Eastman Chemical Q2 2021 Earnings Call Transcript

AlphaStreet
Provided by AlphaStreet
August 3, 2021
Skip to Questions & Answers
Operator

Good day, everyone, and welcome to the Second Quarter 2021 Eastman Chemical Conference Call. Today's conference is being recorded. This call Is being broadcast live on the Eastman's website, www.eastman.com.

We will now turn the call over to Mr. Greg Riddle of Eastman Chemical Company Investor Relations. Please go ahead, sir.

Greg Riddle
Investor Relations at Eastman Chemical

Thank you, Christina, and good morning, everyone, and thanks for joining us.

On the call with me today are Mark Costa, Board Chair and CEO; Willie McLain, Senior Vice President and CFO; and Jake LaRoe, Manager, Investor Relations. Yesterday after market close, we posted our second quarter 2021 financial results news release and the SEC 8-K filing, our slides and the related prepared remarks in the Investors Section of our website, www.eastman.com.

Before we begin, I'll cover two items.

First, during this call, you will hear certain forward-looking statements, concerning our plans and expectations. Actual events or results could differ materially. Certain factors related to future expectations are or will be detailed in our second quarter 2021 financial results news release. During this call, in the preceding slides and prepared remarks, and in our filings with the Securities and Exchange Commission, including the Form 10-Q for first quarter 2021 and the Form 10-Q to be filed for second quarter 2021.

Second, earnings referenced in this call exclude certain non-core and unusual items. Reconciliations to the most directly comparable GAAP financial measures and other associated disclosures, including a description of the excluded and adjusted items, are available in the second quarter 2021 financial results news release, which is available on our website.

As we posted the slides and accompanying prepared remarks on our website last night, we will now go straight into Q&A. Christina, please let's start with our first question.

Remove AdsSkip to Participants
Operator

[Operator Instructions]

Take our first question from Mike Sison with Wells Fargo.

Mike Sison
Analyst at Wells Fargo & Company

Hey, good morning, guys. Nice quarter.

Mark, I guess, when we think about the second half of the year, how much of the improved outlook do you think will come from the specialty businesses and how much of it comes from the Intermediates?

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

Sure. Good morning, Mike, and it's a great day here in Appalachia, beautiful morning. And we're really excited about the results we had in the second quarter and to your point, really excited about the momentum we're building in our specialties as we go forward into the back half of the year, which will be the driving force for earnings in the back half.

When you think about it, we had strong volume and mix growth in the specialties, especially relative to last year or '19 or even '18 in the progress that we're making and that momentum will continue into the back half of this year. Some of that strength in volume and mix growth was offset by, sort of, temporarily high, sort of, distribution costs and some of the other supply chain factors that we faced in the second quarter, and expect those to abate. So, not only do you get the volume and mix growth, we get some improvement in spreads relative to the first half. So, that's going to drive a nice improvement for specialties. And I would say that it's going to hold up better, I think, in the fourth quarter than what is normal seasonality as we look at the lack of restocking customers have made to date and we don't think that they're going to make much progress on it really through this year and that will extend into next year. So, that's a big driver.

In addition to that, you've got lower shutdown costs, a lot of that hit AFP, in particular. So, you've got that as a benefit. You've got lower operating costs from all of our operational transformation work. And as I mentioned earlier, this distribution coming off the, sort of, spike that it was. There are, of course, headwinds as we expect some moderation in spreads in Chemical Intermediates and we have increasing gross spend. So, there are some factors that offset some of that, but it's definitely much more of the specialty story and how you deliver a back half, that's better than the first.

Mike Sison
Analyst at Wells Fargo & Company

Got it. And as a quick follow-up, Slide 6, I noticed that you got a lot of cool companies, incentives of the new Q2, sign-ups or commitments for your new facility. Are you close to filling out that facility at this point? And at what point, do you sort of consider may be continuing to expand, given the momentum you've had there?

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

Yes, Mike, great question. So, we're really excited about how our Circular Economy investments are both solving a serious challenge in the planet, a dual challenge really of getting plastic waste out of the environment and deploying a technology that avoids using fossil fuels and does it in a way that it has a lower carbon footprint than our current traditional process. So, really a win on both fronts.

And our customers see that benefit. It's important -- both elements are really important in the solution and we've had tremendous engagement. As we talked about in the first quarter, you saw a spectrum of brands signing on to take our recycled content, both from our polyester renewal technology as well as our carbon renewal technology into the biopolymers. And getting P&G and Ferragamo, and a variety of other brands to sign on top is putting us in a great position to fill out this first facility that we're building that will come online. And we're already getting benefits from this because we have a bridging capacity in place with our current assets. So, we're building volume and momentum this year and into next, it's part of our growth story. But, with these commitments, we're going to be in a good position to sort of fill out that plant really quickly with specialty products, which is great.

And that's the best way to build a plant when it ramps up for, especially in specialty product line, that's not normal; and certainly, improves the return. And yes, there are interests in going beyond this. We have a core specialty strategy we're really excited about, we're going to continue to invest in that. But, beyond that, a lot of customers out there in the fast moving consumer goods world still have to do a lot of packaging and they have realized that the best carbon footprint is plastic. It's important to keep that in mind when you think about solving these problems. Because in our world of polyester glass has double the carbon footprint even with much higher recycling rates than polyester dye in aluminum is 50% higher.

So, we need to solve this problem. Our brands understand this problem needs to be solved by recycling polymer, as the best carbon footprint solution as well as a way to get the waste out of the environment. So, we have a number of countries actually engage with us about how to help them think about solving their waste problem and we have a number of brands engage with us on how we would potentially build facilities for their packaging needs that really solves this dual challenge. And so, we're engaged. But, to be clear, we're not going to get back into sort of merchant PET business. We are happy to get back into making this product, but it's got to be in a more Airgas model.

We bring a lot to the table in the technology that's proven and scalable, we have a lot of operational capability, a lot ability to build and scale up facilities as well as operate them really well and a lot of history with methanols that allows us to know exactly how to operate this kind of technology, which is difficult when you've got a variable feed stream of content coming into it. And for what we bring to table, we want sort of spread stability. So, we need to have long-term contracts with customers that give us a, sort of, predictable margin and as well feel certain we've got access to raw material supply, which is significant but still complicated to access.

So, if we meet these conditions, we will for sure build these facilities. And we think that the return on capital and the amount of EBITDA, each of these facilities could generate, would be quite substantial. We're not going to get into the details of that now, but we're really excited about doing this, but it depends on the customers and the countries engaging in the right way. And hopefully, we'll be able to build several of these plants going forward.

Mike Sison
Analyst at Wells Fargo & Company

Right, thank you.

Operator

Take our next question from PJ Juvekar with Citigroup.

PJ Juvekar
Analyst at Smith Barney Citigroup

Hi, good morning.

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

Good morning, PJ.

William T. McLain, Jr.
Senior Vice President and Chief Financial Officer at Eastman Chemical

Good morning, PJ.

PJ Juvekar
Analyst at Smith Barney Citigroup

It feels like Friday with the Eastman call.

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

It does. I'm a little disoriented about 9:00 AM too, I'm still trying to get used to that.

PJ Juvekar
Analyst at Smith Barney Citigroup

Yes, just a couple of questions. With the sale of the tire business, you took a big loss on the sale of $0.5 billion. Did this business decline significantly in the last few years? Was the supply-demand getting worse? The last was so big; I guess, the book value.

William T. McLain, Jr.
Senior Vice President and Chief Financial Officer at Eastman Chemical

PJ, this is Willie. Let me start out here. I would also highlight that Solutia was a transformative acquisition that's created significant shareholder value and positioned us for growth through the innovation and the innovation-driven growth model that we have. And that's been highlighted in interlayers performance, films and specialty fluids, which are doing incredibly well right now and we've highlighted that on many calls. Also, over the past couple of years, we've highlighted the fact of the headwinds in the one-third, many of those being macro and trade, also the competition. So, as we assess this business -- as you know, the accounting rules don't let us reallocate the goodwill back to the purchase date. So, overall, we've got a strong portfolio and have transformed.

But, we also need to move forward and I think we've been decisive with those actions; and yes, it's resulting in a $500 million write-off. But, we believe we've contributed really the tremendous amount of value and that we're wanting to focus on what Mark just spoke about, which is investing in the circular economy and growing the two-thirds.

PJ Juvekar
Analyst at Smith Barney Citigroup

Okay, thank you and I'll follow up with that with Greg, later on.

In molecular recycling, Mark, where do you get the raw material waste plastic and at what prices? And then, on the other side of that, if the recycled plastic costs, if they are higher, are the consumer companies planning to pass that through to their customers (i.e.) consumers? Is that what they're expecting to do?

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

So, the supply is one of the more interesting conversations around the circular economy, which is, there is a vast majority of plastic waste out there, but it's also you have to have a plan and a structure to access it. So, when you think about polyester in the U.S. just around the first plant we're building here, there's about 20 billion pounds of polyester waste annually produced in this country that goes into packaging, textiles and carpet; 40%, only 40% of it is actually packaging. And when you look at what can be mechanically recycled of that 40%, only 25% to 30% can realistically be mechanical recycled and the vast majority of that recycling is actually into textiles, not back into bottles, because you have to have extremely clean polymer to clean up and melt it back into a bottle. So, it's very limited on how you can actually solve the packaging problem with mechanical recycling.

And then, all the carpet and textiles pretty much ends up in landfill because mechanical recycling again doesn't really have an ability to do something with it. So, under any of these scenarios, when you look at all this waste -- and we want as much mechanical recycling to happen as possible because it has a good carbon footprint -- it's going be very limited and it also doesn't have a long-term life, because through mechanical recycling the polymer breaks down after sort of five cycles.

So, the molecular recycling, which is what we're doing, is essentially really solving this problem and again it's essential because the alternative materials have a worse carbon footprint. So, we're really excited to be a leader in how to solve this and the advantage of being a leader for our feedstock teams, who are out there engaging on multiple sources, is we're way ahead of everyone else and go into commercial scale, right. We only -- in the polyester world, we only have other, sort of, small start-ups attempting to get into this space on the planet and they don't have the resources that we have in technology, operations, how to build, and scale up plan, etc. So, when we engage with the brands, we have a compelling story not just of the solution but our ability to actually deliver it and be scalable on how we do it.

And when you're willing to assign value to a waste that's going to landwill [phonetic] versus landfill, customer -- suppliers engage quite actively. And so, we're feeling very good about being able to access that. So, we're not going into with the prices, we're keeping our strategy and details of how we're accessing feedstock confidential has a competitive advantage in our point of view. But, we're very confident we can access waste at a very affordable level.

And then, on the customer side, the customers recognize that recycled content is going to be at a premium. As we shared with you all way back in January, the premium that our PET is getting relative to fossil fuel-based PET is substantial, 60% to 80% premium in Europe, right now. The premiums aren't that far behind as they're are now starting to climb in the U.S. as well. So, they know that this is going to cost additional money. And what we can provide is more certainty on the price and predictability than what you can get from the spot, our PET market, that's at the food grade level. So, that's also part of the value proposition of our Airgas model. While we have to have long-term commitments for our customers to make our economics work, it also is structured in a way that gives them a lot more price certainty and how to manage their business. So, I think it works for both parties.

PJ Juvekar
Analyst at Smith Barney Citigroup

Thank you.

Operator

And our next question from Jeff Zekauskas with JP Morgan.

Jeff Zekauskas
Analyst at JP Morgan Cazenove

Thanks very much.

In your commodity business, you earned $144 million and I think last year you earned $22 million. Can you analyze the year-over-year change in that operation? And I think sometimes you talk about Intermediates, plasticizers, and functional amines is being larger chunks of it. How did those sub-sub-segments do year-over-year? Can you talk about the dynamics there?

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

Sure, Jeff. And yes, it's quite the recovery in Chemical Intermediates like many other companies who have similar kinds of products versus last year. And it's a combination of better volume, but significantly better spread that's driving that success in the portfolio. But, before I get to the spread part, I want to just get to the composition of CI, first, as you asked.

So, about 25% of the revenue in CI is actually amines -- functional amines. They're mostly on cost pass-through contracts. And so, they've had very steady spreads since we frankly bought Taminco, in the way their business is structured. And they've had a nice, solid, steady volume growth over time, delivering very predictable and attractive earnings. And they've got a few accelerants on top of that, beyond just the normal ag growth. So, we've got a plant that we just built and are ramping up for Corteva for their Enlist product that's giving us a lot more additional growth on top of that core business. So, that's just been a nice, great, steady business.

Then, you do have plasticizers, which has been a very attractive business. We've been a leader in non-phthalate plasticizers for a long time. So, we get not just underlying market growth but above market growth in that business, as we've been replacing other plasticizers. And the spreads there, of course, connected to the olefin chain have done quite well this year. But, it's not just spreads, it's also a nice growth story with the position we have in that marketplace.

And then, you've got olefins and acetyls. Olefins, that set of intermediates that we make there is by far a bigger part of the business than acetyls. And spreads have obviously -- significantly improved with the dynamics in propylene relative to propane. So, that's been a driver of the performance. Acetyls is a much smaller business for us. It's important to remember we're not really in acetic acid very much, it's just a co-product. We make acetic anhydride; we're the largest player in acetic anhydride in the world to make cellulosics, right.

So, when we look at the value of that stream with all the specialties that are made off of that in Advanced Materials, AFP, and of course, Fibers, the margins are that integrated acetyl stream is quite significant and above company average. So, it's really about the olefins part, where we're having some benefits, obviously, right now, as well as -- at some point, we'll expect moderation. But, even there, we've made investments to improve CI's stability. So, we have a lot of that business on cost pass-through contracts versus spot because we want predictable earnings that really showed a lot of benefit in how well CI held up on an annual basis in '19 and '20, relative to '18. So, we did quite a bit better than others on that front. And, of course, we're getting a benefit this year, with not quite the same spot prices as some others might have and we're happy to make that trade-off. But, we've done other things like the RGP investment, which has been a phenomenal investment that give us the ability to reduce the amount of ethylene we produce, when it's not attractive, and still make it when it is. So, that's been a great way to stabilize that business.

And we've optimized sites, like taking Singapore down, which has been one of the highest parts of olefin volatility in our portfolio, and shutting that down will improve not just earnings but reduce volatility. So, a lot of things going on across the board to optimize value here and it's important to keep in mind, Chemical Intermediates exist to support the specialties, which are growing really well. And part of the reason you'll see volume going down in this business is because the specialties are consuming it so fast in their growth. So, overall, it's playing its role, creating the value reliability for customers, creating value to optimize our cost structure. And we're really proud of the team and how they've optimized value here in the first half of the year.

Jeff Zekauskas
Analyst at JP Morgan Cazenove

How much of what's produced in the commodity segment is used internally, roughly? And how is that changing in the current environment? So, Jeff, what I would say is approximately 50%. And as Mark has highlighted, we continue to debottleneck, that can get 1% to 2% growth a year in that space. So, over time, we're trying to keep the reliability for our customers. But, at the same time, be there when our specialties need it. Okay, great. Thank you so much.

Operator

And we'll take our next question from Frank Mitsch with Fermium Research.

Frank Mitsch
Analyst at Fermium Research

Hey. Good morning, folks. And I agree with PJ, thank god it's Friday.

Hey, just following up on Chemical Intermediates in terms of the margins and the spreads, how did July turn out relative to the 2Q average? Any sort of pace that you could provide for us on how Chemical Intermediates profitability has been trending would be great.

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

Yes. So, as we look at July, what I'd say, Frank, is prices have held up similar in July to the second quarter, but propane costs are trending higher, right. So, part of our commentary is that propane was about $0.90 on average in the second quarter, it's a $1.10 in July. So, you've got some propane headwind. But, prices are holding up well. Now, our guidance includes some expectation that prices will start to normalize as we go through the back half of this year. I think there's a wide range of opinions about the rate at which prices may or may not normalize in the back half of the year. I'd say we're probably in the middle of the road on -- relative to commentary out there where we expect some, but not dramatic.

We said we're getting out of the olefin forecasting business a long time ago and we're going to stick with that. It's a little hard to predict the pace at which these markets can change, but we appreciate the earnings. It's actually been a nice balance as we're working pricing relative to raws in the specialties and so, these sort of neutralize each other out in some ways. And on the spread front, our strategy is focused on growing high-value volume and mix through innovation in the specialties, which is the vast majority of who we are. It's nice to get these benefits out of CI, but it's also nice that it's a small part of the company and not a big driver of our long-term growth story.

Frank Mitsch
Analyst at Fermium Research

Got you. And actually, that feeds into my question in terms of seasonality on 4Q. It looks like the guide is more heavily weighted on the third quarter. Is that more a function of that you have greater near-term visibility? And just in general, what are your thoughts on 4Q seasonality since there does seem to be some thought out there that it's going to be less than typical in normal years?

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

Yes. So, on the specialty side, I'd say our view is, demand is going to be strong and hold up well in the third quarter and continue into the fourth quarter. So, not that normal seasonal drop, as we don't see a lot of progress in customers making sort of improvements in their inventory situation, especially in some markets like automotive or construction and -- those kind of markets clearly are being, sort of, rate limited by supply chain challenges in the way they're serving underlying market demand, which is very strong around the world. And so, they're going to continue to want to, sort of, ramp up production whenever they get raw materials to serve that need. So, we think that continues -- that, sort of, strength continues in the back half of this year and frankly into next year in those kind of end markets.

And then, you've got other steady markets that are just constantly growing like care chemicals, water treatment, ag, etc., that always provide stability. So, we think it's going to hold up better on that side. When it comes to Chemical Intermediates, I think, I already hit that, which is at some point, we expect normalization of spreads, I just don't know when.

Frank Mitsch
Analyst at Fermium Research

Got you. Very helpful. Thank you.

Operator

Our next comes from Vincent Andrews with Morgan Stanley.

Vincent Andrews
Analyst at Morgan Stanley

Thank you.

Mark, I'm wondering in sort of molecular recycling arena, you've talked about the PET opportunity on a take-or-pay basis. I'm wondering like, in polyester fibers if there's an avenue into the apparel industry or textile industry? I mean, I know you obviously have Naia through the fibers, but that's a different solution. So, I'm just wondering if there's another source of customer opportunity to sell recycled polyester fiber?

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

Yes. So, there's two different opportunities for us, Vincent, and good to hear from you, in the textile world. First and foremost, we're having tremendous success with our biopolymer, right. So, you got to remember we have a cellulosic polymer called Naia, that is half biopolymer from certified sustainable forests and the other half now is going to have recycled content in it through our recycling technology. And as a microfiber, it's certified as biodegradable. So, it's a hat-trick of solving the environmental problems that are out there. And we see really strong engagement from customers on that. It's a nice high-margin product for us and a way to, sort of, repurpose all of the fiber's capacity that was making tow.

So, we're spending a lot of time driving that and it's just a great success story. And when you think about just this year, the amount of growth we're having on textiles is offsetting the decline in tow and the one-time hit we took in that discontinued specialty product, which was $10 million alone. So, really great progress by that team.

And yes, there is the opportunity in addition to that to look at polyester fiber with recycled content in it. Those are some of the conversations we're starting to have along with some of the packaging customers on where we could potentially lean in and help on that front. So, it's a possibility to add to our growth story in the biopolymer textiles.

Vincent Andrews
Analyst at Morgan Stanley

And can I just ask you on -- I know you raised the free cash flow guidance. But, just curious how you're thinking of managing the sort of raw material issues that are out there in terms of inventories and some companies, sort of, were seeing a bulge, sort of, during the year, while they're trying to procure inventory to make sure they have what they need for customers. Others are talking about maybe they want to have more on hand in general in the future, just given we continue to see, sort of, unplanned outages and things like that and they want to be a bit more nimble.

What's the thinking inside of Eastman in terms of how you want to manage inventories, given that you're, obviously, very strong free cash flow generator, and that's an important part of the story?

William T. McLain, Jr.
Senior Vice President and Chief Financial Officer at Eastman Chemical

Thanks, Vincent. This is Willie.

Yes, I would like to highlight -- I'll call it the tremendous efforts that our team members across the world that delivered free cash flow here in the first half of the year. To your point, we've delivered greater free cash flow this year, almost $450 million in the first six months, and that's facing raw material pricing inflation of about $200 million higher than last year. As Mark highlighted earlier, the supply chains continue, I'll call it, to be -- I'll call it when and we're looking to ensure security of supply.

So, there would be choices that we would make to ensure in our specialties that we have the ability to meet our demands of our customers and we would make those trade-offs. We factored that in to our forecasted guidance as we think about delivering greater than $1.1 billion this year. But, it is choices that we will continue to make as we see the demand scenarios play out. It's hard to imagine building a lot of inventory right now, just if we assume demand levels of Q2.

Vincent Andrews
Analyst at Morgan Stanley

Thanks very much.

Operator

Our next question from Kevin McCarthy with Vertical Research Partners.

Kevin McCarthy
Analyst at Vertical Research Partners

Yes, good morning.

Mark, with regard to your specialty segments, margins came down a bit on a sequential basis. In that context, I was wondering if you talk about how much of the cost inflation has been recovered, and how much you think you will need to recover, and what role price increases might play in that process for additives and functional products as well as Advanced Materials? Thanks.

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

Yes. So, I think we're doing well on managing prices in the specialties, as we look through the second quarter and where we're increasing prices here in the third quarter. We think we're well on track to managing prices relative to raw material costs; and really, incredibly proud of the teams in how they're doing that.

The challenge we had in the second quarter was the spike in distribution costs on top of the raw materials; a lot of it was just airfreighting, right. So, it's not just price -- per unit delivered, but it's a mode that we had to use to keep our customers supplied. So, there just was a tremendous amount of air freighting going on. We expect that to abate back to more normal modes and as well as, sort of, calm down a bit.

Now, we're getting some price to cover some of those costs, but not all of it; and that's part of the offset that you saw in the second quarter. So, as we go into the back half, we feel really quite good about keeping up with raws and managing the distribution total costs. So, it's not really our concern. We're focused on just trying to get volume and mix delivered to customers. And the market demand out there is really good, well above our logistics capabilities that we can access. And so, the constraint is going to be more about just access to logistics on how we drive demand in the back half of the year and how much of that could limit the level of growth in the back half relative to the second quarter. But, we feel quite good about the raw materials -- managing the raw material situation.

Kevin McCarthy
Analyst at Vertical Research Partners

I see. Thank you for that.

And then, secondly, your prepared remarks released last night referenced $100 million of savings from digitization, site optimization, operations transformation, etc. So, a few questions. Maybe you could elaborate on what exactly you're doing there and how these savings might spread among your segments and what the associated cash outlay might be attached to those projected savings?

William T. McLain, Jr.
Senior Vice President and Chief Financial Officer at Eastman Chemical

What I would highlight is we've had three primary buckets that we've talked about of cost savings. So, as we think about site optimizations, we, I would say, have substantially executed most of those through mid-year and we expect a tailwind. And we frame that, all in, to be a $50 million program, of which we would expect about half of that to flow into next year as well. We've also talked about how we do maintenance turnarounds, I'll call it, spans and layers across our operations' front and we've made those implementations at the end of, I'll call it, end of 2020, going into '21. And we expect as that's fully implemented, there will be additional tailwinds from those actions. Additionally, as we continue to think about leveraging our sites for other partners as another way of creating value and gaining, I'll call it, earnings from additional capacities that we have, we're continuing to make progress on those fronts as well

Year in, year out, our goal is to not, I'll call it, in normal operations is to offset inflation. And also, as you think about going from '21 to '22, I would say on the -- the variable comp will also be a tailwind as we manage all three of those buckets.

Kevin McCarthy
Analyst at Vertical Research Partners

Thanks very much.

Operator

Our next question from Alex Yefremov with KeyBanc.

Alex Yefremov
Analyst at KeyBanc

Thank you and good morning, everyone.

Mark, where do you stand in advancing this industrial Airgas light [Phonetic] business model for your methanolysis technology? Are you in any specific discussions with potential partners and have those discussions been fruitful?

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

Yes. So, we are engaged in specific discussions with partners, both at the country and the brand level, as well as sources of feedstock supply. So, a lot of conversations going on. Now, we have a full team just dedicated to managing this area and quite encouraged by the level and seriousness at which the counterparties are taking this and understanding the challenges and what we see in their commitments to make a real difference in improving the environment with their products. So, I feel good about it, but it's not over until it's over. And so, we just have to see how these discussions play out and I'll be excited to share the news with you once I've actually achieved my objective on the structure of these kind of deals.

Alex Yefremov
Analyst at KeyBanc

Great. We'll look forward to that.

And as a follow-up on free cash flow, you mentioned, for next year, priorities are dividend increase, M&A, and share purchases. The last two categories, how do you think about the balance? If you can't find bolt-ons, should we think of, sort of, share repurchases as sort of a default option, or repurchases are going to be more opportunistic in nature?

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

Yes. So, I'm going to sort of answer the first part of that question and then I'm going to hand it off to Willie for more of the detail.

But, first of all, I just want to, sort of, recognize, we really are proud of how well our teams have managed and delivered free cash flow into stability, in which we've been able to do it in both good and challenging times. And it really -- when we reflect on it, it's been a decade journey to get to this kind of performance. When you go back to where we were before the Solutia transaction, our free cash flow frankly wasn't as strong. And Solutia dramatically improved the quality of our portfolio, along with Taminco being less capital intensive, in improving our free cash flow. So, in addition to earnings, there was a significant benefit that came out of the Solutia acquisition on the free cash flow side.

And then, we've had just tremendous success in growing these high-value innovation products that are quite attractive margins, which means they generate a lot of cash and improving the cash flow of the portfolio that way. And then, of course, there's recent actions we've taken in optimizing our portfolio like selling tires, that's going to give us additional cash. So, we're in a very strong, sort of, strategic position from a cash and balance sheet point of view.

And as we look at it, going forward, just to reiterate our priorities:

First and foremost is doing capex, consistent with our specialty innovation growth strategy and making sure we have the capacity in place to support our growth. Then, of course, there is this acceleration opportunity around the circular economy. The first step is just part of our strategy, which is how do we add recycled content to our specialty products. But, as we discussed on this call, there is this opportunity to build additional plants in this Airgas model that could substantially add to our EBITDA. And so, we're going to be looking at those as an option for cash.

And then, you get to share repurchases and bolt-on M&A as the next steps. Of course, we always have a growing dividend, that is part of that overall cash story. So, the priority is to be clear that we're not looking at large M&A acquisitions out there. And we think that pulling all these levers in concert is a way to create a nice balance growth story for the company.

I'll let Willie give you little more details around exactly where the cash position stand at this point.

William T. McLain, Jr.
Senior Vice President and Chief Financial Officer at Eastman Chemical

Yes. What I would say is, with the improving EBITDA, we expect to be done with delevering at the end of this year. And I would also add, we're now not expecting to need to further delever for the tires divestiture. So, we've committed roughly $250 million [Phonetic] of share repurchases in the back half of the year and now thinking that we would have roughly $600 million to $650 million of cash to repurchase shares and/or bolt-ons, as Mark has highlighted, as we wrap up the year.

Our balance sheet is in great shape. We're below 2.5 times net debt to EBITDA and expect also, from a rating agency view, to achieve 2.5 times or below by year end. We're in a great position and as we think about going forward, we have roughly $1.2 billion remaining on our current stock repurchase authorization. And with the cash that I talked about as we wrap up the year and think about potentially $700 million of free cash flow to put the strategic use of next year. We're in a strong position as we move forward, as Mark highlighted.

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

Yes. And just on the bolt-ons, we're not going to be opportunistic if we're going to be very strategic. In other words, we're only going to do bolt-ons if they really fit with the company, they really create a lot of value and reinforce an existing business. And we're going to be disciplined about what we pay. So, we're not getting caught up in deal fever. Having said that, we very much would like to do bolt-on M&A, but it's got to meet those conditions.

Operator

We'll go to our next question from John Roberts with UBS.

John Roberts
Analyst at UBS Group

Thank you.

In AFP, when you say looking at additional actions, is that more divestments or is that taking out stranded costs from the tire and rubber chemicals divestment?

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

We're always committed, John, to managing our cost structure, including when residual costs might occur from a divestiture. And so, we'll manage that as part of our overall operational and business operating model transition work. But, when it comes to other work, it's referring to adhesives, where we're continuing to pursue both JV and divestiture options for that business, where we have good engagement from multiple parties and we'll see how that plays out.

John Roberts
Analyst at UBS Group

Okay. And then, after the conversion of more standard copolyesters to Triton, what percent of the copolyester production will be Tritan? How much capacity do you have left, so you can have low capital intensity upgrades there?

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

We certainly have low capital intensity upgrades, that's been the story of specialty plastics since it began, right. It started with a bunch of PET assets handed to it from, at that time, if you want go back far enough in history, their big brother. And then, repurpose those PET assets to making our traditional copolyesters and then repurposing those polymer assets to make Tritan. We did a bunch of expansions in 2018 to support growth across the entire company portfolio and are doing a number of them here, that we started last year expecting recovery on the back-end of COVID and the need for growth assets.

Tritan is one of those many projects that we have going on, where we've converted a copolyester line in the second quarter of this year to Tritan; it will come online this quarter. And that's a continuous story, in addition to probably -- we're getting to a point, we're probably going to add polymer capacity because the growth across the portfolio, not just Tritan, has been so robust. But, I think that really has been a big driver of the story.

Greg wants to talk. So, Greg, go ahead.

Greg Riddle
Investor Relations at Eastman Chemical

Tritan, today, probably represents about a third -- from over a third of the revenue for specialty plastics. So, if you're looking for a quantification, that's about where it is.

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

Then, it continues to grow. But, it's important to understand that we're adding recycled content not just to Tritan, but to all the copolyesters, our Cristal Renew product that goes in cosmetic packaging, a variety of other polyesters are also growing really fast with the circular addition to our story. That's why we're going to have to add total polymer capacity.

Operator

Our next question from Matthew DeYoe with Bank of America.

Matthew DeYoe
Analyst at Bank of America

Good morning. Congrats on the P&G announcement. When I read the press release, I guess, I understand the agreement for purchasing of Renew. But, how are you two working together to address the infrastructure problems? You kind of alluded to that in the press release. I'm just wondering, what P&G is committing to doing here?

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

Well, a lot of policy as well as collaboration with the existing recycling infrastructure, that, I think is amplified, when we're working with brands, who have a very deep relationship with the recyclers, right. So, they buy a lot of recycled content today from those companies and working with them and encouraging them to broaden what they do beyond just easy-to-recycle product in making this broader waste stream available to us is a point of collaboration for us.

So,there is collaboration with the existing infrastructure and encouragement for them to improve their capabilities. There's also collaboration at the political level, both national and state level and even local level, on policy that supports the improvement in recycling infrastructure, encourages the consumers to have the right behavior. There is a lot of different ways to get at that with what's called EPR, extended producer responsibility, or bottle bills, etc., that can drive more recycling. And ensuring that the value of recycling material versus putting it landfill has more value; and policy comes in play there too.

So, there is a lot to be done at multiple levels and I think P&G and frankly a number of other brands, that we're talking to, are going to be really valuable partners in advocating to help improve our ability to, sort of, be responsible with this valuable resource, and create a true circular economy.

Matthew DeYoe
Analyst at Bank of America

All right. That makes sense.

And as a follow-up, so paint protection film has been a nice source of growth for Eastman over the last couple of quarters. Has sales expectations for the year, kind of, decelerated for that business, in line with auto sales forecast, or is the adoption cycle making up for that kind of downshift in the underlying?

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

No, it's doing great, and it's not been a couple of quarters, it's been many years of how well this performance films business has done, both in the window film and the paint protection film. It's been a tremendous growth story. Last year, they grew in a very down market because this category of paint protection film, in particular, is just dramatically growing in how people want to protect their paint. And we just launched a new Gen 3 product, that is substantially better than our existing products, which were still market leading in their performance. But, it's much easier to install, it performs better in protecting the paint and it now actually has the gloss of ceramic coating, if you're familiar with the car industry. So, it actually has a better gloss when you put this on than the original clear coat of the car.

I just came back from visiting a bunch of dealers out west and getting their direct feedback about how this is going, and they're just incredibly excited about that. And it's not just the product, we've also rolled out a new software program called Core, that has superior pattern cutting, which is a really difficult part of doing paint protection film, while when you think about all the different car shapes there and getting the film to fit properly around the car. And this software allows them to make very precise cuts and install much easier with the patterns of all the cars in the last 10 years, which is a non-trivial task to create, I might add. So, it's done really well.

And then, the channel strategies we've deployed about working with all dealers and additionally, the retail market has expanded our market tremendously over the last five years. So, it's a great business, growing well, high-value mix upgrade to the segment. And even with the auto market slowing down, we're seeing this business continue to do well because dealers are trying to focus on what they can upsell onto their car with a limited volume they have to sell. So, we're getting good engagement as we're trying to add features to what they're selling.

Matthew DeYoe
Analyst at Bank of America

Would you ever -- if I can just tack on, would you ever look into moving into the installer game for the paint protection film because I understand the margins there are pretty fat and much exposed to slowly, kind of, moving downstream, or is that something that you wouldn't do?

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

We're looking at our models to make sure that our dealers -- both retail dealers as well as the auto dealers have the resources to do the installation, I think, is what you're getting at. And there is a lot of different ways to do that. We have no interest in getting into competition with our customers. We don't think that's a very good business model when the retailers have been such a loyal and valuable partners with us. But, we do recognize that with labor constraints out there, we've got to have different models to enable installation resources to be in place. And so, we're looking at multiple ways to do that. So, that's how we look at it. But it's -- it is an important aspect of what you do is helping them develop the high quality installers.

Operator

We'll take our next question from Bob Koort with Goldman Sachs.

Bob Koort
Analyst at The Goldman Sachs Group

Thanks, good morning guys.

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

Good morning.

William T. McLain, Jr.
Senior Vice President and Chief Financial Officer at Eastman Chemical

Good morning.

Bob Koort
Analyst at The Goldman Sachs Group

Mark, I wanted to ask you, you highlighted quite a few times about being a specialty story. Obviously, the CI earnings are maybe making that a little more challenging for people to embrace and we've seen some pretty good devaluation in your stock over the last few months, almost to, kind of, you being lumped in with some of the the peak fears that are out there on some other maybe more commoditized names.

So,I guess, how do you see CI? I mean, is it going to fade and create a big step down that, sort of, robs from the aggregate growth, as the specialty businesses grow? Do you think it can stabilize? Maybe just looking at consensus numbers, it looks like, something like 2% EBITDA growth in '22 and '23. Can you give us some inspiration that, that is inadequate? Thanks.

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

Yes. So, Bob, thanks for the question.

And look, we think we're making tremendous progress on changing our portfolio in our performance towards specialty. We've done the analysis. I know all of you can go do it. But, if you go look at how we've held up margins over '18 to now, or '17 to now, as a total company, how we've delivered earnings performance, we're much more in the specialty category than in the commodity category of our peer set. The data is actually quite clear. At some point, I'll show to you.

So, I think we've actually held up really well. There is no question that people, sort of, focus on the CI question right now. And the way I look at CI is it's incredibly valuable part of our vertical integration and our reliability to our customers. We've proven the value to customers multiple times on how it supports that. And in times like this, where they get some expansion while prices are catching up to raws in some other parts of the business, it actually gives us more stable earnings. That diversity actually creates economic stability. So, I don't see what's wrong with that.

And as I look at '22, we certainly expect some moderation of CI in its spreads as we go into that year relative to this year. But, when we look at all the growth that we have growing for ourselves and improvements in the cost structure, we're actually quite confident we can deliver quite attractive earnings growth in '22 relative to '21, including the offset of the moderation in CI.

So, when you look at it from a markets point of view, a lot of markets that are still going to be in recovery mode, next year, whether it's auto, building construction, medical, aviation, you've got restocking, that will still continue into next year, I think. And then, you got really steady growth markets like care chemicals, ag, water treatment, consumables that -- those are sort of stable markets that are about 40% of our revenue.

On top of that, you've got all the innovation driving growth across the whole portfolio, whether it's performance films that I just discussed, [Indecipherable] hit on, we still got next-gen acoustics and hired interlayers growing, we've got Tetrashield in food and beverage packaging, textiles, and emulsion etc. And then, you've got the circular economy driving more growth and then we've got good smart segmentation strategies and businesses we're in, in right parts of the markets like luxury cars and UVs, etc.

And it's not just volume because remember all these things that are growing really well are high-value mix. The challenges we had in '19 and '20 were not spread, right; it was, as a company, were in the specialties. It was just that high-value mix coming off and is now coming back. And we said, you will see the mirror image benefit of that and you're seeing it this year and you'll see it next year. In addition to that, you've got cost coming off by $100 million on the operational level, plus another $50 million [Phonetic] in lower distribution and shutdown costs, sort of, the one-time things.

And then, you've got where you think spreads might go, and you've got increased gross spend. And so, when you put it all together, net, we're well positioned to deliver EPS growth in '22 relative to this year.

Bob Koort
Analyst at The Goldman Sachs Group

All right. I'll give you a check on more inspired then. Thank you.

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

[Indecipherable] please, Bob.

Operator

We'll go to our next question from Arun Viswanathan with RBC Capital Markets.

Arun Viswanathan
Analyst at RBC Capital Markets

All right, thanks for taking my question.

Maybe I could just ask a similar question to Bob's here. So, if we look at '21 versus say 2019, or even '22 versus 2019 EPS, you're in the $9 range this year. If we look at a three-year average, CAGR, maybe it's around 9%, which is definitely commendable and within your 8% to 12% earlier comments from a while back.

I guess, is that still kind of how you're looking at it and then maybe if you could just put a finer point on some of this -- so, if you look at next year, you have potentially some parts of the $50 million coming on from recycling technology, maybe CI falls off a little bit. But, how much of AM and AFP is still left for recovery? If you could help us with that, that'd be great. Thanks.

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

So, yes, we've been doing everything relative to '18, which was our last peak and we're really excited that we're going to have EPS well above 2018. And then, as I just laid out, we're confident to keep growing it from '21, into '22. And I think that everything we said on Innovation Day is still true, plus we've had a lot more growth through circular economy onto the Innovation Day story. So, thinking about that growth rate of 8% to 12%, I think, is a reasonable way to think about next year at EPS level.

You got to remember, if we succeed in divestitures, that will have an impact on EBIT, then we will be buying back stock to offset it. So, all of our guidance on commentary today is not at the EBIT level, including the impact of divestitures.

Arun Viswanathan
Analyst at RBC Capital Markets

And I'm sorry, how much of AFP and AM, you think is still for recovery?

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

I think there's a lot of growth left in both businesses. As we look at Advanced Materials, we actually expect very strong growth in Advanced Materials next year, relative to this year. So, that story is going to continue to be strong and be even more compelling next year. So, that's really exciting. When you look at AFP and look at the two-thirds of AFP, in other words, without tires and adhesives in it, the earnings this year are expected to be a bit better than 2018 levels. When you look at that portfolio, a lot of that's just tremendous growth in coatings, in line with our customers, in addition to good steady growth in things like ag and animal nutrition, and care chemicals, as well as fluids. So, good story across the board.

And that even includes the aviation headwind, when I say that about this year being better than 2018 for the two-thirds of AFP. So, that's also positioned [Phonetic] to keep growing both through recovering markets and innovation next year, not quite as much as AM because they're still earlier in their innovation cycle, but still delivering nice growth. So, those two grow well, fibers being quite stable, and improving cost structure gives you very solid position.

Arun Viswanathan
Analyst at RBC Capital Markets

Thanks.

Greg Riddle
Investor Relations at Eastman Chemical

Christina, let's make this next one the last question, please.

Operator

We'll take our last question from David Begleiter with Deutsche Bank.

David Begleiter
Analyst at Deutsche Bank Aktiengesellschaft

Thank you.

And Mark, first, on the molecular recycling facility, when will you be in a position to announce an additional capital investments either as a addition to that facility or new one, could it be in '22 or do you think after that for another investment in molecular recycling?

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

Great question, David. And it, sort of, depends on the pace at which we go in our discussions with these customers and countries. But, for our internal needs, I think this first facility is what we're going to need for '23, '24 [Phonetic]. So, we're not going to be starting a new specialty plant until we get this one up and running.

But, when you look at these other additional growth opportunities, I hope in the next 12 months or sooner, we could have an announcement around making progress on these other additional plants.

David Begleiter
Analyst at Deutsche Bank Aktiengesellschaft

Very good.

And just really on free cash flow, if you do achieve EPS growth, would you say will be attractive in 22? How much above the $1 billion or $1.1 billion of cash flow, do you think you could achieve next year? Thank you.

William T. McLain, Jr.
Senior Vice President and Chief Financial Officer at Eastman Chemical

Yes, David, thanks for the question.

So, as I think about it, as we've talked about all the content being, I'll call it, accretive now on the tires and we think about adding more cash to use on repurchases, it will be a headwind as we think about cash flow next year. So, again, we're looking, I'll call it, to be in the $1 billion to $1.1 billion as a starting point. And that's taking into consideration the headwind that we'll see from the divestiture of the tires business.

David Begleiter
Analyst at Deutsche Bank Aktiengesellschaft

Thank you.

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

So, just to wrap up, I wanted to maybe a couple of quick comments really to my employees and to the investors, which is, I can only sit here and talk about the success we've had this year, how well we performed even in holding up last year, and our ability to actually deliver growth next year on top of this year.

It's the employees. They've just in a phenomenal job. There is a lot of stress and fatigue out there when it comes to trying to keep this market supplied with how strong demand has been. And every day, they show up and just do remarkable work, not just in, sort of, operating delivering against the demand we have in this marketplace, ensuring we get the raw materials that we need, but also keeping innovation alive to get to $600 million of revenue from innovation this year on top of all the chaos that comes from working our way through this dynamic environment is a real testament to the team, to our growth model, and to the way they engage the marketplace.

And I just wanted to express my deep appreciation to all of them for the phenomenal job that they've done.

And with that, I want to thank you for all your questions and wish you all a good day.

Operator

[Operator Closing Remarks]

Corporate Executives
  • Greg Riddle
    Investor Relations
  • Mark J. Costa
    Chairman and Chief Executive Officer
  • William T. McLain, Jr.
    Senior Vice President and Chief Financial Officer
Analysts

Alpha Street Logo

Powered by Quartr

Transcript Sections

Remove Ads