Eastman Chemical Q4 2022 Earnings Call Transcript

Quartr
Provided by Quartr
January 27, 2023

There are 14 speakers on the call.

Operator

Good day, everyone, and welcome to the 4th Quarter and Full Year 2022 Eastman Chemical Conference Call. Today's conference is being recorded. This call is being broadcast live on the Eastman website, www.eastman.com. We will now turn the call over to Mr. Greg Riddle of Eastman Chemical Company Investor Relations.

Operator

Please go ahead, sir.

Speaker 1

Thank you, Emily, and good morning, everyone, and thank you for joining us. On the call with me today are Mark Costa, Board Chair and CEO Willie MacLean, Senior Vice President and CFO and Jake Cloureault, Manager, Investor Relations. Yesterday, after market close, we posted our Q4 and full year 2022 financial results news release and SEC 8 ks filing. Our slides and the related prepared remarks are in the Investors section of our website, eastman.com. Before we begin, I'll cover 2 items.

Speaker 1

First, during this presentation, 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 Q4 and full year 2022 financial results news release, during this call, In the preceding slides and prepared remarks and our filings with the Securities and Exchange Commission, including the Form 10 Q filed for Q3 2022 and the Form 10 ks to be filed for full year 2022. 2nd, earnings referenced in this presentation Excludes 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 Q4 and full year 2022 financial results news release.

Speaker 1

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

Operator

Thank you. We will now go to our first question from Josh Spector of UBS. Josh, please go ahead. Your line is open.

Speaker 2

Yes. Hey, good morning. Thanks for taking my questions. I guess first I wanted to ask, can you walk through your step up in your implied guidance from Q1 through the rest of the year? I guess mostly interested to hear how much you see this within your control versus subject to macro conditions changing?

Speaker 3

Sure, Josh, and welcome. We expected that question. I think it's an extremely important one we spend a lot of time on. First, let's just recognize we're in an extremely dynamic time in this world, where it is difficult to predict some of the macro. You've got China in a weak situation, but likely to recover.

Speaker 3

I see One article saying there's $2,200,000,000,000 of cash out there with Chinese consumers to be deployed. I don't know how that impacts both demand and energy. I know you're creating war, you've got inflation of 4 year highs and what the Fed is going to do with it. So there is a lot of uncertainty and the Q4 was incredibly challenging as we look at Q1 Many of those challenges continue whether it's the destocking in durables and BNC that still needs to work itself out, auto net debt recovering. And the stable markets fortunately getting past destocking, but not growing yet.

Speaker 3

We'll certainly see some raw material benefits in the Q1, Not much in the way flow through works and seasonally energy is high. So the Q1 has a number of challenges, not to mention pension and variable comp. So as we look at the step up into the Q2 and through the rest of the year, there's really 3 key elements. To your point, the one that's most directly in our control is taking out $200,000,000 of cost net of inflation. And not much of that's really helping us in the Q1.

Speaker 3

There are some in the non manufacturing activities that we're executing on, but even that It's being implemented through this quarter and the operational improvements flow into inventory and those benefits won't flow out until We start moving into the Q2. So the vast majority of that $200,000,000 gets spread across those 3 quarters. So that's a big step up Q1 to Q2. The second one is how will spreads improve? Now we've had tremendous success in being disciplined And successful in managing our pricing with just great commercial excellence across all parts of the company.

Speaker 3

It's pretty extraordinary when you think about the amount of inflation that we faced. Last year was about $1,300,000,000 inflation, where at the beginning of the year, we didn't really expect That much inflation, if you go back to our January call of last year. And if you look at it on a 2 year basis, it's $2,400,000,000 inflation. If you even go back to $20,000,000,000 to $22,000,000,000 of inflation. So significant amount of inflation and we've caught up with most of that And across that multi year timeframe, we certainly kept up with it through last year.

Speaker 3

So as you go to each segment, the story is a little bit So Advanced Materials is probably the most important one to start with because it has a pretty significant tailwind in spread. When you think about they had one of the most challenging raw material and energy environments across our segments with VAM and PVOH up 45% relative to 21 PX Up 40%, Energy up 70%. Now they kept up with that inflation with 13% increases in price, But they didn't improve spreads. And if you go back to where we were at the beginning of last year, we had the intention of recovering spread compression in 2021 of about $100,000,000 No, we didn't get that, but we did keep up with inflation. And we're starting now into this year at a much higher altitude with Prices that we've achieved in keeping up with this inflation.

Speaker 3

So as we look at this year, we see that this segment is going to have a pretty substantial tailwind in raw material and energy. And we're not trying to be too optimistic about this. If we just use where raw materials have already come down in BAM, PBOH and PX For the Q1 of this year, and think about the energy off of the natural gas forward curve for the year, That's actually quite a bit more spread tailwind than what we would have got last year of that $100,000,000 because of the higher altitude. So That's part of it. And again, that shows up as a step up as you move into the Q2.

Speaker 3

There's a bit of it that flows through the Q1, But most of that is in the Q2 through the 4th. With Fibers, much shorter, cleaner story, which is You had a lot of challenges in inflation here as well, both especially in energy and the market, The customers have moved to being worried about security and supply. So you've been very successful in increasing the prices last year as well as contractually securing much higher prices this year To make sure the margins are back to sustainable levels to support our customers, and that's $275,000,000 Outlook to earnings this year, which is a significant step up, in fact, enough to offset the spread normalization in chemical intermediates that we expect this year. And then AFP will have modest spread improvement as well, but not as much because they managed spread quite well last year, so they have less upside this year. So when you put it all together, that's a lot of spread improvement and a lot of it flows in sequentially into the 2nd quarter.

Speaker 3

So that's a big step up. The 3rd segment is volume and mix, and this is more of a mix of what happens with the economy versus what's in our control. Peastocking at some point is going to end. We're assuming right now that it predominantly ends by the end of this quarter for burrit durables and BNC. And so you get a step up of Demand going from destocking levels, which are pretty severe to something less than that.

Speaker 3

In the stable markets, we can already see it moving past that and we'll have some amount of growth from those markets. Importantly, innovation is something in our control and we've had a lot of success last year despite our challenges in the economy And securing a lot of new business wins that are going to help this year. And again, that doesn't really happen during destocking. So you got to wait to get that past you to start seeing some of that benefit. Then of course there's China recovery.

Speaker 3

But we're being very conservative and not assuming much of that in our sort of outlook that we provided until we see more proof of it. So the bottom line is there's a lot of step up across these three factors. Many of it is in our control. But as you look at the guidance we gave you For the year, given the outlook for the Q1, I think it's appropriate to sort of look at the lower half of that guidance for how we're going to perform until we Get past this quarter and have more insight on all these factors.

Speaker 4

Thank you.

Operator

Our next question today comes from David Begleiter with Deutsche Bank. Please go ahead, David.

Speaker 5

Thank you. Good morning. Mark, just on Fibers, can you talk to the sustainability of this higher level of earnings going forward?

Speaker 3

Hi, David, and thank you for the question. It's one of the bright spots of the year and one we're excited to talk about. Fibrous has obviously been on a tough journey since 2014 when the market structure loosened up for a variety of factors. But the situation has evolved and changed over time. First is on the demand side.

Speaker 3

We Historically, we thought about demand declining in the 2% to 3% range. But what we've seen over the last few years is it's only declining around 1%. And partly that's driven by the strength of the heat not burn segment of the marketplace that is growing at 15% a year, Offsetting some of the other decline on the cigarette side. China has also stabilized to being pretty much flat to slightly up in demand Over the last several years. So you've got stabilization demand, the heat not burn market growing and the heat not burn devices require quite a bit more tow For smoking experience than a cigarette.

Speaker 3

So that's also helping. If you look at the last decade, we've only been down about 10% of demand as you sort of put all these factors together. We uniquely at Eastman also have the benefit of textile growth, providing stability and margins to our business. On the supply side, there's also a lot that's changed over the last decade. So you can see about 15% of capacity has been shut down and repurposed.

Speaker 3

That's Assets that have been retired, the impacts that Russia has had on capacity in their country as well as That's repurchasing some of our assets towards the textiles growth. And the move to like the slim cigarettes, especially in China, As well as TiO2 Free Cigarettes has actually had a significant impact on the effective capacity. It's much more difficult to make those products, so you lose a lot of At least 10%, maybe 15% of capacity is lost with that. So the industry is gone when you put those factors together to doing pretty high end capacity utilization where The conversations and the focus with our customers is how we are reliable, secure supplier for their needs. You have to remember the value of The final price of a cigarette is a very small percent.

Speaker 3

So making sure they have it to sell their product at very high margins is incredibly important to them. And that's now the focus. So that's allowed us to get quite a bit of price up last year, so already good momentum, seeing some of that benefits already in the Q4 of last year that Indicate the trajectory we're on for this year. So we give you these factors as sustainable and improving the earnings quite a bit. So I would say this year is going to be at least $275,000,000

Speaker 4

when we

Speaker 3

put all those factors together. The other thing that it does is gives us a much more solid base For our overall cellulosic stream and very strong cash flow to support the investments we're making in the circular economy, not just the polyester side, but we have a huge number of Opportunities on the cellulosic side with our recycling capabilities to take plastic waste into that product also being bio also being biodegradable It's allowing us to realize a lot of growth in our Naya textiles, we told you a lot about. So you're going to hear a lot more this year around the Venta for foodservice That has a huge market opportunity to replace polystyrene and then microbead. So the cellulose extreme is shifting to being pretty attractive and sort of We put it all together, growth business.

Speaker 5

And just on cash flow, you mentioned increase $1,400,000,000 this year due to a number of actions you're taking. Can you just unpack those actions you're taking and specifically working capital release this year?

Speaker 4

David, good morning. This is Willie. I would highlight to your point, basically in 2022, I'll call it the inflationary pressures consumed another roughly $300,000,000 in working capital. As we look at We think there's at least $300,000,000 on that front that we'll benefit from on a year over year basis. Also as you think about cash earnings, I would say you need to look at higher cash earnings year over year As we normalize for the pension and also as you normalize for the variable comp coming back to normal.

Speaker 4

Those two items should put us At 1.4% or above and higher taxes will bring us back down to the 1.4% level. So that's a high level bridge for you.

Speaker 5

Thank you very much.

Operator

Our next question today comes from Aleksey Yefremov with KeyBanc Capital Markets. Please go ahead, Aleksey.

Speaker 6

Thanks. Good morning, everyone. The price of virgin plastic has been very volatile lately. So has the interest in recycled content that you're negotiating changed at all, Given lower virgin plastic prices and perhaps weaker demand?

Speaker 3

So good question. We haven't seen any real change in people's interest when it comes to Recycle content. If you think about it, the brands have set out very aggressive goals in 2025 and 2030. And the pressure out there for why they set those goals is just increasing, not decreasing when it comes to plastic waste. So consumers are very sensitive to this topic.

Speaker 3

There's obviously a lot of environmental NGOs putting a lot of pressure on this and politicians both in Europe and in the U. S. Are doubling down On sustainability, climate impact, plastic waste and the policies that they're putting forward. In Europe, you've got We know extensive policy around plastic waste reduction and recycling that's was passed a couple of years ago and the rules are being implemented now that Requires you to have 30% recycled content in your packages if you want to put them on a shelf and 25% and taxes for whatever doesn't have recycled content in it. So there are significant economic drivers in Europe that are driving brands to be committed to that.

Speaker 3

In the U. S, the NGO pressure, the social media pressure on brands is pretty high and you now have at least 5 states Already passing some version of legislation that's driving change like what's going on in Europe and some of those are quite big states like California. So the policy pressure and all those requirements to do it are there versus pay a tax. And from a brand, it's easier to Be sustainable and pay a tax from a choice point of view. So the brands have these commitments.

Speaker 3

The other challenge I've got is the mechanical industry is not remotely capable of Supplying the recycled content that's needed by this 2025 time frame back into food grade. While Madrigal gets recycled down into other applications like Textiles and park benches, etcetera. But to get it back to food grade at that quality, mechanical recycling just can't meet these goals. So the need for our capability is very much there. The brand engagement is very strong.

Speaker 3

And we've seen tremendous success already in the specialty front as we've shared with you The 1,000 opportunities that we're pursuing with customers around our first plant here in Kingsport, but on the PET side, Like the Pepsi contract that we just accomplished, we see that an essential part of actually solving this crisis. The only thing I

Speaker 6

would note is that, Mark, a

Speaker 3

drop in demand in short term. Yes, I just forgot to mention one thing. On the ARPED, if you're looking at short term demand and it's dropping, That's actually not about packaging. It's the carpet people and the textile people having such low demand. They were also buying clear bottles and they're not buying those clear bottles anymore for their feedstock.

Speaker 3

And so that's why short term demand is coming off is Purely what's going on in the durables and building construction sector, it has nothing to do with packaging.

Speaker 6

And just to follow-up on Advanced Materials, Mark. Do you need raw materials to come down from where they are today to get to your targets It will be meaningfully out versus 2021 or are you assuming sort of card spot raw material prices prevail for the rest of the year?

Speaker 3

Yes. On the spread assumption that we've got and how Advanced Materials improves, We're assuming that we don't have another inflation crisis like we did last year, right? So, van and PVH prices were Extraordinarily high because the van producers, half of them in the U. S. Were unable to operate for 5 months.

Speaker 3

So we had prices for some periods of The spring and the summer were double because of that extreme market tightness. And we had to buy a lot of very high priced material from the spot market Out of Asia to continue to supply our customers. So getting rid of all that market tightness, which is where sort of The PVO prices is now gone to some degree. I think there's still more coming down, but we're just using where we are today for this quarter And how we project spread improvement versus last year. Same with PX, we're not assuming a dramatic improvement relative to where PX is now.

Speaker 3

You could look at 6,000,000 tons of PX capacity coming online this quarter in China and PX prices could get lower, That would be upside. We're not banking on that in our outlook. We are assuming energy costs get lower. As I said, we're using the forward curve on natural gas for that. That's what's in the sort of outlook we're giving you for this base case.

Speaker 3

Could things be higher? Sure. But that would require pretty significant move up in oil from the sort of $80,000 $90 range we're in. And I think we feel good about this base case given The world that we're in and the macroeconomic challenges that we face right now.

Speaker 6

Thanks a lot.

Operator

Our next question comes from Michael Leithead with Barclays. Please go ahead, Michael.

Speaker 7

Great. Thanks. Good morning. First question just on the circular plastic build out, a bit of inflation so far and you still need to break ground on the second and third facility. So Can you just talk about what you're doing today to help make sure we don't get further CapEx creepier over say the next year or so?

Speaker 3

Sure. So there's a lot that we've been doing to manage a difficult capital construction environment last year For the Kingsport plant and have done a great job in keeping those costs under control. A little frustrated by Challenging in craft labor to get the plant sort of completed here, but the cost control is working well. And we're confident we'll get this plant up and running early summer. When it comes to the next two projects, there are a couple of things we're doing.

Speaker 3

One is Some of the commentary we provided in our prepared remarks about how we're building these plants. So we had a design for building these plants We were always going to start out with 100 KMT of capacity, but designing them upfront to expand to be 50% bigger When you added on the 2nd phase, we've switched to taking a more standardized approach to sort of say, look, we're going to build identically what We're building here in Kingsport in France and in this second U. S. Project with Pepsi. So very standardized approach to leverage all the To keep the capital cost down.

Speaker 3

Now to be clear, we're still spending capital at the site to make sure the infrastructure is in place So what we will do is double the capacity at each of these sites over time, after we get the first site, First, modules up, if you will. So we're actually sort of expanding what we think we can deliver between now and 2,030, Doubling it versus go up 50%, but we're taking a more standardized approach. And this also allows us to take a lot of insights we have around how to improve the technology Energy efficiency and feedstock robustness into that second phase in this more modular product. So there's a variety of benefits. The other thing we haven't really factored into our capital estimates yet is a slowing macroeconomic environment Should create some deflation in the construction industry.

Speaker 3

We're already seeing it in the price of steel and pipes and things like that. So materials are going to get cheaper. I don't think the cost per labor hour is going to go down, but I do think we're going to have more availability of resources, higher quality resources. So productivity will improve And materials and equipment will probably come off in price. So that will help also keep control on the CapEx numbers.

Speaker 7

Great. Thank you for that detail. And then second, just on fiber and the new contract there. If I remember, most of your So business was moved to long term contracts a few years ago. So is this new pricing just reflective of a portion of your current business and we'll see further resets over the next 2 years or is this a big reset for almost all of your business here today into 2023?

Speaker 3

It's a big reset for most of our business. So about 2 thirds of our business is on contract. A lot of that is multi year, some of it is annual. And even with what is not on contract, it's pretty firm agreements when it comes to volume on an annual basis. So We just the nature of when all these contracts started to turn over happened to be last year into this year that gave us the opportunity to have these negotiations and increase these prices.

Speaker 3

To have these negotiations and increase these prices. That's why you're seeing this all happen now as opposed to A year ago, when the market was already started getting tight, but we didn't have the contractual flexibility to make these changes until now.

Speaker 7

Great. Thank

Operator

you. Our next question today comes from Vincent Andrews with Barclays Sorry, Vincent Andrews with Morgan Stanley. Please go ahead, Vincent.

Speaker 7

Okay. Thank you. Good morning, everyone.

Speaker 3

Mark, could you talk a little bit more about, I

Speaker 7

guess, 2 things. 1, I was struck by the consumer durables comment in Advanced Materials where your volume was down 40%. That just seems like an enormous number. So could you just talk a little bit more about how that's actually impacting Advanced Materials business and what the So cadence of improvement is going to be? And then also, could you just sort of detail a little bit your assumptions about the auto business For 2023, I think I read that you've got expectations for a sequential decline from 4Q to 1Q and some modest growth overall In 'twenty three, but is there anything changing about the customer mix of your products for 'twenty three in terms of the cars they're building and And the tech that's in them or anything like that, just given it seems like the automakers are starting to focus on different things in a more recessionary environment?

Speaker 3

Sure. So both very relevant important questions for us. The consumer durable business is incredibly important markets where we sell our Very high margins and have had tremendous growth over the last decade. What I can tell you, and we've been doing a very Deep dive on what's going on in the Q4 as you would expect, it's entirely market driven. When you look at some of what's going on in the specific parts of the market we're in, which is Small appliances, housewares, electronics, that part of the durables world, It's just been declining really for quite a long time, right?

Speaker 3

So the underlying market Started declining in the Q2 of last year modestly. And then as people started switching to travel, leisure versus You've been buying a lot of durable goods. You saw that in the announcements from Walmart and Target, if you go back to May. And what we didn't really fully appreciate is just how much overstocking the retail sector was doing in ordering from everyone who could supply them, There was so short of material and then suddenly it all showed up, and they had a lot more inventory to get out. And with inflation being so high, The consumer durable sector is the first thing people stop buying.

Speaker 3

And you can see that in the semiconductor data, you can see that in the electronics, So, when we look at what's going on in the end market, you can see a lot of evidence At the primary demand level, demand being off, but not nearly as much as us, right? So the retail sales data will show our direct end markets might be off 10%, 15%, And we're off 40%. So the rest of that is, by definition, destocking. And that's Because of these retail inventory channels that are so overstuffed, it just took a while to get that momentum to try and pull down production through the entire chain. It's a challenge and it's continuing into the Q1 and we expect it to be equally challenging this quarter as the 4th.

Speaker 3

But at some point, it's going to end. And from what we can see so far, we think we will get this under control Mostly by the end of this Q1 and then you've got a big step up in demand with the destocking is over to sort of Lower demand than what is normal, but still a lot better than 40% down and that's part of the step up in earnings for Advanced Materials As you move into the Q2. On the auto side, auto demand, we're being, I think, conservative, probably a little bit more conservative than what the consultants would say about Demand being slightly down in the Q4 and not improving much for the year. So if we're wrong about that and production improves more, That's a lot of upside because those are very high value markets that we serve in our earnings. But the shift in the market to get your question It's really important.

Speaker 3

That shift is very favorable to us. So we've now got about 10% of our sales going into EVs have very high margins. You have to remember that each EV is about 3.5 times more value for us than an ICE car. There's a lot more class than an EV car and a lot more functionality they're putting in it From acoustics to solar rejection to heads up display, etcetera. So the value capture there is tremendous on a mixed lift basis.

Speaker 3

So the EV trend and we are aligned with The top players on this with our products is a significant opportunity. I would also say heads up display in general, not just in EVs, but all cars Had a lot of growth momentum. It was a big mix uplift last year and even though down market and we think that trend is going to continue We'll let you order the HUD because of semiconductor limitations. That's going to resolve and so we see the HUD market picking up. I'd also note that that's in layers.

Speaker 3

The paint protection business and the performance films business is doing fantastic, Very strong growth, very high margins. So we got a lot of mix uplift relative to the underlying market in auto that helped us offset some of the challenges last year And certainly, it will be a significant lever versus last year and to this year. Thanks so much.

Operator

Our next question comes from Jeff Zekauskas with JPMorgan. Please go ahead, Jeff.

Speaker 8

Thanks very much. Of the $200,000,000 in cost savings, how does it split between SG and A and cost of goods sold?

Speaker 4

Good morning, Jeff. Thanks for the question. I would highlight, we have 2 major Pillars within this, we've highlighted roughly $125,000,000 of this we'll be taking from our operations, which will include manufacturing and Supply chain and then $75,000,000 I'll call it more in the non operations, which would be SG and A And primarily, so I'll break it down a little bit for you. So on the $125,000,000 what gives us confidence is We expect more efficient operations as we run at lower rates due to moderating demand. As you think about the supply chains as well as Our planned and unplanned schedule last year, we expect significant improvement.

Speaker 4

I also think we've demonstrated even back to the COVID environment That we also leverage a pretty variable cost structure when it comes to leveraging over time contractors, and we're already Taking the actions at the end of the year starting in the Q1 to change that cost structure to the current demand levels. And we're very focused on operating at the most efficient level from an operation standpoint as we assess the demand environment that Marcus On the supply chain and the network optimization, we see $30,000,000 to $50,000,000 in that As you think about us having to air freight, use inefficient modes on a year over year basis. So a substantial increase on that front. Also, as you saw in the prepared materials, we expect to have roughly $25,000,000 lower maintenance year over year. And we're also looking at our asset footprint.

Speaker 4

And as you saw, some restructuring charges there As we look on a go forward basis. So that's on the manufacturing front. On the non operations, I would highlight We've already, I'll call it, reduced discretionary and we're starting that here in Q1. So as you think about external spend versus our Workforce reductions, that's about fifty-fifty from a cost impact on a year over year basis.

Speaker 8

Okay. So these are net reductions. So does it mean that SG and A should go down $75,000,000 all in, in 2023 exclusive of the $110,000,000 lift in pension expense. And Can you explain what the event was that caused the $110,000,000 lift in pension expense?

Speaker 4

Okay. So let me break that into a couple of parts for you, Jeff. So on the pension, I'll hit that first. That will not impact SG and A or Manufacturing, it's set up on our income statement within the EBIT. There's 2 drivers as you think about pension and they're equal.

Speaker 4

So The pension interest to cost, we had lower discount rates. You can think about 200 basis points on the interest cost in 2022. That will increase over 500 basis points, so 300 basis point change on the interest cost.

Speaker 3

Our

Speaker 4

assets are lower year over year. As you think about the market, basically being down about 20% Versus our assumed return of about 6%. That's about $50,000,000 each is what I would roughly say there. On the SGA question, our variable comp will be normalizing. So that will be a headwind on a year over year basis.

Speaker 4

We expect that to be substantially offset by the 75,000,000

Speaker 3

So Jeff, one way to think about sort of a waterfall across the businesses and the cost actions is The cost reduction actions are sort of equal to offsetting both the pension costs, the return to variable comp and inflation, Right. We put all that sort of together. So the fixed cost structure, if you will, is flat. The fibers improvement offsets The normalization in CI. So you have to have a point of view that the 2 specialty businesses are able to deliver Earnings growth over the annualized FX headwind for this year, that's another way to sort of think about how we get to sort of Flat EPS including pension is the specialty businesses have to offset basically inflation this year and growth relative to last year.

Speaker 3

We've given you a waterfall on sort of where that growth comes from. Okay.

Speaker 8

Is the pension expense cash or non cash?

Speaker 4

It is non cash, so there's no impact on our cash flow.

Speaker 3

Yes. That's why we built the guidance where we did just talk about growing earnings

Operator

Our next question today comes from Frank Mitsch with Fermium Research. Please go ahead.

Speaker 9

Yes, good morning. And Willie, I'll give you a shout Mark, You mentioned in the prepared remarks that you're going to keep the cracker down through the Q1. Can you talk about some of the factors and the outlook That you're seeing on the CI side of things and when it should or should we expect that the cracker will come back up in 2Q?

Speaker 3

Yes, our expectation is the cracker starts to come back up in Q2. Anyway, you can do the math on sort of cracking spreads right now last year. Remember, our crackers are a bit different where they're highly oriented towards propane versus ethane, and we're trying to make as much propylene as we can and as little ethylene as we can With the investments we've made in switching into RGP, which we're doing as much as we can, because the ethylene market is very economically For basically a cash cost on bulk ethylene. But as the propylene markets are starting to improve, you can sort of see that through January. The spreads, the crackers are recovering as we go through this quarter and that feeds into our expectation That is likely to continue or hold, and we bring the cracker back up.

Speaker 3

Demand right now continues to be challenged, so we don't really need as much of the output, Which is why it's easy to sort of make this decision in the moment, for both the demand and the crackers by point of view, but we expect demand to get better in the Q2 as well as the spreads to We continue to sort of stabilize at these better margins. So that's sort of how we're looking at it at this stage. You have to remember that propylene prices are well below any sort of Historical norm to oil. They're very depressed. If you go run that analysis, it's pretty extraordinary.

Speaker 3

So We're really just trying to get back to a more normal relationship to the price of oil on Copeland.

Speaker 9

Terrific. Thank you. And then if I can ask About the 2nd methanolysis unit in the U. S, you'd indicated in your remarks that you've made progress on permitting, but You haven't selected a location as of yet. Can you just talk about how that process plays out?

Speaker 9

I mean, I don't doubt that communities would welcome a methanolysis unit In our locations, can you talk about a little more color there?

Speaker 3

Sure. So we first of all, we're really excited to have this relationship with Pepsi that baseloads this facility and gives us the confidence to move quickly On this project, we are looking at multiple sites. As you might imagine, we're looking at existing sites we own and whether we can leverage all that brownfield And existing infrastructure cost down in Texas, but we're also looking at some other brownfield sites in some other States that could be attractive and evaluating the capital efficiency of each of these sites, The feedstock benefits of each site as well as the incentives that different states are willing to provide to promote Investing in the Circular Economy and playing a role in solving this environmental challenge. And the engagement, frankly, across the states has been really high. And as you said, I think they're all quite interested and excited to sort of participate in this kind of a green project.

Speaker 3

But we haven't finalized that. I'm hoping within the first half of this year, we'll have that finalized and then start moving very quickly So not just incentives, but the permitting and the site development and everything else. The advantage of our new sort of standardized approach in building these So it allows us to start the engineering now without knowing what the site is going to be. So we're already spooling up engineering for this site and designing it. And then we'll do from what is what we call inside the battery limits, the actual operating units of this plant, The sort of infrastructure will obviously be dependent on which side we finally select.

Speaker 9

Very helpful. Thank you.

Speaker 3

Yes.

Operator

The next question comes from Kevin McCarthy with Vertical Research Partners. Please go ahead, Kevin.

Speaker 10

Yes, good morning. A couple of questions on your capital deployment. So In the prepared remarks last night, Mark, I think you mentioned your methanolysis Investments in the aggregate would cost $2,250,000,000 which is up about 10% Relative to your prior projections, can you talk about how that flows through? Is it going to be ratable Over the next 5 years or some other shape. And then related to that, are your returns Still the same?

Speaker 10

In other words, are you able to perhaps extract a larger premium to offset The higher project costs. And I guess more broadly for Willie, do you think CapEx will run $700,000,000 to 800,000,000 Over the next several years or again is there a different shape to that as you execute on these investments? Thanks very much.

Speaker 4

Kevin, thanks for the question. So I would highlight here in 2022, we've Already invested approximately $300,000,000 as we think about our secular investments that we highlighted in the prepared comments. So as you think about approaching $2,000,000,000 over the next 3 to 4 years, in 2022 or We're increasing our CapEx budget to $700,000,000 to $800,000,000 That includes a step up on a year over year basis. And yes, as you think about a normal, I'll call it, large capital curve, it will definitely be over $800,000,000 through that time horizon And probably the peak around 1 to 1.2. Okay.

Speaker 4

And then, Mark As I think about capital allocation.

Speaker 3

Sorry, go ahead. You're talking about the insurance? We didn't answer your question.

Speaker 10

Yes. I was just going to follow-up on that. I think in the past you talked about 12% plus.

Speaker 3

Yes. So on the return front, to be clear, what we announced in the prepared remarks today around the design of the facilities It is the same as what we had in our economics back in 2021 Innovation Phase. So the first phase is always going to be around this 110,000 tonnes of waste being processed. And so the $450,000,000 EBITDA has not changed and we feel more confident We're actually securing prices with contracts and securing feedstock, both availability as well as what it's going to cost Supporting those economics. The capital cost being a little bit higher than what we had talked about, that sort of 10% increase That we discussed in our prepared remarks don't affect the returns.

Speaker 3

We said our returns were above 12 Percent for the 2nd, 3rd project above 15 for the first project. We said greater than we have room to absorb some of these challenges because You always expect them to happen frankly, when you're doing these kind of capital construction projects and we always want to make sure we have robust Plans for the economics to deliver returns.

Speaker 10

Okay. Very helpful. Thank you.

Operator

Our next question comes from Matthew Day with Bank of America Merrill Lynch. Please go ahead, Matthew.

Speaker 5

Good morning. Thank you.

Operator

Good morning.

Speaker 11

I might

Speaker 5

have missed this, but If we're looking at the Kingsport Methanolysis Unit, can we just walk through the progression from cost to profit? How much commissioning cost is in 2023 numbers? What do we think for how that moves to profit In 2024 and getting back to like full run rate earnings on that facility.

Speaker 4

Yes. So I would highlight, as you think about the start up, we're talking about roughly $35,000,000 including, I'll call it, the Appreciation as it starts up in the back half of the year. So as we think about the first project, You should be getting to a more normalized run rate of growth in 2024. And By the end of 2025, we would expect to be close to the full run rate of the plants, which we've highlighted could approach roughly 100 and

Speaker 5

24 is just neutral or would you see EBITDA? And then I guess just a question, you don't really talk much about buyback for next year and I know CapEx is going up, but it still seems like maybe you'd have $200,000,000 $250,000,000 of after dividend cash flow. Do we Assume that goes to buyback or I mean your leverage is fine. Can you do in excess of that?

Speaker 4

Yes. So definitely we expect 2024 to be accretive from our Kingsport circular methanolysis project. So We're confident in the progress. You'll see revenue here in the back half of 'twenty three. That turns into earnings and growth in And approaching those run rates as we expect these plants given, I'll call it, the market Excitement is around that in the 1,000 leads that we're already working on.

Speaker 4

As you think about Capital? On the capital front versus share buybacks, so yes, we're on the capital allocation, Our priorities remain the same. We increased the dividend here in the Q4 for 2023. Also, as we think about $700,000,000 to $800,000,000 of CapEx and we're looking at Prioritization of bolt ons versus share repurchases. We're going to always fully leverage our cash flow to give shareholders return.

Speaker 4

So there is that capacity and we will pump the cash to use?

Speaker 3

We always have this debate around best uses of cash in a principal basis. When we look at the Circular platform, The capital we're deploying there has substantially better returns and valuation potential for the company than buying back stock today. And We think that's the appropriate way to deploy the capital versus buybacks on that front.

Speaker 5

Sure. But that's not contemplated in the earnings guidance, right?

Speaker 4

What?

Speaker 5

Any accretion from like a deal or a buyback or anything like that. That would be upside.

Speaker 4

So just to highlight, obviously, we executed $1,000,000,000 of share buybacks in 2022, Both in our operating cash flow and the divestiture proceeds. So we will have, I'll call it, EPS So the accretion as a result of the full year benefit from that, right now that's primarily offset by higher interest expense. Understood. Thank you.

Operator

Our next question comes from Mike Sison with Wells Fargo. Please go ahead, Mike.

Speaker 12

Hey, good morning guys. Mark, just one question. You spent a lot of time over the last several years Transforming the portfolio to more specialty assets. And when you think about the performance of the second half, kind of the start to the Q1, What can you point out to folks that demonstrate that maybe the performance has the special characteristics or maybe it's more

Speaker 3

Sure. So first of all, we think we've made tremendous progress in improving our portfolio over the years. We've obviously divested a lot of commodity businesses, acquired Great specialty businesses. In the past, if you go back to that, certainly, 2011, 2012 timeframe as well Through the acquisitions to 14 and the divestitures more recently and optimize the portfolios, I think we have a very good track record and portfolio discipline. I think last year, as you look at it, was a uniquely challenging year for two reasons that You have to sort of consider in judging a history and a future of this portfolio.

Speaker 3

Obviously, the 4th quarter Turns out, it was the entirety of the earnings decline from a volume mix point of view. So we were actually flat in volume and mix leading up to the 4th quarter And the entirety of the volume mix decline is driven there. And because of some of the very unique Operational challenges we had last year, those limited our ability to deliver growth in specialty and Advanced Materials. So those two factors sort of constrained what was on track at the beginning of January before the Ukrainian war and rapid inflation and everything else It was going to be a really impressive year of earnings growth. So I wouldn't sort of over torque on trying to interpret too much into the 2022.

Speaker 3

Our challenge and our proof point will be if we deliver this performance that we've just sort of suggested in our outlook discussion today, In this kind of challenging economic environment, that's a really strong endorsement about the quality and strength of the portfolio So we manage through these challenges. There's no question we create a lot of value in markets that have economic Whether it's B and C or durables or auto, auto all last year was at recession levels, 80% below 2019 It's not a good year for auto demand, and we managed to actually still do reasonably well in that That business on the volume mix side. So I think we feel really good about the quality of the portfolio From a volume mix point of view and its ability to deliver innovation and growth through all kinds of platforms, not just the big circular platform we've been talking about, but Cellulosix has probably $200,000,000 upside when we go forward over the next 3, 4 years. And then the Air Layer's business, as I discussed earlier, has a tremendous amount of growth. Is great.

Speaker 3

Coating additives has a lot of sustainable introductions to the marketplace. Semiconductor leverage we have in hydrous solvents. So growth innovation is very much there as the specialty business should have to deliver good results. Margin stability actually is on the spread side quite good. When you look at the portfolio and how it combines together to deliver Steady spreads at the favorable margin level, and we've demonstrated very good commercial discipline.

Speaker 3

So what you really got last year is a manufacturing recession in 1 quarter and a huge currency headwind for the year And then some limitations on how much growth we're going to have with some one off operational issues. So I don't think there's any lack of differentiation in this portfolio or quality of it. And I think as we get through this year and start delivering pretty significant growth next year,

Operator

The next question comes from John Roberts with Credit Suisse. Please go ahead.

Speaker 3

Thank you. You had an ethylene propylene flex project for Longview. Has that been delayed? And if you had had that in place, would you have still shut down the cracker? So we're not yet constructing that project.

Speaker 3

We are completing the licensing And the early engineering work around being able to pull the trigger on that project as soon as we feel it's appropriate. We have a lot of requests for capital across our portfolio back to valuation discussion that I just commented on. It's not just Circular that has a lot of capital opportunities for a very attractive returns on investment. Our whole specialty portfolio Has those opportunities as well. And while certainly the current economic challenges are there, We don't see lack of growth opportunities across our portfolio on the specialty side.

Speaker 3

So Those get priority call on capital relative to the ethane propylene investment. It's one that we will for sure do when it's at the right time, Look, we're going to have to be thoughtful about how we manage our overall CapEx budget. And to answer your question, if E2P was in place, We would not have left this cracker down. Remember, we had it down for maintenance. We just didn't bring it back up after we completed the planned maintenance.

Speaker 3

And we will certainly have been down for the maintenance in Q4, but would have been switching to E2P right now. Thank you.

Operator

Our next question comes from Laurence Alexander with Jefferies. Please go ahead.

Speaker 11

Good morning. Two quick ones. First, on the renewables Capacity, will that inventory build show up on your P and L or will it be separates? And can you give a sense for the magnitude? And secondly, on the end market comments that you're hearing from customers, I guess that it looks from your presentation as if the Overall theme is the industrial recession driven by destocking to recalibrate, But underlying demand is pretty solid, is pretty stable outside the construction markets.

Speaker 11

How confident are your customers on that? And when do you think they need to and how much warning do you think you would have if they need to recalibrate?

Speaker 3

So I'll let Louis take the first question. I'll take that.

Speaker 4

Sure, Lance. On the Keysport Methanalysis project, obviously, we've built out a supply chain. We already have the key Raw materials and recycled materials as part of our inventory here at year end as we're preparing for a start up next year. So you can think about there's no significant impact of transitioning from fossil fuel feedstocks to recycled content As we go from 2022 to 2023, as we think about our projects, 2nd U. S.

Speaker 4

Project And the project in France, again, we could have different operating models in the regions, Those are not significant working capital deals.

Speaker 3

When it comes to your end market question, You really need to think about end market exposure in 3 buckets, right? The one that's most impacted by this sort of manufacturing recession is durables And building construction, the 40% down in durables as we talked about earlier, 30% down in building construction in the 4th quarter in AFP. So those markets are being very heavily impacted. And that destocking relative to the retail data It's pretty significant relative to the end market demand, which is still quite weak. So there's that.

Speaker 3

We do think destocking by definition has ended at some point. It's hard to say exactly when, but we've told you what we're assuming and you can factor what you want to believe into the models. When it comes to auto, the auto demand is already at recession levels all last year, right? So that second bucket was a huge driver of profit for the industry as well as for Eastman, It probably has limited downside and more upside as we go through this year, even though we are going into an economically or already in an economically Challenged area where consumers have discretionary choices on where they want to spend money. So we do think that's going It would be stable and sort of modestly improve.

Speaker 3

And within that mix, I should have also said earlier, we are levered to the luxury market With all of our products, because they're very high value products that we're selling. And that part of the market is likely has held up better last year and certainly going to, I think hold up better this year in sort of these economically sort of expensive times when it comes to interest rates. And then the 3rd bucket, which is about half of our revenue, is what we call our stable markets. This is medical, consumables, ag, food, feed, All these sort of end markets that are water treatment, they are very stable. Now we saw quite a bit of destocking even in these stable markets in the 4th quarter Across the entire company, as people were trying to get rid of high cost inventory, generate cash for themselves, so that was a big part of the headwind Less than a percent basis, but happening everywhere as part of the challenge.

Speaker 3

There we see that The second, the overall revenue base across the company.

Speaker 1

Thank you. Let's make the next question the last one, please.

Operator

Of course, our final question today comes from the line of P. J. Juvekar with Citi. Please go ahead.

Speaker 13

Yes. Hi, good morning. Thank you. And thanks for taking my question. So Mark, on methanolysis, you mentioned your CapEx is up 10%, but you don't expect a huge change in the returns you expect.

Speaker 13

Are you passing on that increased cost to your customers? And Also, the plastics are cyclical. And so if you want to get steady returns there, are your customers willing to take the cyclicality of the plastics And volatility, so that you can have steady margins?

Speaker 3

Yes. So I think from a spread point of view, the way we're sort of contracting into the PT market is with our what we call our circular contracting model, I'm going to provide steady spreads between the cost of feedstock and energy and the price of materials. So from a spread point of view, we To have quite good stability, think Airgas company kind of model. Demand, of course, is still subject to end market demand. When it comes to sort of the volume, there's always going to be some variability, but we're going into packaging and the consumables, so the variability in that volume On an annual basis, year over year is pretty stable, right?

Speaker 3

So I don't have a lot of volume concerns there. When it comes to the specialty side of this circular platform, we're not changing the end market sort of structure in both demand Well, how we do pricing, we're just adding recycled content as another dimension of differentiation to Triton and all the other copolyesters in the cosmetics and everything else So we'll still be sensitive to demand changes when it comes to the Circular platform that will be capturing Higher margins relative to what we currently realize in these products and growing total volume Quite fast, right? One of the reasons we win the marketplace is high value growth driving mix upgrade against such cost leverage, right? That is very true In good times and this will lead to much more accelerated growth from these kind of products to give fixed cost leverage. But Unfortunately, you faced down times like the last Q4 and Q1 of this year where that mix is a headwind.

Speaker 3

But when you look at The upside in our stock as you get through this, not just for Circular, but for just market recovery, there's a huge mix upside for our company as you go into the back half of this

Speaker 13

So Mark, The air gas or the industrial gas model hasn't really worked in plastics. What gives you confidence that

Speaker 3

Yes. So as I said, especially, it's just our current model. But when it comes to the PT, That's where the industrial gas model concept applies. And yes, it's a unique offering, right? We're the only large scale company on the planet, Especially North America and Europe, who's offering recycled content from hard to recycle plastics.

Speaker 3

And when you get to the food grade industry, mechanical can't remotely meet their needs. And someone has to plug that gap if they're going to hit their targets and we are way ahead of our competition in being able to provide that Service. And that's exactly what an air gas company does too, provide a service to convert product into a highly needed Input. And that's sort of where we're at today and that's our confidence as we go forward into these three projects. And that's why we continue to maintain this disappointment of not building these kind of facilities unless we get these kind of contracts, Because I'm not getting back into, as you said, PJ, the traditional plastics business of high margin volatility, we just We'll do that.

Speaker 1

Okay. Thanks again for joining us today. We really appreciate it. I hope you have a great day.

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Earnings Conference Call
Eastman Chemical Q4 2022
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