of Icynene-Lapolla. I expect it to be closed in the next week or so. This acquisition will be combined with our existing spray foam business called Demilec that we purchased less than two years ago in April 2018.

The LTM EBITDA when we closed on this business was approximately $25 million. In the calendar year ending 2019, we earned approximately $45 million. We turned a mid-teen purchase price multiple into an under eight times multiple within 18 months. With Icynene we will turn a 10 times multiple into a 7 times multiple within 18 months.

As we merge all of these businesses by the end of 2021, these two businesses will add an additional $100 million of EBITDA and we will become the largest global polyurethane spray foam business. We will be a market leader in technology, service and integration as this business will consume in excess of 0.25 billion pounds of polyols in commodity MDI grades raw material. In addition to this transaction, we are presently reviewing multiple opportunities in all of our divisions.

Matthew DeYoe

Good morning. You had mentioned that given 1Q headwinds and margin pressure in Polyurethanes, it might be difficult to grow the business year-over-year. Does that include any of the benefits from the completion of the Icynene deal?

Peter Huntsman

Yes, that is assuming that the Icynene deal does close. As I said, when we look at that $10 million to $15 million per month, I would say that probably 90% of that is going to be borne by Polyurethanes. That is the predominant business that we have in Asia. And as we look at our largest manufacturing footprint in Asia, virtually all of our manufacturing assets in Asia that have been impacted or slowed down or shut down, which depending on which asset you look at are all in Polyurethanes as well.

Kevin McCarthy

Yes, good morning. Peter, what did your polyurethane spray foam volumes grow in North America in 2019? Maybe you could talk a little bit about your experience in that market and how you would expect it to change assuming the Icynene deal closes here soon?

Peter Huntsman

Yes. In 2019 throughout the year, we saw that just around 10% — 9%, 10% growth in North America. And I think that if anything that will be continuing. As we see, the continued growth of the market, we’ll see more resources going into that market more in 2020. We’ll have more sales reps. We’ll have better open and closed cell technology that will be into the market. And we’re also going to be doing a big branding push as well throughout 2020.

Some of you might see, Huntsman advertise for the very first time in our history. I think we have a very compelling story to tell from a renewability and environmental story. We now have a facility that is capable in North America that is fully operational today of taking up to one billion PET bottles, the equivalency of one billion PET bottles of used plastics and converting that into polyester polyol, which is a raw material for the spray foam industry.

Later this year, we’ll be opening a similar facility in Taiwan that will actually have better raw material economics to produce polyester polyols for the Asian markets which are growing very rapidly for us in the spray foam insulation business than what we’re seeing in Texas because of the abundant supply of PET bottles and so forth that are there.

So we not only are going to be looking at maintaining the sort of growth in the past. I think we’ll be looking to accelerate that as we encourage states and local municipalities to increase their building standards their installation standards. This will be a unique opportunity for a chemical manufacturer to actually go out and push for tighter environmental standards in building — so Kevin you kind of got me out an attention here I’ll shut up. But I see that it certainly is continuing and moving forward from what we’ve seen in the past.

Frank Mitsch

Thank you. That’s very helpful. And while we both know that you’re not a crude MDI pricing play, we’ve heard from some of your competitors so far this quarter that — a sense that that’s kind of bottomed and I guess there’s a competitor out today with a North American MDI price increase. A, are you guys following along in terms of announcing an increase? And; B, what is your projection on crude MDI pricing?

Peter Huntsman

Well, I think that I’ve never — internally and as we look at our pricing, we’d look at the internal matrix more than what we would ever look at what a competitor would be doing. But I’ve rarely frowned on the idea of raising prices and I don’t think I would here either.

But I do think though that it’s important to look back on slide number 4, a slide that I affectionally call the snake chart. And again this is not pricing. This is margin that we’re talking about. And so as you think about that polymeric side that red line along there look at the margins on — this is over a 10-year period. The margins today on polymeric MDI globally and this is a composite, this isn’t an absolute region, this is a composite of the global is they’re low today as they’ve been in the last decade.

And that would tell us that we probably — just from a pricing and price recovery and raw material recovery, investment justification we need to get prices up. Conversely if you look at the blue line on that where we expect to be moving the business into more of our formulated and I would say that that blue line represents about 60%, 65% of our overall volume in MDI. That blue line over a decade period, I would challenge you — again there have been a couple of ticks down from time to time there.

But I would challenge you that over the last decade to find another chemical in our industry that has had that sort of growth. I’m sure there are a couple of them. But by and large that blue line is where we want to be focusing the business. And when you look at that margin differential between the blue and the red, not only is it larger today than it’s ever been, but we also see that it’s almost double — the blue margin today is almost double what the red margin is.

So again I think that short-term economics we sometimes get caught up as to what prices are doing in the next quarter and the next month or so. But as I look at this over the next decade, I think that that’s a very compelling argument. But no, to answer your question directly around pricing if you look at that red line we’re in need of getting some prices up. And so we certainly would encourage our internal sales and marketing to be doing such.

Laurence Alexander

Good morning, Peter. Just to follow-up on that pricing discussion, how much of what you’re laying out is just the industry dynamic as opposed to Huntsman’s own value-based pricing efforts? And on the latter where are we in that process? I mean, early stages or is it largely tapped out at this point?

Peter Huntsman

Well, I think that when you look at the red again on the more commoditized polymeric that’s going to be driven by industry dynamics, I think more than anything else. When I look at the blue, I’d be foolish to say that the blue doesn’t have any correlation at all with the red.

But I mean, when you see macro spikes up and down on the red, you’ll also see some movement on the blue. But as you see on the blue, I like to think that we’re — I don’t want our customers that are buying the blue, that are buying formulated downstream products, I don’t want them to think that they’re buying a benzene molecule. I don’t want them to think that they’re buying polyurethanes. I want them to buy an effect. I want them to pay for what our product is capable of doing for them or changing their customer experience.

And so as we look at pricing on the blue side of the business, I think that again, while — I don’t want to say that it’s completely disassociated from the red. As we look at our Chinese business for instance moving business from the red to the blue taking polymeric pricing and moving that into a Tesla seating application as we have recently done that is going to allow us to take those molecules and to move them to the blue.

And we’ll be — our ideas around pricing that seat MDI steering wheel and so forth, which will have about 12 pounds per car produced in China for Tesla that blue pricing will be completely disassociated from what we see in the red side of the business.

Matthew Blair

Hey, good morning, Peter and Sean. Peter you provided some helpful color on the demand impacts from the coronavirus. You mentioned things like customers canceling orders. Could you talk about how the virus might be impacting the supply side of the equation, or are you seeing like competitor plant shutdowns? Any thoughts there?

Peter Huntsman

Yeah. I think that if you start looking at — I think a good indicator of this is probably our facility in — our MDI facility in Shanghai. It’s actually south of Shanghai. And as we look at that site, that is a site where even though we’ve got some — between the total joint venture some $2-plus billion invested in that site, we’re a relatively small player on that side.

You’ve got refineries and olefins facilities and other urethanes and oxygen all the ancillary power plants anything that entire site is being impaired is being shut back. I don’t want to say that the entire site is cold. A lot of facilities are idling and kind of operating in standby. But I would be shocked if there’s anybody in our industry of our competitors in China that are running at full rates right now and distributing unimpeded throughout China.

The other area just again anecdotally, I think that it’s probably safe to assume that the supply chain in China is extremely low. If a customer has product or has been keeping inventory, remember, it’s the logistics across the country that are being impaired and a lot of logistics within provinces are still open.

And so if I’m a customer and I’m producing footwear or components to the automotive industry or anything, I will be depleting my inventory and I’ll be depleting anything I can get from within that province.

So again I don’t want to be overly optimistic here but I would assume that how this virus plays itself out, there’s going to be quite a bit of restocking that needs to be taking place because this isn’t – with a product like MDI, products like our polyols, these aren’t products that we’re just stockpiling and stockpiling and filling up warehouses of this stuff. It doesn’t store like that.

Jim Sheehan

Great. And on MDI, particularly in Asia, we’ve seen weak pricing for a while, margins are pretty low and now we’ve got this pandemic. Are low margins in the business causing high-cost competitors to rationalize their idle capacity in your view? And alongside that, could you give us a sense for what operating rates were in the region heading into the coronavirus crisis and where that would be normalized?

Peter Huntsman

Well, I think that as we look at going into the fourth quarter, as we kind of came out of the fourth quarter we’re probably – we’re pushing close to 80% capacity utilization in Asia. And where we are today I think all the facilities are being idled and so forth, and so it’s exactly what the operating rates are today in the snapshot. I just don’t have a full picture of that.

But I would imagine that they’re operating pretty much in line with what the demand is right now if not unable to fulfill that demand. So as we look at the overall operating rates, I think that when you look at the size of the facilities in Asia, you’re going to see of the MDI capacity that is in Asia and that should probably read China for the most part, I don’t see anybody shutting back because of economics at this time.

I think most of the producers in China are – have a pretty close cost basis. And I don’t see economics at this point that would say that we’re going to shut down the facility. So today we’re largely idled ourselves and operating it and I say largely operating facility at 50% or less. And I would imagine the rest of the industry is kind of in that same boat.

Hassan Ahmed

Peter, wanted to follow up on the MDI sort of supply-demand situation. And as I took a look at your Q4 numbers I mean, volume growth within Polyurethanes was up 4% year-on-year, which with all the sort of macro headwinds and the like is clearly not a bad figure. I mean leaving the impact of coronavirus aside with the macro continuing to look the way it has been, where do you see that underlying demand MDI-wise in 2020, 2021? And part and parcel with that, obviously we’ve heard about some MDI sort of facility curtailments, some project cancellations, some delays. How are you thinking about the near term? And when I say near term, call it the next year to three years in terms of global utilization rates.

Peter Huntsman

Yes. Well, our prior year — our quarter-on-quarter growth, fourth quarter 2019 versus 2018 we were up 6%. And a big chunk of that was from Asia dealing — because of the new capacity that we were able to bring in during that time period. So, I think that probably had as much to do with the 6% growth as did anything. But we still saw a 6% growth in Europe.

But again I’m not trying to pour cold water on that. That was in part because a year ago as you remember in the fourth quarter of 2018, we were still — the beginning of that quarter, we were down at the beginning of 2018 if my memory serves right from an overall site outage dealing with a third-party plant T&I. And so a lot of that growth is taking place in China.

As I look at the overall capacity utilization again assuming that there’s not a macro recession or something like that if we continue to see global growth of around 4% to 6% in MDI.

I don’t see any grassroots facilities that are coming on over the course of the next two to three years in that time period that you’re specifying. There will be some construction projects, no doubt and there might be some brownfield expansions around plant debottlenecks and so forth. But as far as world-scale capacity entering into the market I just don’t see it. If anything we ought to be looking at tighter times.

Eric Petrie

Hi, Peter. It’s Eric Petrie on for P.J. You talked about international expansion for your spray polyurethane foam. I was wondering if you could talk about, the EBITDA margin, if you were to take that product to Europe as well as Asia. And then, could you talk about the competitive landscape?

Peter Huntsman

Well. It should be — the competitive landscape in many of the areas, where we’re starting to grow the business is virtually non-existent. And — which is very good. But the, urethane supply chain again is coming from those regions.

I talked earlier about starting up a polyester polyol facility, in Taiwan. And I would see that, being able to — well I would see that, being able to supply our Chinese spray foam in Southeast Asia spray foam markets, out of Taiwan on the polyester polyol side. And the MDI side of that will be coming out of our facility in China.

As we look in Europe, we would be supplying those markets, out of those areas as well. But, this last year was our first year that we had international growth in our spray foam businesses. And that was for the most part all organic growth on our behalf.

And we — I think we’ve made about $5 million or so of EBITDA this last year. So, again starting from nothing, it’s — but it’s — we’re seeing very good growth. And we’re going to be very aggressive in those international markets.

Eric Petrie

Okay. And for my follow-up question, have you seen any pricing concessions in your differentiated downstream, MDI with the lower raw materials? And how often do those price contracts reset?

Peter Huntsman

Yeah. No. The answer is no. We haven’t. And as far as the price contracts, yeah, I would just say that, we’re dealing with end-use applications that would go into the 10,000-or-so different customers, plus customers.

And every one of those customers, every one of those applications, every one of those formulations, are going to have different price movements and times and so forth. I don’t want to leave the impression that at the end of every year or somehow in the summertime, that we’re continuously, kind of getting into a season to renegotiate prices.

Our terms on the downstream businesses go anywhere from 3 to 5-plus years. And so, it all really depends on the application, the customer. In the automotive industry you’re typically specking in for a 3-to-5-year period on a particular model.

On a short-term basis, you might be looking at a couple of months on other applications. And so, — and these are all going to be different as you go further-and-further downstream.

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