Urethane Highlights from Huntsman Earnings Call
November 7, 2022
Huntsman Corporation (HUN) Q3 2022 Earnings Call Transcript
Nov. 04, 2022 2:00 PM ETHuntsman Corporation (HUN)
Q3: 2022-11-04 Earnings Summary
EPS of $0.71 misses by $0.00 | Revenue of $2.01B (-11.99% Y/Y) beats by $166.90K
Huntsman Corporation (NYSE:HUN) Q3 2022 Earnings Conference Call November 4, 2022 8:00 AM ET
Ivan Marcuse – Vice President of Investor Relations
Peter Huntsman – Chairman, President & Chief Executive Officer
Phil Lister – Executive Vice President & Chief Financial Officer
Thank you, Ivan. Welcome, everyone. Thank you for joining us this morning.
Let’s turn to Slide number 5. Adjusted EBITDA for our Polyurethanes division in the third quarter was $138 million. Overall, sales volumes in the quarter declined 16% with Europe accounting for over half of this decline the Americas for about 35% and then China for about 10%. These declines were caused by a combination of inventory destocking throughout the supply chain and falling demand. Europe is clearly in a recessionary economic environment which could potentially get worse over the coming months due in large part to high and volatile natural gas and energy prices.
In Europe, natural gas prices have been moderating since peaking at the end of August but remain at historical high levels. And moving forward, prices remain dramatically higher than in the United States. We expect and are planning for high and volatile natural gas prices in Europe for the foreseeable future. As we mentioned on our last earnings call, we do have the benefit of 60% of our natural gas-related production costs via our nitrobenzene and aniline facilities, or in the U.K. where natural gas prices have been lower this year versus Mainland Europe. Despite this cost advantage, our profitability has been significantly impacted in Europe and we will have to lower our cost structure in the region to generate acceptable returns.
Over the long term in Europe, outside of the current recessionary environment, we do expect to be a large beneficiary of energy conservation initiatives. The world and Europe, in particular, need increased levels of insulation to reduce energy consumption. We remain well positioned to bring solutions to both the residential and nonresidential markets. Demand in China continues to be impacted by lower overall economic growth as the government mandates a zero COVID policy and the impact it is having on its economy, as well as lower construction activity. Improvements around the COVID situation and possible economic stimulus to get the economy going in the right direction would be a catalyst for our business to improve in the region. Lower propylene oxide margins in China drove our equity earnings lower year-over-year.
Our joint venture contributed approximately $18 million in equity earnings for the quarter, below the $32 million reported a year ago. Given current levels of PO margin, we expect the equity earnings could be approximately $70 million lower in 2022 versus the record earnings of 2021. The impact of rapid increasing interest rates in the United States as the Federal Reserve fights higher inflation is having a real impact on the residential construction markets. We’re seeing this clearly in our OSB, spray foam and furniture businesses.
HBS, our spray foam insulation business, saw revenues decline 22% compared to last year as we saw deinventory through the quarter. In an early part of the fourth quarter, we’ve seen a slight improvement in order patterns but we anticipate the greater than 7% mortgage rates will be a clear headwind going forward. As a result of slowing demand and our expectation for this environment to continue for at least the next several months, we are taking swift near-term and long-term actions to address these challenges. I’ll make further comments in my closing remarks but suffice it to say, we will be taking out more costs in our polyurethane businesses going forward.
In the short term, in polyurethanes, we’ve adjusted our MDI production to match demand. This will do 2 things. On the positive side, it will help to manage our inventories and costs as our focus on cash generation is a top priority. However, the lower production will have some negative impact on our fixed cost absorption and delay the positive impact of lower benzene prices moving through our income statement. Moreover, we are aggressively moving forward on the cost reduction plans we discussed last quarter and have been in the process of implementing which include exiting current certain regions that are not generating an acceptable return such as Brazil. And we also continue to consolidate certain back-office functions. Our Polyurethanes automotive platform, again saw improved volumes year-over-year of 18%.
Looking through a recessionary environment, we have an automotive business that is well positioned and poised to recover over the coming years. Looking into the fourth quarter, we expect Europe will generate a loss. We expect continued destocking in the United States. The economy in China looks like it will remain muted. As a result, seasonality will be much more pronounced this year due to all the headwinds impacting demand as well as costs. As we sit here today, we expect polyurethanes adjusted EBITDA for the fourth quarter to be in the range of $55 million to $85 million and below 10% margins due to European market conditions.
Phil, thank you very much. In the past 12 months, the global economy has gone through a number of shocks and unforeseen events. These include 40-year high inflation and the related consumer reaction. The most devastating destabilizing European land war since the Second World War, trillions of dollars of value wiped from the global markets and unprecedented energy volatility with its related supply chain challenges.
In light of these events, it is worth reviewing those things within our control and how we are responding to events outside of our control. First, we announced today in Europe a European-based restructuring that will take a minimum of $40 million out of our European businesses. I think it will be some time before Europe fully picks up the pieces of its failed energy policies. However, I believe that any new normal will be based on a gas plus transportation to supply their needs, where Russian gas supplies to Europe usually sold at a slight premium over U.S. prices, I think that Europe will now find itself competing with Korea, China and Japan to name a few for gas imports.
If I look over the past decade, gas has been sold in these export markets at a premium of about $5 per MMBtu over historic gas prices in Europe and North America. If Europe is to endure a $5 per MMBtu gas charge for freight, this will cost Hunt spend approximately $40 million to $50 million per year. This is our initial target for cost reduction.
We are announcing today the closure of 2 of our divisional HQ and a series of initiatives that will permanently remove an excess of $40 million from our European businesses. Let me be clear. This is not an abandonment of any of our $2 billion European commitment but rather a recalibration of a business based on the realities of cost, customers, investor expectations and having a business built around those customer requests that will provide future growth and opportunity. We will complete this by the end of 2023. This will be in addition to the $240 million that we outlined at last year’s Investor Day presentation.
The second variable is how customers are managing inventories. How much of our drop in demand are inventory controls by our customers? And how much is consumer sentiment and falling consumer demand varies customer by customer? Broadly speaking, we would estimate that about half is inventory control and should work itself out by year-end or early 2023. Either way, we’re operating our facilities to match our own working capital objectives and the needs of our customers. We are also supplementing some of our production needs with imports from outside Europe.
Our immediate priority continues to be to complete our operational and restructuring objectives. Continue to work with our customer base to understand their longer-term needs and make sure our pricing and margins are what the market will bear. Through 2023, the worst mistake we can make is to wait for conditions to fix themselves. We will be aggressive. We’ll do whatever we can as quickly as we can to recover the profitability and returns our investors deserve and our company needs to restore our European business to where it should be.
Throughout 2023, the U.S. will start to get control of inflation and I believe we will see China rebound as it refocuses more on economic growth. Europe will start to stabilize and there will be winning industries and those that will move out or move on. We’ve taken the right steps to assure that we are in a position to take advantage of any of these improvements as markets dictate.
Peter, can you talk about your asset footprint in polyurethanes? I think last quarter, you sort of advertise some work you’re doing in Brazil. Do you see potential to continue that rationalization in markets like Asia?
Yes, we’re looking at various areas in Southeast Asia. Without getting into too much detail, some of those facilities we’ve looked at shutting down and other of those facilities we’re looking at selling off or perhaps giving the option of giving a facility over to a partnership or something. So again, some of those are in motion right now. But having said that, I think, again, longer term, where we want to see our volume concentrated or in those markets where we are going to see a value over volume strategy. That means that we are going to be looking for those markets where we can move the production that’s coming out of our splitters. We can move the higher end, less volatile, higher-margin materials. And that’s not something that’s going to happen overnight but it’s a 2-year or 3-year transition and commitment.
And I believe that we’re probably 1/3 of the way halfway through that. And so it’s a combination of how quickly can we shut down those assets and move them in an orderly manner and how quickly can we reabsorb that tonnage into new applications and into qualifying applications. So it’s not just a question of moving the product instantaneously. In many cases, we’ve got to go through a qualifying process. It would take several months.
How is the loading on the new splitter going? And do you think the slowing economy is going to delay your ability to load that?
Well, again, I think that the single biggest product that we’re moving out of that split is in the automotive sector. And that continues to be a very good sector for us right now. We also see a lot of flexible foam that is going to be coming out of that splitter and that’s again, got both residential and automotive applications to it. But again, as we look at the automotive market, I think it’s going to be very interesting over the course of the next year. How much — how many of the OEMs in the automotive sector are going to be relocating from Europe to North America and shifting a lot of their products back. And when I said in my comments, we’re speaking with a lot of our customers, I think that over the course of the next year or two, you’re going to see quite a few customers moving production, European production, particularly in areas of aerospace, automotive and so forth to either China or more likely to North America and then reexporting, if you will, that product back into North America.
Peter, on your Slide 12, looking at 2023, you listed a number of positive and negative or challenges. Any early thoughts on ’23 EBITDA relative to the roughly $1.2 billion you’ll do this year?
Boy, David, I appreciate the question. You give me the variables and I’ll give you the number. Without trying to sound too evasive here, I think that the year will probably look a lot like 2022 but backwards, if you will. I would hope that we will see improvements throughout the year as we see the impact coming in of our cost reduction initiatives and further opportunities we have to move product through our Geismar splitter as we see the capital that we’re investing come to fruition, as we see the full integration of recent acquisitions and so forth. I think that even if it stays to be a pretty flat year, we’re going to see those improvements sitting throughout the year. And so I’m not overly optimistic but I’m rather optimistic as we go through the year we’ll do better than the market on a relative basis.
And like I said in my prepared comments, I think that throughout the year, we’ll start to get a handle on inflation. A lot of the inflation in the U.S. is due to our own failed energy policies here. And I think that a lot of that is going to be addressed here after the first of the year. And I do have confidence that China, when it does fully open economically, I think is going to open with quite a sharp uptick in demand given how long these — the restrictions have been on economic growth.
I just wanted to talk a little bit more about MDI and the competitive environment you’re maybe seeing there. You noted that you’re running your assets at about 50%. So curious what are you seeing kind of the broader industry. And particularly, as you think about pricing dynamics and your efforts in passing through costs and surcharges, can you just talk about maybe how that’s progressing, how it’s kind of evolving? And within that, maybe give a little bit more color on the energy assumptions for your fourth quarter versus what you maybe need to recoup and potential benefit?
Yes. Our energy forecast going into the fourth quarter, safe to say that they’re pretty parallel to where the market — forward-looking market numbers are right now. If you were to look at the forward trading numbers for the month of December and for the remainder of November, it shows a gradual uptick in those months. If the temperatures remain warmer than usual, they have so far this season in Europe. I think that you might — we might actually see a bit of a tailwind coming from lower-than-expected gas prices. With the areas on pricing, look, we’re going to continue to be pushing prices and surcharges wherever we can. But we’re not going to do that at the destruction of our customer base.
And I think that we’ve been a leader, particularly relative to our size here in Europe on pricing and on trying to move costs through as aggressively as we can. And we’ve clearly have put the value of our product over moving volume. I think you can look across the competitive polyurethane landscape. And as I look at our third quarter numbers, we were able to offset all of our raw material increases in the third quarter through pricing and through pricing discipline. I think that says something about the seriousness of — and our commitment to our pricing over volume.
Now having said that, I think that as you start getting into year-end as far as what customers, what customer segments are and so forth, we are disproportionately weighted towards probably the automotive industry. Some of the insulation industry, the footwear, the ACE markets and so forth, CWP. Other polyurethane players are going to be more weighted than us towards appliances and towards synthetic leather and towards other applications. So I wouldn’t necessarily want to read that whatever we’re doing is what the rest of the industry is doing and vice versa. So I wouldn’t feel comfortable commenting on what others might be seeing with their margins, with their demand and with their capacity utilization.
But as we said, we’re going to be focused on. This is not a time to be also to be running plants to try to build inventory in our opinion. It’s coming to the end of the year with the amount of uncertainty. We’re trying to match very closely our production to customer demands.
Peter. You mentioned you’re running your Rotterdam MDI plant at about 50%. You’re relying on some imports and overall EBITDA negative in Europe for MDI. Is it possible to shut this plant down and fully rely on lower-cost imports? Can you talk about the considerations there?
Yes. Well, of course, it’s possible to do that. I’m not sure that it’s very practical to do that just because there are 2 things that you have. You have a number of fixed costs that are going to be there whether you run the facility or not. Those are going to be fixed costs that are going to include your minimum take-or-pay agreements, people that are building hydrogen and CO units. Next are your facilities that are supplying new utilities, your labor costs and so forth. We’re not going to fire all of our people then and rehire them back in 6 months. So all of those fixed costs you’re going to have, if you idle your facility regardless or not. Another thing that I would say and this is — typically, again, I say typically, MDI plants don’t operate very well under 50% capacity utilization. You’re basically making — this is a highly technical term here but you’re basically making glue. And you’re moving glue through your pipes and so forth and through your process. And as you slow that down, you have greater and greater risk of gumming up the facility, if you will. And typically, these plants just don’t do very well, much under 50%. So I think that’s about as low as you can go until shutting the plant down.
I will remind you that of our European facility, we do have 2 lines there. Think of roughly a 35/65 sort of split on capacity, so we could shut down the smaller unit if we wanted to and run harder on the larger, newer units. We did that in Geismar Louisiana during the 2008 and ’09 recession. We had 1 of our units that was down for over a year.
The other variable that I would just ask you to keep in mind as you think about the idea of movement of MDI globally. We thought very long and hard about moving MDI last August from the U.S. into Europe when European gas prices were at $100 and spiking at $100 per day. At that point, there was over $1,000 per ton difference between U.S. prices and European prices. Now again, when I say $1,000, remember that about $400 of that has to be chewed up through freight, logistics and handling and so forth. What that $400 million does not include is also your working capital, the specifications and so forth. And you’re thinking that it takes about 2 months, give or take, a couple of weeks on that number to get the product here. So had we been moving product in August building inventory to move it year end of September, moving it, you would have been arriving product here in November, where gas prices are around $10, $15. So it wouldn’t have made a great deal of sense to move MDI when you do that, you’ve really got to be taking a speculative hedge, if you will, that what I’m going to be moving today is going to be competitive 3 months down the road. And so a lot of variables in that.
So again, Matt, I’m sorry, this has been a convoluted answer but it’s just a lot tougher than most people say to move product around. If you’re going to do it, it’s got to be something that really under normal business conditions under today’s environment on a normalized basis, you’re willing to do that. and you’re willing either to shut down a plant in its entirety and supplement that from overseas. Or you’re just going to bite the bullet and take the risk on some of these sort of things. But as far as shutting down our Rosenberg facility, our European MDI capacity, I don’t see market conditions getting to that point. As I sit here today, I don’t see market conditions getting to that point where we would be idling that plant, the entirety of that plant.
And in reality, our cost competitiveness on the cost curve of Rotterdam which is the second largest facility, MDI facility across all of Europe remains extremely attractive relative to others, particularly with the position that we have in U.K. energy intensive and aniline production at a much lower natural gas price to mainland Europe.
As you move volume out of the HBS business. Is that PU production going off-line? Are you moving those polymeric molecules into other markets? And when you do that, what is the — is there a margin headwind from that mix shift? And what would that look like?
That will all depend on the demand of the market, pricing and the margins that we have at that given point. Ideally, most of that product that we’re moving in to HBS, it does have other homes in spray foam and in rigid insulation applications. And so we have an opportunity to move that. If we’re not moving in HBS, we have an opportunity to move that. But typically, it’s also the same product I would mind you that goes into CWP, the composite wood production, OSB and plywood applications.
I would remind you, though, that typically is our lowest margin MDI. It’s our polymeric, it’s our commodity-grade MDI which is one of the strengths of HBS is that you’re taking what otherwise would be some of your lower margin materials and moving it upstream, if you will. So typically, I’d like to think that we can find a home for it. But there’s not a — it’s not necessarily a black and white answer. That all depends on market conditions and alternative places where you place that tonnage.
And typically, if we’re moving that product through HBS, it’s not only a polymeric MDI. We’re also matching that with an aromatic polyester which is our own technology which we purchased back in 2013 and that’s what makes it a much more attractive proposition as we’re selling a formulation downstream into the market rather than just a component polymeric MDI.
Just on the European restructuring, is it fair to characterize it as currently mostly a cost realignment because your customers haven’t yet made their repositioning decisions. And so was there probably another round of European restructuring needed once they’ve made their decisions but also if capacity is going to be moving to the U.S. and China, do you have sufficient capacity in place to handle the next up cycle if there’s also going to be a structural shift in capacity into those regions? So I’m thinking particularly on the MDI side.
Yes, excellent question, Laurence. I would say that no, on the program that we’ve announced today, you’re looking at roughly around 300 positions. And we’re really trying to calibrate this business around what we believe to be the new market reality. And look, as I look around Europe, I look at areas like insulation, aerospace, lightweighting, spray foam. A lot of the infrastructure spending. A lot that’s going to be going into automotive. These are going to be continuing markets in Europe. And they’re going to continue to prosper and so forth. And we’re going to continue to need technical support and a business infrastructure to support these.
Now they’re also going to be, as you well know, more energy-intensive customers and energy-intensive applications that have already talked about moving. And some of those or some of the OEMs, if you’re producing anything that’s going into somebody that’s producing glass or materials that are going to the automotive in those areas and coatings and some of the adhesions and applications, those are going to be moving out because they’re more energy intensive. Again, not all of them but some of them are going to be moving out. And we’ve tried to calibrate all of those as best we can.
And I think that what we’ll be doing today and not just eliminating the positions but also in relocating, Again, we’ll be relocating somewhere between 125 to 150 of those positions to Krakow, Poland where we have about a 35% lower labor cost on, again, depending on the position and from which country they’re coming. So as we look at that arbitrage, I don’t see us coming out here 6 months from now or 12 months from now and saying we’re going to go through another cut and another repositioning because of where we see customers falling out. I think we’ve given that a lot of thought over the last 6 months and I think we have a pretty good idea as to who’s going, who’s staying and which customers are going to be here on a longer-term basis. And frankly, who’s going to have the financial strength. A lot of customers today. We’re not just looking at margins of our customers, we also have to be looking at the creditworthiness of our customers.
As we look at that excess material and do we have the product to supply all of our customers I’d like to think that we will. But as we’ve said the last couple of quarters here, we’re in the process of transitioning and we’re going to continue to transition. So as we see a lot of this customer base move from Europe to North America, we are going to be moving volume from lower-margin areas of South America and less profitable applications into North America. As everybody on this call knows. We just recently opened up our splitter in Geismar, Louisiana. We’ve been pulling out of some of the polymeric applications that we’ve supplied over the last 15, 20 years. And we’re moving that tonnage into downstream businesses as well.
So again, to the extent that we can’t supply everybody that’s moving and we’ve got shortages, frankly, it’s an opportunity for us to do some bottom slicing and take some of that polymeric lower-margin business. If it’s not as profitable as we’d like to see it, split it, upgrade it and move it into higher end applications. And frankly, we have that ability to do that in in China. We have the ability to do that in Europe and in North America. And those volumes can also be supplemented with purchased polymeric MDI, crude MDI from around the world as well. It doesn’t just have to be our MDI. So I feel very good about not just our ability to supply MDI but more importantly than supplying MDI, we want to supply profitable MDI. We want to supply it where we can have — we can be fulfilling a niche where we can get a little bit better edge on pricing, margin and reliability. And that, at the end of the day is the urethanes business that we continue to try to build here.
Operator, with that, we’d like to thank everybody for taking the time to hear us out this morning and wish everybody the very best.