Avient Corporation (NYSE:AVNT) Q3 2023 Earnings Call Transcript

Avient Corporation (NYSE:AVNT) Q3 2023 Earnings Call Transcript November 4, 2023

Operator: Good morning, ladies and gentlemen, and welcome to Avient Corporation’s Webcast to discuss the Company’s Third Quarter 2023 Results. My name is Victor and I’ll be your operator for today. At this time all participants are in a listen-only mode. We will have a question-and-answer session, following the Company’s prepared remarks. As a reminder, this conference is being recorded for replay purposes. I would now like to hand the — turn the call over to Joe Di Salvo, Vice President, Treasurer and Investor Relations. Please go ahead.

Giuseppe Di Salvo: Thank you, Victor, and good morning to everyone joining us on the call today. Before beginning, I’d like to remind you that statements made during this webcast may be considered forward-looking statements. Forward-looking statements will give current expectations or forecast of future events and are not guarantees of future performance. They are based on management’s expectation and involve a number of business risks and uncertainties, any of which could cause actual results to differ materially from those expressed in or implied by the forward-looking statements. Please refer to the investor presentation for this webcast for a number of factors that could cause actual results to differ. During the discussion today the Company will use both GAAP and non-GAAP financial measures.

Please refer to the presentation posted on the Avient website where the Company describes the non-GAAP measures and provides a reconciliation to their most directly comparable GAAP financial measures. Joining me today is our Chairman, President and Chief Executive Officer, Bob Patterson and Senior Vice President and Chief Financial Officer, Jamie Beggs. I will now hand the call over to Bob to begin.

Robert Patterson: Well, thanks, Joe, and good morning. Today we reported our third quarter results and adjusted EPS was slightly ahead of our guidance, despite lower than projected sales. We also updated our guidance for the full year, to reflect our current view of the demand environment and weaker foreign exchange. Our prior guidance assumed, we would start to see a modest recovery in the fourth quarter, but based on our current orders, that is not the case and we are lowering our demand expectations, as we finish out the year. While we have adjusted our revenue projections, you’ll see that we are expecting to grow fourth quarter earnings by 12% on a year-over-year basis, as margin expansion more than offsets lower sales. Jamie will cover specifics in a moment, but I wanted to start with some general observations about the economy and markets and what we’re hearing from our customers.

Destocking appears to be nearing an end. In many industries with the exception of a couple that I’ll touch on first, and I’ll start with healthcare. Historically, this is an industry where we see growth nearly every year without fail. So it’s unusual to be reporting healthcare sales are down and I would further characterize this year is unprecedented. Sales in the quarter to healthcare was down about 25%. Our customers are telling us that this is related to their efforts to reduce inventory levels to more normalized pre-pandemic levels, and they simply built up too much over the last couple of years. As a result of COVID response and the supply chain challenges that followed. In the third quarter, you can see the impact of negative mix for engineered materials, when Jamie covers our results.

And we expect destocking in healthcare to continue into next year. But the good news is that ultimate demand for healthcare services remains positive, and we continue to view it as one of our four key long-term growth drivers. The other industries, where we expect weaker demand conditions to continue, are those that are sensitive to interest rates, like building and construction and infrastructure projects, which slowed down in the second half of the year. In general, I certainly think there is uncertainty about the impact of higher interest rates, and whether or not countries like the U.S. find themselves in a recession that extends beyond manufacturing and industrials. Fortunately, employment has remained relatively strong and we view that as a positive.

And on the good news category defense and energy continue to perform well, and so far transportation is also holding up. We benefited in the Americas with composite applications in these end markets. We also believe we’re benefiting from re-shoring trends, particularly in Mexico, where we have been able to move production with ease, based on where our customers ask us to. And lastly, I believe, destocking and packaging, our largest end market is nearing an end. A recent Wall Street Journal article highlighted that P&G expects return to volume growth in 2024. That bodes well for us, specifically for our European businesses, where 30% of our sales are to packaging customers. I had the chance to meet with our teams in Europe a couple of weeks ago.

And overall the sentiment was more positive than it has been in some time. While the work continues in Ukraine, there is much less concern about energy availability, in sharp contrast to a year ago when the region was worried about having enough natural gas storage to get through the winter. In total, we have delivered — are expecting to deliver positive EBITDA growth in EMEA for the first time in a year-over-year in the fourth quarter. In fact, Europe will be contributing significantly to our bottom line results, and the 12% increase and adjusted EPS we’re projecting for Q4. Margin expansion is substantial, as we have rationalized our footprint in the region, reduced administrative costs and we are seeing lower raw materials. And I think this is a positive development in earnings momentum as we look ahead to next year.

I also spend time with the Avient Protective Materials team while I was in Europe, to celebrate the one year anniversary of our acquisition of Dyneema. Our composites portfolio makes up more than half of our Specialty Engineered Materials segment, and is one of our fastest-growing areas of our portfolio. The integration of APM continues to go very well. Culturally APM leaders share our commitment to investing in sustainable innovation and a strong desire to leverage all of our technologies, to best serve customers, and translate in those into new areas. And there are natural cross-selling opportunities between the businesses, and year two of integration will focus on accelerating those among our commercial and technical teams. Now, I’d like to share some examples with you.

Half of Dyneema’s business is in protective materials, providing lightweight ballistic protection and applications, such as vests and helmets. But as you can see helmets today, not only provide important safety and protection, they also serve as a structural foundation for other components, variety of communications, audio and visual capabilities and other equipment that assist with a mission. The customer relationships and expertise that APM has in this space, represents a great opportunity for the broader Avient portfolio to further enhance the value we bring to the customers. As shown here there are multiple components on a helmet they can benefit from our portfolio of colorants, additives and engineered materials, with some examples including high strength, lightweight monitoring brackets, materials for electronic and communication components, and softish Thermoplastic Elastomers for ease of fit and use.

Defense was not an end market that we have served historically, but with our acquisition of Dyneema we find valuable foothold in the industry, upon which we can grow, and it’s also positive that we are a U.S. headquartered Company where we believe we will have further opportunities with the U.S. military. The helmet, you see here is just one example. And our portfolio is very well aligned for other applications and law enforcement and military-related products. We also have high durable strike materials currently enabling rugged outdoor equipment like tents, packs and portable essentials, where we not only see growth opportunities in consumer, but the ability to translate those into military grade specified versions. The slide here illustrates a combination of legacy Avient and Dyneema applications.

And the beauty of cross-selling is that it goes both ways. Consider that Avient as long had a strong representation in outdoor high-performance applications, and leveraging these relationships we see further growth opportunities to cross-sell and bring Dyneema technology to consumer. We’re early in our exploration process, but we’re extremely excited about the potential that this presents, and look forward to sharing more with you in the future in this regard. I’ll now turn it over to Jamie to provide details on the third quarter results and our fourth quarter outlook, before I make some closing remarks.

Jamie Beggs: Thanks, Bob. The translation opportunities we have in composites, as well as in the other key growth areas, provide a great segue of how the changes in our portfolio will improve margins over time. Let’s start with the third quarter, where continued margin expansion was the highlight. Third quarter adjusted EBITDA margins were 16.3% compared to our guidance of 16%. This reflects a 90 basis point improvement over the prior year. As has been the case all year, we have been able to partially offset weaker demand conditions with favorable mix from sustainable solutions and defense applications, which has proven resilience in the current environment. Lower raw material prices, along with cost reduction initiatives, also factored into the margin improvement.

Our adjusted EPS of $0.57 was slightly better than our guidance of $0.56, while sales came in lower than projected due to slower demand and the strengthening of the U.S. dollar, margin improvement, partially offset these impacts. EBITDA was short of guidance, but EPS was higher as EPS benefited from lower depreciation expense associated with restructuring actions, as well as lower interest expense. We paid down $100 million of debt during the quarter, and refinanced our term loans, which not only reduce the interest rate but also extended its maturity from 2026 to 2029. The annualized impact of this refinancing will result in $10 million of interest expense savings. The third quarter EBITDA bridge reflects the impact of demand, price and mix, as well as raw material cost on a year-over-year basis.

Starting with demand customers remain cautious and closely managed inventory levels within the quarter. As Bob mentioned previously, we have started to lap some of the weakness that started in 2022, particularly in Europe and that is reflected in overall demand, which is down less than in the second quarter. Also highlighted on this bridge is the impact of pricing and deflation. This is the second consecutive quarter we’ve seen raw material deflation on a year-over-year basis and we continue to hold onto price for a net benefit. You will note that SEM had unfavorable mix during the quarter, which was primarily driven by healthcare applications. As Bob mentioned, healthcare demand has been significantly impacted this year by destocking as our customers reduced their inventory levels, which increased following the pandemic and supply chain disruptions.

We recently did an analysis of our healthcare OEMs who are public, and their inventory as a percentage of quarterly sales is running about 80% today, versus pre-pandemic these levels were closer to 60%. Most of these customers have made explicit comments about managing down their inventory levels, and we expect that destocking to extend into 2024 before it’s complete. Further down the walk, you’ll see the impact of certain cost reduction activities, taken earlier this year, including targeted European restructuring, and reduced discretionary spend, which provided a $13 million benefit in the quarter. Net price benefit and cost reductions more than covered wage inflation. When we started the year, we modeled a modest recovery in demand in the second half of 2023.

We are not seeing that and have updated our guidance to reflect lower sales, and weaker foreign exchange, partially offset by higher margins. For the fourth quarter, we project adjusted EBITDA and EPS of $112 million and $0.47 per share, which reflects an increase of 5% and 12% respectively over the prior year. Margins are expected to improved 230 basis points, which more than offset weaker demand to provide earnings growth for the quarter and for the first time this year. As Bob highlighted, Europe is driving a significant portion of this improvement. This results in full year revenue of $3.13 billion and adjusted EBITDA of $500 million. 2023 adjusted EPS is now projected to be $2.30 compared to $2.40 as lower EBITDA is partially offset by lower interest and depreciation expense.

The negative impact of our stronger U.S. dollar accounts for $0.03 of the change and adjusted EPS from our prior guidance. We are maintaining our free cash flow guidance of $180 million, as we expect to benefit from working capital efficiency and reduced capital expenditures to offset the change in EBITDA. Through our transformational journey to a specialty Company, our ability to generate strong free cash flow has remained consistent. We are confident in our ability to continue managing through the near term and about our long-term growth prospects, as outlined in our Sustainability Day a month ago. In October, we increased our dividend for the 13th consecutive year bearing this is an important element of value for our shareholders. I’ll now hand the call back over to Bob for some closing remarks.

Robert Patterson: Well, thanks, Jamie. Well the year isn’t over and we’re obviously focused on delivering in the fourth quarter. But as we look ahead, I am encouraged to see destocking come to a conclusion in many end markets. There remains some question marks related to healthcare, and interest rate sensitive industries. But overall, we expect to return to growth in 2024. And I’m very pleased to see the EBITDA expansion in Europe in the fourth quarter, and see that as a positive heading into next year. And lastly, over the last few years, we have done an exemplary job of managing price, initially to overcome significant raw material inflation, and now with lower raw material costs we see that as a potential tailwind heading into next year.

Our performance in this regard reflects the specialty nature of our applications, and the important steps we have taken over the years to upgrade our portfolio. We’re obviously very positive about our growth potential and in September, we hosted our virtual Sustainability Day to highlight the opportunities we see in this area. The objective was to provide detailed context around the mega trends, supporting long-term demand for our portfolio and specific product examples of where we are helping our customers, achieve their sustainability goals. As a reminder, our four key growth drivers now account for 60% of total Company sales. There are sustainable solutions, composites healthcare in emerging regions. Combined, these growth drivers support a 6% long-term revenue growth rate.

These projections are based on our historical performance as well as a deep understanding of the megatrends to support the long-term advancement of these areas. This includes customer sustainability goals and government mandates, that rely on our material science know-how and formulation expertise to achieve them. At our Sustainability Day we summarized our portfolio in the three categories, reduce, renew and preserve and each of our segment presidents talked about the real challenges our customers face that they incorporate more sustainable solutions, as well as we showcased several product examples that highlight the performance characteristics of our formulations. We also provided data from independent sources to support the key megatrends that will drive demand for these applications.

For example, we believe we are well positioned to take advantage of the infrastructure investments, such as the broadband equity access and deployment program, that can take hold in 2024 and increase demand for our composite applications and fiber optic cable and related applications. And the same is true for the Inflation Reduction Act, which could translate into increased demand for our existing infrastructure, as well as building new renewable energy sources. Other legislation mandates and customer poll are also in play in Europe, driving the increased need for material solutions at lightweight reduced carbon footprint and enable recycling. If you didn’t watch our Sustainability Day live, I encourage you to go back and do so with a replay.

The feedback has been consistent and that it helps investors gain a broader appreciation for the depth of our materials and the underlying external factors that will continue to create demand for them at a rate of 8% to12%. We also reiterated our long-term objective to expand margins. We’ve come a long way from the 5.4% in 2006 to 16% margins we have today. The growth in sustainable solutions, composites healthcare will play a meaningful role, and further expanding our margins to 20% on a total company basis. And expanding margins to 20% is just one of the strategic objectives that we have as a company, which you can see here and that we shared during our Sustainability Day. With that, we’d be happy to now open the line for any questions.

Operator: [Operator Instructions] Our first question comes from the line of Mike Harrison from Seaport Research Partners. Your line is open.

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Q&A Session

Mike Harrison: Hi, good morning. Can you hear me okay?

Robert Patterson: Yeah.

Giuseppe Di Salvo: Yeah, Mike.

Mike Harrison: Perfect, thanks. Wanted to see if you could provide some more detail on what you’re seeing in the packaging end market as you acknowledged, it’s a very important market for you, particularly in Europe, and it’s very encouraging to hear that you expect destocking to kind of run its course. But what are you seeing in terms of order pattern trends, what are you hearing from customers. And I’m curious, are there differences between what you’re seeing in the food and beverage side and personal care, and maybe some other parts of that packaging market.

Robert Patterson: Yeah, look I think, first of all customers have all you know, told us that they expect the balance of this year to be you know, weak. We’ve kind of have that reflected in our guidance. But we are hearing from them that there is you know, less of a focus on just inventory reduction and maybe more of a focus on inventory management. So maybe not such as specifically stated goal to try to reduce inventory beyond works out, which I think is a good thing. I believe directionally they are planning for growth. I mean obviously, if I just referred to someone like P&G, it’s just one of many customers that we have and that Mike could be in the areas of personal care, as well as consumer food and beverage packaging. I think all of those are actually going to start to show a positive trend those are historically very resistant — food and beverage packaging historically recession resistant, and I think that will be proved the case when we get into the beginning of 2024.

Mike Harrison: All right. And then just in terms of the healthcare destocking that you’re seeing, obviously a very unusual dynamic and your analysis suggests that that’s going to continue. Is this a, a consumables issue, is it an equipment issue, is it both. And I guess just maybe give us a sense of what keeps you confident that healthcare should continue to be one of your, your strategic growth areas.

Robert Patterson: Yeah, I mean, look for the most part, you know what we do can be viewed as probably part of the consumable or disposable space in terms of minimally invasive you know, catheter tubing drug delivery devices and related packaging. We do some medical equipment but the prior descriptions of what we doing it really makes up most of what we’re doing in healthcare. And I mean, look, I just think overall the system, just had too much inventory of all those things on hand, largely in response to you know COVID and then of course the supply chain challenges that followed have had some conversations in the healthcare industry, where, you know, look we’re encouraged. We know that people are still actually seeking medical care.

I think with employment numbers being strong, that’s going to continue to be the case as long as people have access to insurance and so on. So I think the real demand is actually there. And systems, hospitals themselves, as well as OEMs are just trying to work down their inventory.

Mike Harrison: All right. Thanks very much.

Robert Patterson: Yeah.

Operator: Thank you. One moment for our next question. Our next question will come from the line of Frank Mitsch from Fermium Research. Your line is open.

Frank Mitsch: Thank you and good morning. Appreciate the, the level of details. I was wondering if I could drill down a little bit more into the sales miss for 3Q and the 10% down guide for 4Q. You know, at the last conference call, Bob, you, you indicated that you thought pricing would be flat in the back half of the year and in fact that’s how it looked like the third quarter came in. So that, so that 5% delta on the. on the sales line, can you talk a little bit more about how much of that might have been volume versus FX because I know I think FX was also an issue there. And then on the 10% down. I assume you’re still calling for flat pricing in the fourth quarter. So then, so then, how much of that is also kind of volume and FX in terms of a decline.

Robert Patterson: Do you want to say something on the FX number?

Jamie Beggs: The FX for the quarter, it’s about $5 million of the total, you know, I have to look at the for the fourth quarter. I think that was in total $0.03 of total from an EPS perspective and that’s combined in the back half and $45 million in the fourth quarter for bringing it down.

Frank Mitsch: Okay. So that — all right. So more sizable in 4Q. So — and in terms of again on this 10% down sales for 4Q. How is your visibility on orders for the quarter. I mean what sort of expectations are baked in, in terms of, you know, let’s say when Europe shuts down or any, any sort of color that you can provide on how you built up into that 10% down sales would be helpful.

Robert Patterson: Yeah. I mean look we — I mean, first of all, this whole year visibility has been even shorter than normal, and you know, we’re not a backlog business. But typically we’ve got good visibility 30 to you know sort of 40 days out, let’s call it 30. When I look at where October and orders are for November, it’s aligned with our expectations. And the guidance that we just gave today with some of what you just said, you know, Frank acknowledging that there will be some plant shutdowns at the end of this year. Europe and so on and holidays. That’s really all included in the numbers that we’ve provided today.

Frank Mitsch: Okay. And then in terms of the planned shutdowns, I know you were talking about your customers, which is what I was asking about. But in terms of your own planned shutdowns, there was a 3% sequential decline in PP&E. I assume that that’s a result of planned restructuring in Europe, where do you stand on those shutdowns. Yeah. So those are really all related to the timing of previously announced facility closures that finally came to a conclusion and ow you’re seeing the benefit of less depreciation expense. We’re really through that. There’s one last facility that we continue to work on as part of the legacy Clariant and PolyOne combination that could come into next year.

Robert Patterson: And then I am sorry, I wanted just, to come back to one of the very first thing you said about price because that assumption is correct, you know, that we basically have got that assumed to be you know, flat as we go through the end of this year. We did have some unfavorable mix that we highlighted for engineered materials that will probably be the case for Q4 as well. And the pricing should be you know, should be about a push.

Frank Mitsch: Great, thanks so much.

Robert Patterson: Yeah.