Eastman Chemical Q2 2023 Earnings Call Transcript

Presentation

[Operator]

Good day everyone and welcome to the second-quarter of 2023, Eastman Conference Call. This conference is being recorded. This call is being broadcast live on the Eastman's website www.eastman.com. I will now turn the call over to Mr. Greg Riddle of Eastman, Investor Relations. Please go ahead, sir.

[Greg Riddle, Investor Relations at Eastman Chemical]

Thank you, Elliot, and good morning everyone and thanks for joining us. On the call with me today are Mark Costa, Board Chair and CEO; William McLain, Executive Vice-President and CFO, and Jake LaRoe, Manager, Investor Relations. Yesterday after market closed, we posted our second-quarter 2023 financial results news release and SEC eight-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 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 second-quarter 2023 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-K filed for full-year 2022 and the Form 10-Q to be filed for second quarter 2023.

Second earnings referenced in this presentation 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 2023 financial results news release. As we posted the slides and accompanying prepared remarks on our website last night, we will now go straight into Q&A. Elliot, please let's start with our first question.

Questions and Answers

[Operator]

Thank you. [Operator Instructions] Our first question today comes from Josh Spector with UBS. Your line is open.

[Josh Spector, Analyst at UBS Group]

Yeah, hi, thanks for taking my question. I guess first I was just wondering if you could talk about the cadence of earnings here in the second-half, obviously you're talking about a number of inventory adjustments impacting 3Q. If you could talk towards why you're taking more of the steady state looks like, whether it's 4Q or maybe beyond that and what that implies for longer-term earnings CAGR here. Thanks.

[Mark Costa, Chief Executive Officer at Eastman Chemical]

Good morning, Josh and thanks for the question. So there's a lot embedded in that question about the back half of the year and how that indicates where we go into next year. So first of all, I'd start with, we obviously in April, thought demand was going to be better in the back half of the year, which was principally an assumption based on destocking. Really being complete by the end-of-the second quarter, obviously we and everyone else in this sector has come to a different point-of-view that while demand at the primary level I don't think it's changing that much, it's not getting worse in our perspective, and I haven't heard anyone else suggest that.

We are expecting that there is a lot more destocking that continues to go on in some end markets, which has really been the impact to our outlook in the back half of the year. So some areas, whether it's this year or next year. For example, automotive, we have solid growth in this quarter, we expect that to continue to be solid to the back-half of the year and there is so much pent-up demand. When you think about 2024, I would expect it to continue to be a tailwind next year relative to this year. So that market aviation, same story in very good shape. You have a lot of sort of stable end-markets, where demand has been off in that sort of 3%, 4%, 5% range when you look at all the fast-moving consumer goods companies out there, fully recognizing that they are holding price and being very disciplined to expand their margins that way with raw-material tailwinds and accepting that they probably wouldn't gain much volume if they reduce price.

So, disciplined while maintaining frankly in our specialties. But in addition to that they're managing cash too and so we saw an additional sort of 8% to 12% destocking on top of that demand in the fourth quarter, first quarter but fortunately as we go in the second-quarter, lessening on that destocking and expect much less destocking in those kind of stable markets like packaging, personal care, water treatment. So that feels like it's moving in the right direction as we go to the second half and, of course, that would continue also into 2024. When you look at, the consumer discretionary markets actually, take two other stable markets just to deal with them so there's a couple that also took some sort of extreme negatives in additional destocking in Q2, which was packaging and medical in the Advanced Materials segment and that they were carrying a bunch of safety stock from last year.

Demand wasn't improving as they expected and so, you know, they really started destocking in the second quarter, but they also seem to have addressed their issues predominantly in the second quarter. So that also expected to get a bit better as we go into the back half of the year. The destocking reduces through to third quarter and certainly it seems to run its course in that by the fourth, so again improvement relative to next year, especially when you think about all these markets had a certain amount of destocking that won't repeat in 2024 that's a tailwind. So the two bigger markets that drive a huge amount of value for us on a profitability point-of-view like automotive that has the most demand impact is sort of in the consumer discretionary area as well like durables and building construction.

When you look at the durable market, that's the one that's gone through the most extensive destocking of any market and it really goes all the way back to last May of last year when the retailers sort of got 2X amount of inventory they needed. Because they were buying everything they can think of to because of supply chain crisis and then they started destocking over 14 months ago. That bullet finally hit us in the fourth quarter of last year really knocked us down about 40%, when the underlying market was only down 10% to 15%, so a lot of destocking. It got even worse -- 10% worse into the first quarter. And then, fortunately, we saw that destocking start to abate in the second quarter, it got 22% better in the second quarter versus the first quarter.

So, we saw momentum there. You just don't see the results because of the medical and packaging destocking that occurred. So that destocking will continue to lessen as we go into the back half of the year and be another tailwind as you go into it. And then of course building construction, I'd say, is one that's been doing some destocking in this year, demand is down and we expect that to be sort of flat to the first first-half. Because that market still has more action taken. There's also maybe some more hope with first home builds. So there is a spectrum of things going on. When you look at it, but it's each of them sort of add up to less destocking, but it's not as much as we had hoped for you know, In April, and that's really the predominance of how our volume forecast came down, which is the entirety of our earnings reduction when you combine that with the need to take inventory actions for this lower demand outlook to make sure we hit the $1.4 billion of cash.

So all those then feed into a year next year, that's going to look better, right. When you don't have all this destocking going on which we're assuming for 2024, you have some normal seasonality coming back into the demand outlook for next year, that's going to help improve things and you've got the recovery of all this volume in our most -- down markets are our highest-value markets, right. So it's been a huge mix hit to us this year and as we've shown in past recessions when the mix comes back and if there's a little bit of restocking, the high value of these markets drops to the bottom line pretty significantly, especially with the costs we've taken out of our fixed cost structure. So it all comes together, which is building momentum in the second half to having a much better year in 2024.

[Josh Spector, Analyst at UBS Group]

Okay, thanks, if I could just ask very quickly, then so your volumes were down 15% in the first half. What's your baked in assumption on the second-half, all those things put together?

[Mark Costa, Chief Executive Officer at Eastman Chemical]

You're saying what is our specific volume forecast. We've got it as a combined company for the second-half relative to the first-half. Is that what your question is?

[Josh Spector, Analyst at UBS Group]

Yes, you assuming down 15% for the majority, down 10%, down 5%, I'm just trying to get a quantum of what you're considering?

[Mark Costa, Chief Executive Officer at Eastman Chemical]

As we look at I think it's all together the volumes in the back-half of the year are going to be a bit less than the first half of the year, but I don't think we're going to provide a quantitative number to it. It's basically just a little bit down when you put it all together. The real headwinds in the back half of the year is from a sequential point of view, first-half, second-half the entirety of our earnings decline is the inventory management, right. So that's $75 million, sort of additional headwind you know a good sort of alliance with sort of where our earnings outlook has now moved, so volumes are relatively stable when you put all the ups and downs, right. So, some down in AFP, some up in AM. Stability in fibers and CI, sort of a flat volume number from a sequential point-of-view.

[William McLain, Chief Financial Officer at Eastman Chemical]

Josh, I would also say the mix should be more favorable, as Mark has outlined with our durables markets recovering in the back half.

[Unidentified Participant, at Eastman Chemical]

And if I could just add one more point which is third-quarter year-over-year the volume mix decline would be less than what you seen in the first-half, but still meaningful when you get to the fourth-quarter, again on a Year over Year basis. The comp is a little bit different and so you get to a point where that decline in volume mix is even less still than it was in the first half of the year.

[Josh Spector, Analyst at UBS Group]

Okay, understood. Thank you.

[Operator]

Our next question comes from Vincent Andrews with Morgan Stanley. Your line is open.

[Vincent Andrews, Analyst at Morgan Stanley]

Thank you and good morning. In advanced materials and in AFP when you talk to your customers about what's going on volumetrically what are they indicating in terms of the desire on a go-forward basis, where they want to have inventories and where things might get back to you and I guess what I'm trying to understand is whether what's going on right now is just sort of a structural reset in terms of how they're going to manage their own business versus something that maybe is just temporary that snaps back, it's just -- it's been going on for a long-time. So it's starting to feel like whether it's interest rates or whatever else is happening, it's just starting to feel like the entire supply chain is doing is doing a reset. So I'm just curious what your customers are telling you in regards to their sort of medium to long-term intention in terms of holding inventory?

[Mark Costa, Chief Executive Officer at Eastman Chemical]

That's a great question Vincent and I mean, I'll try and keep it simple since my last answer was rather long, but you know, it's very different by end-market on what's going on stability of underlying demand and then what they're trying to do on destocking, right. So a lot of these stable markets. It's more fine tuning even they -- everyone built safety stocks last year through 2021 and 2022, and they're trying to generate cash and adjust those inventory levels to different perspectives on end markets. So if you're in the personal care world, medical world, these markets are stable and they may be down a little bit, but they're very stable, so destocking is clearly the entirety of what's going on there in many of those sort of end-markets.

When you get to some of these other markets you know where the supply chain is incredibly long like durables, you know we're making things that go to China, that can make[phonetic] the products and come back to Europe or US. Really understand just how much inventory is out there through that entire chain is difficult for everyone in these markets and exactly where end market demand is on these more discretionary markets. I think is a little bit more difficult to judge. But what I'd say we've seen you know is a couple of cycles, right. So there's a lot of destocking in the fourth quarter, demand is really low in January, got a bit better through March, and then there was a realization that the banking crisis people got nervous about what was going on the broader economy until they went into a really low-level of demand in April, which was probably the low point for the year.

And then started to do a little bit less destocking or a lot less destocking in durables, through the -- through the second quarter. So as we get into the back half of this year I think what happened with customers in the June timeframe is everyone assuming the back half was going to be a bit better in our downstream customers across most markets, especially, maybe the more sensitive ones that things would stabilize destocking after 14 months-to your point would have played its course, more back in June, after 12 months and they realize they all have that built-in their plans, they sort of said that's not going to happen. Demand is going to be flat, which is all of our collective assumptions now and everyone's in destocking now to that assumption relative to things getting better, but it's not because the markets are getting worse, Vincent. It's just they had assumed things will get a little bit better, they're not and they are sort of correcting for that and it's important that it's a lack of expected growth as opposed to I think things are getting worse. I don't see anyone saying things are getting worse at the primary demand levels. Does that make sense?

[Vincent Andrews, Analyst at Morgan Stanley]

Yeah, thanks so much.

[Operator]

Our next question comes from Frank Mitsch with Fermium Research. Your line is open.

[Frank Mitsch, Analyst at Fermium Research]

Hey, good morning. With much of the discussion regarding inventory management and so forth I'm just curious obviously the queue hasn't come out yet. So we don't know where the second-quarter inventory levels are. But if can you give us an idea of where they are relative to the 1.94 that was in the first-quarter and what are your expectations as to when you go through these actions how much further down will you be drawing your own inventories?

[William McLain, Chief Financial Officer at Eastman Chemical]

Good morning, Frank. It's Willie. Yes, so as we think about inventory levels, I'll call it from Q1 to Q2. Inventories were about flat. So as we think about the level of the supply chains, the demands that Mark has just outlined we have about $300 million that we would expect inventory to decline in the back half of the year. That's also central to getting us to generating roughly $100 million from working capital on a full-year basis and I'm confident that our business teams and supply-chain that we have a plan in place that we've already activated to execute and deliver that cash flow.

[Frank Mitsch, Analyst at Fermium Research]

Terrific, thank you and Mark I was wondering if you could talk to the raw-material benefits that you're seeing in your specialty businesses anyway you can provide some order of magnitude in terms of what sort of benefits are you seeing and what your outlook is there. Thank you.

[Mark Costa, Chief Executive Officer at Eastman Chemical]

Yes, so I think in invest materials we're certainly seeing some pretty meaningful raw-material benefits, Frank. If you remember last year we had a tremendous spike upward in VAM and PVOH prices that created a pretty significant headwind for the interlayers part of that business. Those prices have now collapsed and dropped price pretty significantly versus last year and that's translated into a tailwind for us to recover our margins there. PX has not been as much of a tailwind. Those prices have been holding up relative to last year. There's been a bunch of outages in that industry, new plants having trouble starting up, alternative-fuel value all those typical explanations with PX. So, not as much of a tailwind there, but we're still well over $100 million of spread tailwind in that segment for the year.

And I think that is obviously helping with some of the demand challenges and building us into a very good margin position as we go into next year when mix comes back and how that flows -- how that -- those margins will flow through to the bottom line in our fixed-cost leverage. In AFP, again, we've got good raw-material tailwinds in that business as well, but the spread improvement is not as significant, because we really have a lot of cost pass-through contracts, especially in Amines business. So we had very stable margins last year, that means we are also going to be stable this year by the nature of those contracts. But those spreads are also coming in relatively good when you think about ammonia, methanol, and some of the olefin-related propane, ethane type products going into specialty.

So overall, spreads are better there as well as on a full-year basis helping this year and we'll of course build momentum as volume comes back with better margin as we go into next year.

[Frank Mitsch, Analyst at Fermium Research]

Got you, thanks so much.

[Operator]

We now turn to Aleksey Yefremov with KeyCorp. Your line is open.

[Aleksey Yefremov, Analyst at KeyCorp]

Thanks and good morning everyone. You've discussed lower conversion of MOUs to definitive agreements in France. Can you just elaborate on that? Is it just in France or is it related to your second plant in the US as well and is this really related to demand uncertainty or price volatility in the plastics markets? What's happening there?

[Mark Costa, Chief Executive Officer at Eastman Chemical]

I was wondering, you broke up a little bit Aleksey. I want to make sure I understood the question you're asking what's happening with the pace of contracting in France, given the current market conditions. What is the other question?

[Aleksey Yefremov, Analyst at KeyCorp]

Yes, it was. Apologies. You're talking about MOU conversions to definitive agreements. Could you just elaborate on what's going on there?

[Mark Costa, Chief Executive Officer at Eastman Chemical]

Yeah, sure. So first of all, you know the commitment and desire to get recycled content and products remains very strong. So when you look at the specialty businesses we're in right now from our Kingsport plant the demand commitment which is global, not just in North America but across the world for products and durables, cosmetics, packaging from recycled content remains very strong. We've got 70% of our potential output where customers are very committed as you saw in prepared remarks.

When it comes to these PT or textile contracts the long-term sort of take or pay kind of structures for those markets like the Pepsi contract we are having great engagement and good discussions with a number of companies about those contracts like Pepsi, it takes a long-time to negotiate. These are very complicated contracts and the current market conditions I would say are sort of slowing those discussions, down a little bit and so if you're looking at the PT market whether it's vPET or rPET those market prices have come off in a pretty significant way which is purely just the story of everything else in the current macro. Demand is off and beverages people are downscaling to sort of cheaper water bottles that have less material, a lot of that rPET also goes into carpet and textiles where demand is down 23%, so that is just a temporary thing.

The key thing to keep in mind in these contracts, is we are targeting applications within these brands where mechanical recycling doesn't really work. So if they want to have recycled content in those applications. They're going to have to use chemical recycling because the performance requirements in a variety of different technical aspects the mechanical is just not going to actually work. I mean, I'm not going to get into the details of that because I think that's a competitive advantage for us, given our deep polyester expertise relative to other companies out there but that's definitely a key part of how we're going to win.

The second part is the degradation of polymer is already becoming clear in some markets that you can mechanically, get to a 100% recycled content. So while regulatory requirements, maybe only 25% in 2025, a lot of brands have set targets for some key applications to be 100% recycled content and to maintain quality they're not going to be able to do that with mechanical. So we feel very confident that these contracts will get resolved and we're going to get them in place. Engagement is high and the regulatory requirements in especially in Europe are going to require people to have recycled content, and you look at the market situation there, right now, only about 12.5% of PET is sort of recycled, mechanical industry does not have the ability to double that capacity between now and 2025, when that number needs to be 25% recycled content, where you can't put the packages on the shelf. So we feel like we're in a good position and working really productively with our customers and we're aiming to have those contracts done by end of year.

[Aleksey Yefremov, Analyst at KeyCorp]

Thanks, Mark.

[Operator]

Our next question comes from Mike Sison with Wells Fargo. Your line is open.

[Mike Sison, Analyst at Wells Fargo & Company]

Hey, good morning guys. I was thinking about Advanced Materials little bit, it feels like this year obviously maybe hopefully a trough adjusted EBIT [indecipherable] sustainable there you had a couple of years ago, you had pointed to adjusted EBIT for the segment maybe closer to $700 million. Do you still think that that's the longer-term upside and how do you bridge sort of the gap between the two tosort of get there from these levels.

[Mark Costa, Chief Executive Officer at Eastman Chemical]

Sure Mike and yes, we still think that's the destination for this business, obviously that's been a pretty volatile time over the last few years from the pandemic to supply chain crisis to a recession. And as I said a bit earlier, the extremity of what's happened in the switch from a COVID live to an experiences live, and the impact of inflation, interest costs and how people can afford to spend on goods when they're just trying to afford everyday life and maximize their experiences at very high prices when it comes to hotels and everything else has created a short-term constraint in how people can afford goods. And consumer durables, as an example is one of the places that is most discretionary, especially after they bought a lot during COVID.

So demands are way below anything normal in consumer durables and then you've got this huge amount of destocking on top of it on a very-high value mixed product. So as that market stabilizes you'll see some recovery coming in the back half of the year, especially if you back out the inventory -- inventory utilization headwinds and will build good momentum into next year from an underlying market point of view. And then you add on top of that recycled content, allowing us to add additional incremental value and substantial new volume from those applications and as we said, just getting started, to $75 million added to next year in EPS for the Advanced Materials segment. So that obviously is going to be significantly helpful.

The fixed-cost leverage in this business as we demonstrated in the last 10 years is significant, right. This world is always grown double-digits for us on the underlying markets are typical growing 3%, because we win so many applications because of better value proposition, just because of product performance and product safety and now you're adding on recycled content to further accelerate that curve. The problem is in a market like this there's not a lot of new product launches, right. But we continue to win new business, even now that it's going to help volume in the back-half of the year on top of just waiting for less destocking. We've won a lot of applications but they really ramp-up next year when things stabilize and they start launching new products.

So, all that sort of brings in better value from that side and then, of course in the last couple of years, the inflation has been really high. We've been trying to keep up with it, but now we're finally recovering our margins in this space. So you've got better margins on top of this volume recovery to sort of lever you to better earnings, so as you go through 2024, 2025, driving towards that 700 is very much what we expect to do.

[Mike Sison, Analyst at Wells Fargo & Company]

Got it and just a quick follow-up for just kind of overall volume growth in 2024, which I know it's a long way from here, but when you look at your customers' inventories. Do you think they will need to restock and if that's the case when do you think a restocking event would occur, and if not, is it possible you just sort of plug along low-single digits or so on volume growth from 2024, 2025, 2026 and maybe they don't need to replenish.

[Mark Costa, Chief Executive Officer at Eastman Chemical]

Well, first of all I think what happened from April to now the whole industry from us all the way down to retailers have gone to group thing that's going to be bad for the rest of the year. All right. And everyone is acting under that assumption and pulling inventory down, managing of that context but there's a limit to how much destocking can occur at some point warehouses go empty right and then some of these markets, especially like durables it's been emptied out for a long-time, where automotive there's a huge amount of pent-up demand because we're talking about demand being better this year, but it's from a really bad level last year, right. So there's still plenty of pent-up demand there and there's going to be plenty -- plenty of pent-up demand and building construction with the dynamics of what's going on this year constraining both demand and production of homes.

There's a lot of upside across the whole corporation when you think about it from both the demand point-of-view and you got to remember these destocking levels are huge, right, so destocking is two or three times more than the underlying demand and if that goes away that's all volume recovery at some point, even if the underlying market demand doesn't improve and then to your question around inventory I think it's with the actions that we're taking when everyone else is taking you can see people driving inventories at very low levels. It's more likely than not that they're going to go below what they in improving demand environment. And so there'll be some amount of restocking. Now our back-half just to be clear, has no restocking assumed in it in the guide that we gave you.

So if that happens, that's upside. But if you -- but if you look at 2024 and say destocking got to run its course, eventually. So that you don't have that as a headwind for next year and then some just a little bit of restocking, just to get to levels to serve that demand I think you can get a much better picture of volume next year than this year.

[Mike Sison, Analyst at Wells Fargo & Company]

Thank you.

[Operator]

Our next question comes from David Begleiter with Deutsche Bank. Your line is open.

[David Begleiter, Analyst at Deutsche Bank Aktiengesellschaft]

Thank you, good morning. Mark, thanks for the update on Kingsport. On the project do you have any forecast for estimated losses this year as you ramp up and do you have an updated cost of the Kingsport project. Thank you.

[Mark Costa, Chief Executive Officer at Eastman Chemical]

Thanks, David. First, I would just highlight that the the operating costs are going to be approximately neutral on a Europe basis if you think about the pre-production that we're incurring this year as well as the start up expenses and also as we're using our bridge technology with like [indecipherable] the market that's at a higher-cost to bridge. So on a Year-over-Year basis, the way I think about this as revenue growth it's actually accretive to EBITDA. And as we outlined within our guidance on the $75 million of EBITDA on a Year-over-Year basis roughly $50 million of that will be in advanced materials and the absence of the pre-production and startup costs in our Corporate other. So as I see it, that's roughly where we're getting the $75 million.

Also if I think about our capex this year, we started the year at roughly $700 to $800 million for the project. We took that up to $800. You can think about the combination of that and how we're managing our overall capex as the increase is into the project this year for the Kingsport project.

[David Begleiter, Analyst at Deutsche Bank Aktiengesellschaft]

I apologize I meant to ask what was the updated capital cost for the project itself not the total company capex.

[William McLain, Chief Financial Officer at Eastman Chemical]

Yes. I don't think at this time were given the capital costs for the Kingsport project, so we're not going to -- we're not going to provide that at this time, David.

[David Begleiter, Analyst at Deutsche Bank Aktiengesellschaft]

Understood and just Mark, just on fibers in tow do the contracts next year have price increases, embedded in them?

[Mark Costa, Chief Executive Officer at Eastman Chemical]

They don't have price increases embedded in them for next year versus this year David, if that's your question, obviously prices have gone up considerably from last year. But the idea of these contracts is to prove our margins and profitability to a level where we can continue to reinvest in this business to be a reliable supplier to our customers and we've achieved that type of pricing with our -- with our customers in these contracts. We've also put formulas in them to adjust for changes in energy costs to give stability for us and for our customers which we have not had in the past. So we feel great about what we've achieved in improving our sort of ability to support our customers and our current profitability and these contracts are now in place, where about 75% is fully contracted now through the next 2024, and many of those are multi year contracts.

Hopefully, by the end-of-the year we'll have that number up to 90%. So great improvement in this business from its performance last year and we're very focused on stabilizing it. On the tow side to provide very attractive cash-flow to support our growth investments across the company. I would also note the textile business continues to do great on top of that where even in a 20% down-market, that we have this year in textiles we're growing that business. So, we're winning a lot of market share versus other materials, because of the value proposition is nice. Very compelling. It's a great beginning of life story being based on bio content and recycled plastic and importantly in a bigger issue going forward now is micro plastics which are the fiber is breaking up and getting into the ocean and our fibers are fully certified biodegrade when they do end up in the environment and so that's a very significant positive as the world is becoming more concerned about that as well. So it's just a great business.

[David Begleiter, Analyst at Deutsche Bank Aktiengesellschaft]

Thank you very much.

[Operator]

Our next question comes from John Roberts with Credit Suisse. Your line is open.

[John Roberts, Analyst at Credit Suisse Group]

Thank you. On the second US PET projects, are you growing more slowly on that?

[Mark Costa, Chief Executive Officer at Eastman Chemical]

We're not go more slowly in any significant way, John. I mean, right now what we're doing is really focusing we haven't made a side announcement. So you could ask that question to. Because we're really looking at the incentives across several states. We've got three sites that are all very attractive and the engineering work is continuing for whichever side we pick and so we're just trying to get those incentives in place. We feel great about our partnership with Pepsi as a significant base level[phonetic] customer in that project and we are sort of moving forward with that project to make sure we can serve their needs and put that together with the French project in Kingsport to get that $450 million of EBITDA of value for our owners, which is a great return on the capital curve[phonetic] required across those three projects.

[John Roberts, Analyst at Credit Suisse Group]

And then on the fibers business assuming raw materials are sequentially stable is all of the earnings step down in the third-quarter, just remind us of the frequency of the reset on price versus cost.

[Mark Costa, Chief Executive Officer at Eastman Chemical]

The contracts are quarterly, so a little bit of a step-down from Q2 to Q3 is just in the prices adjusting for lower energy environment.

[John Roberts, Analyst at Credit Suisse Group]

Thank you.

[Operator]

Our next question comes from Kevin McCarthy with Vertical Research Partners. Your line is open.

[Kevin McCarthy, Analyst at Vertical Research Partners]

Yes, good morning. Mark, with regard to Advanced Materials, do you have a sense today as to whether your third-quarter earnings are likely to be flat, up or down sequentially versus the $99 million that you posted in the second quarter. The reason I ask is reading the prepared remarks last night, it looks like you have a $40 million of inventory-related hit in the third-quarter but you also say the second half should be better than the first half. So it seems like there's some countervailing trends there. So any comments on the seasonal cadence would be helpful.

[Mark Costa, Chief Executive Officer at Eastman Chemical]

So, Kevin. I think we highlighted earlier that most of the $40 million headwind on the utilization rate will be in Q3. So as a result I would expect it to be somewhere to slightly down sequentially in advanced materials.

[Kevin McCarthy, Analyst at Vertical Research Partners]

Slightly down versus 2Q, Willie.

[Mark Costa, Chief Executive Officer at Eastman Chemical]

Correct.

[William McLain, Chief Financial Officer at Eastman Chemical]

Yeah, of course, there will be -- the lack of that sequentially from Q3 to Q4, you know, where that improving in volume and spread will pop back up. So you can't think of normal seasonality around the back-half of the year, really for the -- for either AM or AFP, because most of the inventory reduction actions are happening in Q3 more that -- much more so than Q4. But the volume momentum and margin improvement is continuing through 3Q and into 4Q, not just because of our inventory actions, but because our customers are doing the same thing, right. They are also taking inventory down more in Q3, and oddly less in Q4 when you think about it in the sort of odd year we're living in right now.

[Kevin McCarthy, Analyst at Vertical Research Partners]

Yeah, it is. Thank you for that. That's very helpful. Secondly, I wanted to ask about A&FP I think you referenced a heat transfer fluid project that cost $15 million to be pulled into the second quarter. Can you just elaborate on what you're doing there and how that is translating to a meaningful earnings swing.

[Mark Costa, Chief Executive Officer at Eastman Chemical]

Yeah, sure, so the fluids business is a bit sort of chunky and how volume shows up, right, because you have these very large projects and at some point they complete the project and at the end-of-the completion, they need to charge that plant with heat transfer fluids and then start-up the plant. And in this case, this was an extremely large LNG project that had been under construction for several years and their completion actually happened a little bit sooner than they expected and move forward with wanting to charge that system. And so we ship that volume. We thought it was going to be in the third quarter, turned out to be in the second quarter. But this overall business is a great business and something I'd say that we've really accomplished a lot and this business is diversifying our market exposure to different end-markets.

So historically, it's been very driven by the polyester industry and a few other sort of chemical facilities that use a lot of heat transfer fluids. But we've seen a huge growth in LNG as you --as you know well with the geopolitical dynamics going on right now with Ukraine an Europe. And there's lot of heat transfer fluids in those plants too so we're diversifying out of China into other applications like this project that creates a lot of value for this business. And they're are very-high value projects. So when they -- when they do show up, they dropped a lot of earnings to the bottom line and so it just happened to be in Q2, which then means as you sequential go from Q2 to Q3, you get a $30 million swing in earnings.

[Kevin McCarthy, Analyst at Vertical Research Partners]

Okay, perfect. Thank you so much.

[Operator]

Our next question comes from Matthew DeYoe with Bank of America. Your line is open.

[Matthew DeYoe, Analyst at Bank of America]

Good morning, everyone. To talk a little bit about Naia textiles what's the opportunity for EBIT, if we think about next year and growth. I mean, I'm just thinking, given the margin recovery in cigarette filter tow does it even make sense to rotate tonnage from filters to fibers and is Naia still growing into your excess capacity or are you now transitioning filter capacity to textiles.

[Mark Costa, Chief Executive Officer at Eastman Chemical]

So first of all Naia is a great business, the margins are very good. Obviously, recent improvements until margins are better. But the reality is we're really excited about the improvement in the tow business. It is a stable business, it's still going to decline in volume about 1% a year, it's not a growth business. So we continue to be very focused on serving our customers. These heat-not-burn products are certainly growing at 15%, and need more filter tow, but that's just offsetting some underlying natural decline of cigarettes, to get you to that sort of net 1% decline, so we're not conflicted capacity-wise between this and growing our Naia business, but we are getting to the point where we are going to start using up the available capacity and we're looking at our capacity expansion options to continue to support the growth, right, because our goal here was cellulosics has not optimized the stream, does it turn it into a grocery, right.

Our goal here is to win in a variety of applications. So like polyester being a very-high gross stream for environmental reasons and providing sustainable products our strategy as we laid out at Innovation Day is to get $200 million of EBITDA growth. The stream on top of the tow business, right. So when we talk to you in 2021 we weren't including improvements in tow, right. So as a new base and we're still aiming to grow $200 million EBITDA on top of that new base. That's a very significant change from where we were in 2021, so we've got growth in Naia which we're really excited about as I explained the value proposition, a moment ago.

We have great growth prospects and some early wins in Adevinta. This is our foamed[phonetic] cellulosic that can replace polystyrene and packaging clearly polystyrene is being banned in many places for packaging, whether it's food packaging in sort protein trays, for meat or the clamshells et cetera and we validated that our venture product will biodegrade both in not just industrial but in residentials composting which is sort of the equivalent of landfill. So really is a true end-of-life solution.

So the customer is super interested in that huge market, lots of volume growth opportunity there. Then you got microbeads, which is a super-high value opportunity in cosmetics. We've got success in recycled content. There [indecipherable] business with how we are recycling the eyewear back into the products. There's a lot of growth going on across the cellulosic stream and so we're going to be looking at incremental capacity expansion to support all these growth opportunities as we move forward.

Fortunately, we have a very large installed asset base. So it's not like building methanolysis plants, we can really leverage the capabilities we have here, but they'll still be capacity routing for Naia and all these other products between flake and fiber.

[Operator]

Matt are you good? Our next question comes from Patrick Cunningham with Citigroup. Your line is open.

[Patrick Cunningham, Analyst at Smith Barney Citigroup]

Hi, good morning, thanks for taking my questions. I know you have no expectations for any sort of restocking embedded in the full-year guide, but which end markets do you think are potentially best set-up for restocking, whether it'd be in 4Q or into 2024 and how should we think about this in the context of upside to earnings from the specialty businesses.

[Mark Costa, Chief Executive Officer at Eastman Chemical]

Well I think you know it doesn't matter what end market we're in right now. There's amount -- there's a lot of destocking going on as everyone focuses on generating cash and so I think there's probably opportunities for restocking pretty much across the markets. Building construction might be the one exception where I think there's a lot of destocking, still to be done from what we've seen from our customers in that space. But everywhere else I think there is some degree and then you just gets into proportions, right. So where the destocking numbers are bigger like consumer durables and the potential for restocking is higher. In more stable markets like personal care and water treatment and medical I think the restocking opportunities are still there, but muted because they're just not doing as much.

As far as earnings opportunity for next year, relative to this year, we're not going to sort of get into that yet, it's a little early.

[Patrick Cunningham, Analyst at Smith Barney Citigroup]

Yeah, that makes sense. What's driving the strength in acetic anhydride and I think you referenced overall resilience in asset sales. I would have expected some weakness given declining spreads than some of your end-market commentary.

[Mark Costa, Chief Executive Officer at Eastman Chemical]

Acetic anhydride goes more into food, pharma, feed type applications, where the demand is actually really stable. So it's not acetic acid goes into polyester where demand is down a lot in textiles. VAM goes into coatings, and a bunch of other more economically sensitive applications when you think about different asset yield derivatives, silicon hydrate just as much more stable end markets and a large customers that place a lot of value on security of supply that product for those kind of applications. So they tend to be more focused on suppliers and just what's the best price. So that just allows our business to be relatively stable. I mean, we still have some price pressure there, but it's not nearly as much as some of these other sort of derivatives or important olefins, which is the bigger part of our portfolio where the price pressure and spread compression occurring in CI is really more of an olefins and plasticizer.

[Patrick Cunningham, Analyst at Smith Barney Citigroup]

Very helpful. Thank you.

[Operator]

[Operator Instructions] Next[Phonetic] up is Laurence Alexander with Jefferies, your line is open.

[Patrick Cunningham, Analyst at Smith Barney Citigroup]

I just have two quick ones. As you think about the dynamics around inventories and fixed-cost absorption should incremental margins next year be above 60% or do you think some of the inventory reduction efforts you're doing now will spill-over into Q1.

[William McLain, Chief Financial Officer at Eastman Chemical]

All right. This is Willie. To your point I think we've demonstrated through various environments, one that we can deliver strong cash flow and that's what we're focused on doing now, as we think about the fixed cost utilization. I don't expect any spillover into 2024, the actions that we're taking will be complete this year. Also on the incrementals I think you've seen the decrementals that we're talking about the incrementals will be equally positive and I would add-on to that, to your point, to get to the levels that you're talking about that, that includes the mix upgrade and the higher-value products as we think about our Advanced Materials and the more specialty nature there.

[Patrick Cunningham, Analyst at Smith Barney Citigroup]

And secondly, kind of, now that your peers are facing kind of more pressure on from the credit cycle you've always seemed to have a sweet[phonetic] pause in M&A around finding people who are under-investing in the engineering has your M&A pipeline changed or can you characterize kind of how actively, you're looking at opportunities.

[Mark Costa, Chief Executive Officer at Eastman Chemical]

Yes. We're more focused on the bolt-on pipeline. We did a great bolt-on earlier this year in our performance films business. We're right now focused on our organic growth strategy with our investment and the three circular platforms, we are looking -- our pipeline is mostly focused in smaller bolt-ons in Advanced Materials and Additives and Functional Products. And we're going to be disciplined with our strategy and stay focused on executing and executing it well. The recent acquisition we did of manufacturing site in China is a great example. Performance films business has been performing incredibly well in this auto market last year and this auto market this year, it's very high margin business. And that acquisition allows us to be domestically based on how we support customers in China, which is definitely where the China government wants to go as things made in China and those are great tuck-in acquisitions, very highly-accretive, those are kind of things we're focused on right now because our real priority is growing our dividend and creating this sort of organic driven growth story around being a leader in the circular economy both polyester and cellulosics.

[Patrick Cunningham, Analyst at Smith Barney Citigroup]

And then just lastly, can you characterize or give a little bit more detail on what you think is going on with the agriculture chain inventories? I guess the timing and the severity of the adjustments due to kind of a lot of the industry, a little bit flat-footed. So just curious about what you're hearing in terms of when people think it will end. Because I think you have a comment on this remarks about this accelerating into Christmas.

[Mark Costa, Chief Executive Officer at Eastman Chemical]

Yes, so. I wouldn't say it's accelerating the Christmas necessarily but what happened I think it's pretty well discussed out there. Two things really, last year with all the Ukraine events around ammonia and other uncertainties around supply-chain farmers around the world were stocking up on safety stock in their warehouses and retailers who are stocking up on safety stock. There are distributors who are stocking up on safety stock all the way back to the big players that make the products like [indecipherable] et cetera. And so demand was really good. That was true. Through the first-quarter and as this change started looking at season wasn't quite as much product because of the dry weather and not meeting it as much in feeling like supply chains were now safe to rely on. Sort of in the middle of Q2 kicked-in significant destocking downstream of us.

So we started to feel some of that destocking from our direct customers in the second quarter and it ramped up to full destocking as we go into the third quarter and to some degree in the fourth quarter. There was a lot debate going on, I'd say about just when does that destocking in and when they have to start ramping up on production to meet the growing season next year. It's important to realize that the final in demand for the farmers is good this year and expected to be good next year. So this really is a whole inventory management cycle we're in and at some point, they'll have to cut-back -- kick back into gear to make sure they have enough supply for next year and whether that's in the fourth quarter or the beginning of the first quarter, it has to happen sometime around or they won't have enough inventory for the next growing season.

[Operator]

Our next question comes from Arun Viswanathan with RBC Capital Markets. Your line is open.

[Arun Viswanathan, Analyst at RBC Capital Markets]

Great, thanks for taking my question. I guess I just wanted to go to AM and AFP. There are some markets which you are seeing -- which you are seeing some strength and notably, maybe the Aerospace side and aviation[phonetic] side is that what you're seeing as well and some of the stronger markets, you expect that to persist through the second half. How would you comment on some of your stronger markets? Thanks.

[Mark Costa, Chief Executive Officer at Eastman Chemical]

So when it comes to aviation our view is that the market was really improved through the first half of the year and will stay you know, strong in the back half of the year. I wouldn't say that's not going to grow relative to the first-half of the year, because it's been pretty strong. But that will stay that way. The airlines are obviously very confident about their demands in email[phonetic] going forward. And we'll track with wherever their demand goes right now, that's their viewpoint. And we're using their view to build our forecast.

[Arun Viswanathan, Analyst at RBC Capital Markets]

And then just as a quick follow some other markets are notably on the weaker side. You addressed some of the destocking that's going on [indecipherable] and the ag side what are some of the other areas that maybe turned out worse than you expected and you've addressed a couple on the call already, but to reiterate some of the weaker areas where would those be. Thanks.

[Mark Costa, Chief Executive Officer at Eastman Chemical]

From a Q2 point-of-view, the end-market wise I'd say -- from an end-market growth point-of-view I don't think much has changed in our view, across all of our end-markets. We haven't seen different end-markets get worse or better, auto is strong obviously discretionary markets are under pressure. The personal care, water treatment, those kind of markets are offering a 3% to 5% as all those downstream customers of ours as you can see in the fast-moving goods and everything else reporting that they are focusing on pricing, discipline, and as a result, having a little bit less volume.

I don't think anything -- that's changed really. It's been more of a, it's all about inventory management. The entire story for some of the negative surprises like medical, packaging, and ag in the second quarter and you know in destocking dragging out into the back half of the year, right. I just think that the extremity of COVID and then the following stimulus in the supply-chain crisis has just led to a lot more inventory being you know built throughout the world and I think many[phonetic] of us really understood and it's taking obviously a lot longer to pull it down, especially when demand is soft, to some degree at every market.

[Greg Riddle, Investor Relations at Eastman Chemical]

Okay, I believe that was our last question. So thanks very much for your interest in Eastman and for joining us this morning. I hope everybody has a great day.

[Operator]

[Operator Closing Remarks]

Participants

Corporate Executives

• Greg Riddle, Investor Relations
• Mark Costa, Chief Executive Officer
• William McLain, Chief Financial Officer

Analysts

• Josh Spector, UBS Group AG
• Unidentified Participant
• Vincent Andrews, Morgan Stanley
• Frank Mitsch, Fermium Research
• Aleksey Yefremov, KeyCorp
• Mike Sison, Wells Fargo & Company
• David Begleiter, Deutsche Bank Aktiengesellschaft
• John Roberts, Credit Suisse Group AG
• Kevin McCarthy, Vertical Research Partners
• Matthew DeYoe, Bank of America Co.
• Patrick Cunningham, Smith Barney Citigroup
• Arun Viswanathan, RBC Capital Markets