Urethane Highlights from Stepan Investors Call

Stepan Company (SCL) Q3 2023 Earnings Call Transcript

Company Participants

Luis Rojo – Chief Financial Officer

Scott Behrens – President and Chief Executive Officer

Scott Behrens

Good morning and thank you all for joining us today to discuss our third quarter results. I plan to share highlights from our third quarter performance and will also share updates on our key strategic priorities, while Luis will provide additional details on our financial results.

The company reported third quarter adjusted net income of $14.7 million. Earnings were significantly impacted by a 9% decline in sales volume versus the record prior year third quarter due to continued demand softness across most of our markets and continued inventory destocking in certain market channels.

In the third quarter, Surfactant unit margins were lower versus the prior year, due to less favorable product mix, high cost raw material inventory carryover and pricing pressure in Latin America from imported products. Volumes in Latin America grew by high-single-digits, compared to the second quarter. Specialty Product unit margins were significantly lower due to high-cost inventory and pricing pressure related to increased MCT import activity.

Expenses were slightly lower versus prior year due to proactive headcount and discretionary expense controls implemented earlier in the year and lower incentive-based compensation approvals. We recorded a $4.1 million after-tax restructuring reserve for the transition of employees participating in our voluntary early retirement program. We continue to make significant progress on our cash objectives, reducing our inventory levels by $55 million. Finally, we completed our low 1,4 dioxane capital investments and continued our alkoxylation project in Pasadena, which is expected to be operational in mid-year 2024.

For the quarter, adjusted EBITDA was $48 million versus $85 million in the prior year quarter, primarily driven by the decline in sales volume. Adjusted EBITDA in the third quarter of 2023 was slightly higher than the second quarter of 2023 adjusted EBITDA of $46 million. Surfactant operating income was $15.4 million versus $39 million in the prior year and $15.1 million in the second quarter of 2023. The decline versus prior year was primarily due to a 7% decline in global sales volume and lower unit margins in Latin America, driven by competitive pressure from imports.

Demand within the agricultural end market remained low, due to continued customer and channel inventory destocking. Polymer operating income was $21.8 million versus $31.9 million in the prior year and $16.3 million in the second quarter of 2023. The decrease versus prior year was primarily due to a 12% decline in global sales volume, driven by a 10% decline in Rigid Polyols. Unit margins for global polymers remain in line with previous year.

Luis Rojo

Thank you, Scott. My comments will generally follow the slide presentation.

Let’s start with the slide four to recap the quarter. Adjusted net income was $14.7 million, or $0.64 per diluted share, versus a record $46.3 million, or $2.01 per diluted share, in the prior year. Because adjusted net income is a non-GAAP measure, we provide full reconciliations to the comparable GAAP measures. This can be found in Appendix 2 of the presentation and Table 2 of the press release.

Specifically, the adjusted net income for the third quarter, exclude deferred compensation income of $2.1 million versus $1 million of income in the prior year. It also excludes business restructuring of $4.3 million of after-tax expenses. This business restructuring reserve is driven by the company’s voluntary early retirement program. The deferred compensation figures represent the net income related to the company deferred compensation plan, as well as cash-settled stock appreciation rights for our employees. Because these liabilities change with the movement in the stock price, we exclude this item from operational discussion.

Slide five shows the total company net income breach for the third quarter, compared to last year third quarter, and breaks down the decrease in adjusted net income. Because this is net income, the figure is not here and on an after-tax basis. We will cover each segment in more detail, but to summarize, we experienced lower operating income in all segments versus prior year.

Now turning to polymers on slide seven. Operating income for polymers was $21.8 million. We continue delivering sequential growth quarter-on-quarter, driven by mid-single-digit volume growth. Volume increased 6% versus the second quarter of 2023, driven by high single-digit growth in global Rigid Polyols. This was partially offset by a 25% decline in our commodity PA business. Finally, specialty product operating income was $2.4 million, down versus the second quarter of 2023 at $3.8 million. This reduction was primarily due to order timing differences.

Vincent Anderson

Okay. No, that’s helpful. If I could shift over to Polymers. It was kind of looking to just get your thoughts on where you are with some of the opportunities in Polyols. Maybe a bit longer term, but thinking about spray foam products and then maybe any progress towards converting a former INVISTA asset to run PA. Just curious if you’ve been able to push those a little bit harder in this weaker demand environment or if that’s something that we should return to maybe next year?

Scott Behrens

Yes. Vincent, I would say our activities with our prospective customers in spray foam continue at a very robust pace. I do think that market has been impacted by the overall market conditions, but that has not stopped our pursuit of new customer approvals, and that business and the outlook is still positive from our perspective. With regards to PA, there are no plans or intentions to put PA into the INVISTA assets. Millsdale is our PA production site, and that will remain our only PA production site going forward.

Vincent Anderson

Okay. I was — I apologize if I was unclear. I was referring to using your Millsdale PA as a feedstock into one of the INVISTA plants. Not…

Scott Behrens

We did the integration of the business in ‘21. Vincent, so whatever raw material and operational synergies that we’ve gotten though were taken care of in 2021.

Vincent Anderson

Okay. All right, that is all from me. Thank you. Thank you very much.

David Silver

Yes, hi. Thank you very much. I’ll stipulate here. I did have to step away for a couple of minutes during your remarks, so I apologize if I make — apologize in advance if I make you repeat yourself.

I did want to maybe just start with the Polyols segment. And in particular, I did want to talk about — ask you about the improvement in a couple of areas. So the per unit margins, I guess. So, sequentially — on a sequential basis, you had higher operating income and I think, kind of, flattish or slightly better shipment volumes. And then I did pick up on the comment about improvement from China, and assuming that these products are mainly used in the construction area. You know, I was kind of scratching my head and wondering if you could provide a little color. I mean, I wasn’t aware that the construction segment in China in general was especially robust now. So, just a couple comments there would be helpful. Thank you.

Scott Behrens

Yes. Good morning, David. Regarding unit margins in Polymers, so we have been reporting in the last couple of quarters, you know, we’ve had a significant raw material headwind. And as we continue to work through those raw material headwinds matching our pricing structure. You know, our margins, we believe, are now stabilized. And you can see the sequential volume growth between Q1 to Q2, and now Q3 — Q2 to Q3. We do believe that the stocking has run its course and we’re back on a positive trajectory towards more and more normal market demand in the Polymer space.

As it relates to China, since that asset was fully commissioned three, four years ago, we’ve been on a diversification strategy of unused markets and applications. And I think what you’re seeing is the result of our team’s efforts in bringing a much broader diversification of markets and product technologies to that site.

Luis Rojo

Yes, remember, we use that site, it’s a different end market when you think about [coal] (ph) storage and all of that is not typical insulation that we do here in the U.S. or Europe. And on top of that, the team has done a fantastic job diversifying to other businesses, and using the assets in different end markets. And that is what is driving a very strong double-digit growth in Q3.

David Silver

Very good. Thank you. And I did just want to pick up on Scott’s comment about destocking being largely completed, I guess on the Polymers area. But I think, if I mess that with the comments in the press, I mean, you are still pointing to inventory liquidation and destocking into the fourth quarter, I believe. And I guess that would make maybe at least four, maybe five quarters where destocking has been in effect.

And you know, from a big picture perspective, should the fourth quarter be, I don’t know, the bulk of having the destocking behind us. And I did notice you know, there’s customer destocking and then there’s your own inventory drawdowns. I was just wondering if you might be able to draw a contrast between the two?

Are the customers largely through it, but maybe there’s going to be a big reduction at the company level or how would you just characterize the overall progress in draining, I guess, this overall supply chain of excess product maybe built up during the pandemic and during some concerns over supply chain reliability. Thank you.

Luis Rojo

David, so what Scott was mentioning was destocking is almost done in the Polymers business. There is a pocket in the West Coast, due to rain and other activities where not all the construction activities were able to be executed. So there is a small piece there remaining, but most of the destocking in Polymers is already flushed through. What you see in Q4 in Polymers is the normal seasonality of the business, right. If you go back five, 10, 20 years, Q4 is our lowest quarter in term of demand, because of course, a lot of winter state don’t execute a lot of reroofing activities during the winter. So, that’s only seasonality.

And then when you look at surfactants, we have — what we are seeing is destocking is mostly done in all the cleaning personal care markets. And what is remaining is ag. We believe ag will continue, the destocking in Q4 and we will have more perspective in February, how we see Q1 and Q2.

Scott Behrens

In the ag destocking, lagged the consumer and Polymer’s destocking activities by almost two quarters.