Trinseo Q1 2023 Earnings Call Transcript

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May 5, 2023

There are 7 speakers on the call.

Operator

Morning, ladies and gentlemen, and welcome to the Trinseo First Quarter 2023 Financial Results Conference Call. We welcome the Trinseo management team, Frank Bozich, President and CEO David Stasse, Executive Vice President and CFO and Andy Meyers, Director of Investor Relations. Today's conference call will include brief remarks by the management team followed by a question and answer session. The company distributed its press release along with presentation slides at close of market Thursday, May 4. These documents are posted on the company's Investor Relations website and furnished on a Form 8 ks filed with the Securities and Exchange Commission.

Operator

I'll now hand the call over to Andy Myers.

Speaker 1

Thank you, David, and good morning, everyone. At this time, all participants are in a listen only mode. After our brief remarks, instructions will follow to participate in the question and answer session. Our disclosure rules and cautionary note on forward looking statements are noted on Slide 2. During this presentation, We may make certain forward looking statements, including issuing guidance and describing our future expectations.

Speaker 1

We must caution you that actual results could differ materially from what is discussed, described or implied in these statements. Factors that could cause actual results to differ include, but are not limited to, risk factors set forth in Item 1A of our annual report on Form 10 ks or in our other filings made with the Securities and Exchange Commission. The company undertakes no obligation to update or revise its forward looking statements. Today's presentation includes certain non GAAP measurements. A reconciliation of these measurements to corresponding GAAP measures is provided in our earnings release and in the appendix of our investor presentation.

Speaker 1

A replay of the conference call and transcript will be archived on the company's Investor Relations website shortly following the conference call. The replay will be available until May 5, 2024. Now, I'd like to turn the call over to Frank Bozich.

Speaker 2

Thanks, Andy, and welcome to our Q1 2023 earnings call. I'd like to start by addressing the spill at our Bristol, Pennsylvania PMMA operations that occurred in late March. Let me begin by saying that our organization is deeply disappointed in this event and the disruption to our neighbors and the concerns of our stakeholders. We are working very hard to regain everyone's confidence. Due to an equipment failure and the accidental release of an estimated 8,100 gallons of acrylic latex emulsion occurred and some portion of this material was not contained at our facility and ultimately flowed into a local waterway.

Speaker 2

We immediately reported the events and cooperated closely with local, state and federal authorities on the response activities, while at the same time collecting material and preventing further flow into the waterway. This material is used in various downstream industrial Tumor and medical applications, including dialysis filters and is approved by the FDA for use in medical devices. Importantly, our acrylic polymer latex emulsion has a nonhazardous OSHA classification. Within our material, there are certain precursor chemicals that are potentially present. Our estimates Of these chemicals dispersed within the 8,100 gallons of material and reported to the Pennsylvania Emergency Management Agency was £0.32 of butyl acrylate, £1.62 of ethyl acrylate, £27.22 of methyl methacrylate and £0.26 of styrene.

Speaker 2

None of the water sampling conducted by authorities detected these chemicals. Due to the on-site containment and cleanup activities as part of the initial response to the release, we believe that portions of the material never reached Waterway. Additionally, I'd like to take this opportunity to address the record about the historical environmental performance of our facility at the multi tenant Bristol site that includes other company's operations. Our facility has a history of clients with environmental regulations as indicated by the EPA's Enforcement and Compliance History online database. Not including this event, our facility has had no significant violations, no quarters of non compliance and no formal enforcement actions.

Speaker 2

As you all know, we are committed to strong environmental, health and safety performance. And as a company, we've had an overall outstanding EHS record. I'm proud of the response of our employees and the emergency responders to handle this in a cooperative and transparent way. Now I'd like to turn to the Q1 results. As we entered Q1 2023 in a continued low demand environment, We established 3 near term priorities for Trinseo.

Speaker 2

1st, to focus on working capital management to increase cash second, to recover volumes that may have been lost to low cost imports in Europe in the second half of last year and lastly, the continued driving organic growth programs targeting material substitution and sustainability. I'm happy to say that our efforts around working capital management were very successful in Q1 as we reduced working capital by $52,000,000 in the quarter. Dave will elaborate on our cash management actions in more detail. But based on the actions we are taking, we are confident we will be free cash flow positive in 2023 even at these reduced demand levels. From a market and volume standpoint, we saw 4% increase in volume over the levels of to Q4.

Speaker 2

This volume increase reflected normal seasonal improvements rather than a broad recovery in our end markets. Business conditions in the Q1 were broadly the same as what we experienced in the Q4 with continued destocking and building construction, weak demand in consumer electronics, but healthier automotive demand. While our total sales volume for the company was down 20% year over year, Volume for specialty and modified resins as well as for case applications in latex binders declined at about half that rate, which shows that these offerings have more resiliency during periods of destocking and lower structural demand. The volumes and margin for our technologies that enable our growth programs in general outperform the broader portfolio and that the Q1 run rate should deliver year over year margin growth. The volume of products containing recycled materials, which are very high demand by our customers, grew at 1% year over year during Q1.

Speaker 2

So far in the Q2, April volumes are consistent with Q1. Structural demand remains low and the recovery in China has been softer than expected. While we've Seeing an increase in orders for some high value specialties in China for May June. It's too early to tell if this represents sustainable demand. Therefore, we have implemented a series of cash improvement initiatives.

Speaker 2

We've already seen the benefit of these through with our strong first and we'll continue to take action. While the timing and trajectory of the market recovery is unknown, we are addressing what we can to optimize near term performance while preparing for the market recovery. I'd like to comment on the results of our Engineered Materials segment in Q1. While volume and unit margins were largely In almost all of our EM product lines, our MMA margins were significantly lower due to ongoing ammonia force majeure of our supplier and the impacts of the natural gas hedges against declining gas prices. These costs cannot be recovered through sales of MMA into the merchant market through our sales of ammonium sulfate byproduct into the fertilizer market.

Speaker 2

However, our input costs have decreased significantly in the 2nd quarter as our ammonia supplier has restarted local production and we expect to see a significantly lower natural gas hedging impact in Q2. For these reasons, we expect to see significant sequential improvement in EM results. One last Comment I would like to make is related to our process to sell our styrenics assets. We continue to have ongoing dialogue with parties interested in specific assets and regional business activities related to our styrenics business. As we have previously stated, Separating these assets is part of our long term strategy and monetizing them is an important part of deleveraging the balance sheet.

Speaker 2

Given the continued interest in specific assets as well as improvements we have made to them through our restructuring actions last year, We are restarting the sales process of our Steretics business, which will include the marketing of individual assets and regional businesses. Now I'd like to turn the call over to Dave.

Speaker 3

Thanks, Frank. Our first quarter adjusted EBITDA was below our expectation due to unfavorable impacts of $19,000,000 for natural gas hedges and $10,000,000 for fixed cost under absorption related to inventory reduction actions. I'd like to spend a minute on both of these topics as it's instructive for modeling for the rest of the year. Of the $19,000,000 loss related to natural gas hedges in the Q1, dollars 7,000,000 was from realized hedges related to gas purchased in the quarter and the other $12,000,000 was related to mark to market on hedges that settle in future quarters. This was the result of a €30 or approximately 40% drop in the price of European natural gas in the quarter.

Speaker 3

Moving to the 2nd quarter, The forward curve is substantially the same now as it was at the end of the Q1. Based on this, we expect minimal P and L effect from the mark to market on the hedges related to future periods. However, we do expect a realized loss of about $10,000,000 on hedges related to gas purchased in Q2 and lower amounts in Q3 and Q4. As it relates to fixed cost absorption, preserving liquidity is one of our foremost priorities in this environment. In the Q1, we drained $50,000,000 of inventory by running the plants at lower operating rates, In so doing generating a negative P and L impact of $10,000,000 This cash flow versus P and L trade off was clearly the right decision for us, and we will be prioritizing cash flow if and when these decisions arise during the rest of this year.

Speaker 3

The $52,000,000 working capital release we had in the Q1 led to our positive $24,000,000 of free cash flow, which is significant for us given the relatively low profitability in the quarter and the fact that the Q1 is seasonally our lowest quarter for cash generation. For the full year, we are increasing our cash generation guidance due to a series of actions despite reducing our EBITDA guidance. First, we signed an agreement to sell our cast acrylic Sheet site in Matamoros, Mexico for $19,000,000 We expect that transaction to close shortly. 2nd, we will be substantially reducing our dividend beginning with the dividend payable in the Q3 of this year. 3rd, we are reducing our CapEx by $10,000,000 by deferring discretionary project spend unrelated to maintenance or and S.

Speaker 3

And finally, as I mentioned earlier, we are aggressively reducing working capital across the company and we're off to a good start in this initiative with the results in Q1. Our strong liquidity position and improving results gives us great confidence in our ability to weather this economic downturn while continuing to support our strategic initiatives. Now I'll turn the call back over to Frank, who will talk about our expectations for the Q2 and the remainder of 2023.

Speaker 2

Thanks, Dave. Looking ahead to the Q2, we expect a significant sequential profit improvement of about $40,000,000 from lower raw material and corporate costs, a lower natural gas hedge loss and higher fixed cost absorption. These are the driving factors in our Q2 guidance of a net loss of approximately $15,000,000 and an adjusted EBITDA of approximately $80,000,000 This outlook assumes no volume growth and therefore demand improvement would represent an upside. For the full year 2023, we are guiding to a net loss of $94,000,000 to $61,000,000 and an adjusted EBITDA of $275,000,000 to $325,000,000 This updated outlook is $100,000,000 below our prior guidance due to $45,000,000 of natural gas hedge losses, $10,000,000 from the Q1 fixed cost absorption and the remainder from slower market recovery. While we're expecting a gradual demand increase through the end of the year, the low end of this full year guidance range assumes no demand improvement for the rest of the year and at the high end about a 10% improvement beginning in Q3.

Speaker 2

We see this set of 2023 forecast assumptions as independent from a full economic recovery or restocking cycle, both of which represent upsides. There is no question that we continue to face very challenging business conditions and we've reduced our 2023 outlook to reflect this. Amid these conditions and uncertainty around the timing of a market recovery, we've taken cash improvement actions to maintain our strong liquidity position. We expect increased cash generation compared to our prior guidance with cash from operations of approximately $165,000,000 and free cash flow of approximately $75,000,000 This reflects more than $100,000,000 of cash improvement actions that Dave described earlier. Our CapEx guidance of $90,000,000 includes all necessary plant maintenance as well as the funding of growth and sustainability programs.

Speaker 2

While we're taking actions for the short term, roll offs are focused on strategic long term initiatives such as our sustainability and material substitution offerings. These programs offer us growth opportunities irrespective of the market environment. And now we're happy to take questions.

Speaker 4

Thank

Operator

you. Will pause for a moment to compile the Q and A roster. We'll take our first question from David Begleiter with Deutsche Bank. Your line is now open.

Speaker 5

Hi, this is David Huang. I guess first question on the Stryrenics business sales. Can you talk about the potential timing and I guess Are there any additional closure actions you can take, if that's your option, if there are piece of the businesses you can't sell during the process.

Speaker 2

Well, the timing is that Maybe let me step back and just give more color. And as I said in the prepared remarks, When we paused the process last year, we saw significantly deteriorating results beginning in Q3 and we took action to close our Boland styrene monomer plant, which had historically been the least productive of our sites and that's permanently closed. During our entire process, we had a number of parties, mainly regional strategics and other interested parties in specific assets. They've continued to express that interest and we've had new inbounds. And for that reason, we're going to engage them formally in a process to investigate the sales.

Speaker 2

I can't Really comment on that more than that to say when we might see a positive outcome from this. But Suffice it to say that we are engaging and will engage in the near term with inactive discussions with those interested parties.

Speaker 5

Okay.

Speaker 2

The second part of your question about asset rationalizations, Look, we're always going to look at our assets and our sites to against the forward outlook in the market and relative to their competitiveness. And that's part of our ongoing business activity. So at this point, we don't have anything that would be on the table that's in our mind, but We always would look at those activities as part of the ongoing strategic review of our assets.

Speaker 4

Okay. And then how should

Speaker 5

we think about the long term normalized earnings potential for the core portfolio ex Steranix?

Speaker 2

In a mid cycle EBITDA, I would argue that that core portfolio should perform in the $300,000,000 $250,000,000 to $300,000,000 range excluding the styrenics assets.

Speaker 5

Okay. Thank you.

Operator

Thank Next, we'll go to Angel Castillo with Morgan Stanley. Your line is now open.

Speaker 4

Hello. This is actually Stefan Diaz sitting in for Angel. Thanks for taking my question. You called out absorption costs. How much of this is baked into the midpoint of your guide going forward?

Speaker 4

And then maybe specifically on the EM segment. How much of the absorption costs were felt in EM in 1Q? And what would you say utilization rates are in this segment? And how do you see that progressing going forward?

Speaker 3

Angel, I'll take a crack at the first part of that. So of the under absorption, we had $10,000,000 in the first quarter, $6,000,000 of that was in the Engineered Materials segment and the rest was spread amongst the other segments. I would say going forward for the rest of the year, I don't expect anything of materiality to be going through the P and L in terms of under absorption, and that's what our guidance reflects. I think it's helpful to maybe point out a couple of other things just to kind of transition I'm going to say on the engineering materials for me that the transition from Q1 to Q2 in that business because we do see a pretty significant increase in EBITDA from the Q1 to the Q2. So as we just talked about, there's plus 6 of under absorption.

Speaker 3

I don't see that repeating in the Q2. Engineering Materials had $7,000,000 of negative timing in the Q1. And that negative what we call negative timing is, we're in an environment now in the Q1 and we see this continuing in the In the second quarter, we're seeing rapidly decreasing input costs and there's specifically ammonia and natural gas. And because we're on a FIFO basis, the realization of that, in our P and L can be somewhat lagged. So that's when I call it that $7,000,000 that's what that is.

Speaker 3

It's kind of that lag effect of the realization in our P and L. We're not going to have that in the Q2. We see that kind of stabilizing in the second quarter. We also have $3,000,000 less of hedges natural gas hedge impact in the second quarter. And then the last thing is Just the overall benefit of decreasing input costs.

Speaker 3

So if you add all that up, I think we see Q for the segment, the result in the second quarter, dollars 25 plus 1,000,000 higher than it was in the result in this Q1, just Engineered Materials.

Speaker 4

Great. That was super helpful. Thanks for the color. And then maybe you could just speak about Some of the demand trends by region. Yes.

Speaker 4

So What

Speaker 2

I would tell you is that we were globally let me start globally by segments. Automotive is the one market that we're seeing increases year over year, the other and versus the second half of last year. And what I would tell you is that U. S. Demand has held up Relatively well.

Speaker 2

European demand is better than Has improved slightly over where it had been in the second half and then Asian demand is lower. So on balance, we're at a consistent level of demand from where we were in the second half, As I indicated and what we saw, the 4% increase in Q1 is really reflective of more seasonal uplift Then any structural change in the underlying market. I did reference

Speaker 4

Okay.

Speaker 2

Yes. Just maybe let me add, I did reference in the prepared remarks that we have seen reestablishment of orders into certain higher value specialties in China beginning in May June and we're that's a very positive sign. Again, it's difficult to say whether that's sustainable or not. But It's a good signal that these order that these companies have come back to the market and reestablish purchasing. We're watching that closely to see if it's structural.

Speaker 4

Thanks for the color and good luck in the quarter.

Operator

Next, we'll go to Kevin Eastock with Jefferies. Your line is now open.

Speaker 5

Hi, this is actually Kevin Ansoci on for Laurence Alexander. Thank you for taking my question. So just Just curious, now like in the event of a recession, let's say, the back half of the year into 2024, I'm just curious what sort of levers you guys could back to pull to sort of mitigate that loss and sort of improve operating performance. Thank you.

Speaker 2

Sure. So let me start. There's 1, we see input costs going down Fairly rapidly across the portfolio. So one, that's a tailwind. If that continues in a recessionary environment, would typically also come with continued lower input costs.

Speaker 2

But that being said, The destocking that we've seen, again, if you look across our portfolio, it's 20% down year over year in the Q1 versus prior year. Clearly, the broader economy isn't down 20%. So there's a significant destocking effect that we're still seeing throughout most of our value which in a normal recessionary environment, we would actually see demand stabilize At a higher level than or we wouldn't see a significant decrease from where we are today with the destocking still ongoing. So again, it's difficult to say and unpack what the difference between destocking and the underlying market demand. But again, I Would not anticipate that we would see significant further decrease in some of our value chains Beyond what the destocking levels are showing.

Speaker 2

As it relates to levers, There are always opportunities for us to use regional arbitrage as well as reflects our network to reduce our fixed cost. And what I would tell you is that While we took $60,000,000 in fixed cost out through the restructuring actions that we had last year, There were other actions that are available to us that required some capital investment for us to be able to implement. Many of those investments will be completed by the end of Q3. So it gives us optionality In the future to run our assets and our network slightly different.

Speaker 5

Okay. Thank you very much.

Operator

Next, we'll go to Priya Ranjran with RBC. Your line is now open.

Speaker 6

Hey, guys. Thank you so much for the call. Can you talk a little bit when you say that volumes are flat in your 275,000,000 Expectations on EBITDA, is that flat to Q1 2023?

Speaker 3

Yes, it is, Priya. So the I think if I heard your question correctly, was at the At the low end of the range of $275,000,000 of EBITDA, is the volume assumption flat to The Q1 of 2023 and answer that is yes. So look, we give fairly explicit guidance in our materials that we put out of $80,000,000 EBITDA for the second quarter. So that $275,000,000 obviously reflects 3 quarters of $80,000,000 plus the $35,000,000 that we had in the Q1. So that's a flat EBITDA environment from where we are Where we operated in the Q1.

Speaker 6

Got it. And then on the hedge losses, is there a way to quantify to the extent that Natural gas prices go to 10% from here, how much further losses you would potentially see from your guidance?

Speaker 3

Yes, it's very hard. We've talked about that. It's very hard to kind of quantify or to give you a rule of thumb that says that gas prices Go down next. This is the hedge loss because as we go forward in time, our hedges expire. And The other thing I would point out is that you really can't just look at the spot price, you have to look at the forward curve, right, so the entirety of the forward curve And how much the forward curve shifts that impacts the mark to market of all our future hedges.

Speaker 3

I mean, what I can tell you, Priya, is that In the Q1, as I said, there was a €30 drop in European gas prices, And that resulted in a $19,000,000 hedge loss in the Q1. And again, I think it's very important to distinguish, Priya, that $19,000,000 is comprised $12,000,000 of that is mark to market on hedges that are 4 quarters other than Q1. Okay. And 7 of it is actually cash and related to Hedges that settled in Q1. Now again, that ratio, if you're going to I just want to warn that I don't think you can take that ratio and assume a 30 year change going forward is going to be $19,000,000 a Because it will be less than that.

Speaker 3

And the other thing I'd say is with gas natural gas trading at €35 right now, you're not going to have You certainly can't have a €30 on the downside. Our belief is that we probably We're probably near the bottom, I think, on European natural gas right now. And we actually think there's a very Incredible and plausible scenario that natural gas prices rise and could even spike in the upcoming winter. Whether you look at the drop in natural gas prices has stimulated demand or kind of incented industrial and residential demand is up considerably in Europe. It's the statistics we look at.

Speaker 3

It's early in the year. So without the flow of Russian gas, what it used LNG is not going to offset the Russian what used to be Russian imports. So a cold winter coming up this winter Could result in, we think is a very credible scenario for higher natural gas prices In which we would obviously see a benefit from the hedge results.

Operator

And those are all the questions we have at this time. I'll now I'd like to conclude today's conference. We thank you for your participation. You may now disconnect.

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Trinseo Q1 2023
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