Orion Engineered Carbons S.A. (NYSE:OEC) Q1 2024 Earnings Call Transcript

Orion Engineered Carbons S.A. (NYSE:OEC) Q1 2024 Earnings Call Transcript May 3, 2024

Orion Engineered Carbons S.A. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Ladies and gentlemen, good morning, and welcome to the Orion S.A. First Quarter 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions]. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Wendy Wilson, Head of Investor Relations. Please go ahead.

Wendy Wilson: Thank you, Ryan. Good morning, everyone, and welcome to Orion’s conference call to discuss our first quarter 2024 financial results. I’m Wendy Wilson, Head of Investor Relations. With me today are Corning Painter, our Chief Executive Officer and Jeff Glajch, our Chief Financial Officer. We issued our press release after the market closed yesterday, and we also posted a slide presentation to the Investor Relations portion of our website. We will be referencing this presentation during the call. Before we begin, I’d like to remind you that some of the comments made on today’s call are forward-looking statements. These statements are subject to the risks and uncertainties as described in the company’s filings with the SEC, and our actual results may differ from those described during the call.

In addition, our forward-looking statements are made as of today, May 3, 2024. The company is not obligated to update any forward-looking statements based on our new circumstances or revised expectations. All non-GAAP financial measures discussed during this call are reconciled the most directly comparable GAAP measures in the table attached to our press release. I’ll now turn the call over to Corning Painter.

Corning Painter: Thank you, Wendy. Good morning, everyone, and thank you for joining our call today. We started 2024 on a strong footing with adjusted EBITDA of $85 million our second best Q1 behind only last year’s results. More importantly, we saw underlying improvement in the business. Our specialty volume grew 19% compared with last year. At the same time, we increased our gross profit per ton from $492 in Q4 to $659 to a level more in line with normal margin levels. Rubber gross profit margins of $435 per ton were well above last year’s average of $409 per ton. Prior to 2022, our rubber gross profit margins typically ran in the $200 to $300 per ton range. These results clearly show that our key markets continue to restructure and this is the new normal from which we can build.

As a result of our progress in both markets, we continue to expect 2024 to be another year of growth leading to record EBITDA. In summary, we’re on track to outperform expectations in specialty and to exceed per ton margins in rubber despite a more challenging geographic mix in both markets. Digging deeper into rubber, we expect strong demand in Europe, but weaker than expected demand in the Americas. We are confident that we can adapt to these changes with agility and remain committed to our guidance range of adjusted EBITDA at $340 million to $360 million and adjusted diluted EPS of $2.05 to $2.20 per share, up 5% and 11% respectively. In sustainability, we were recently notified that our EcoVadis rating has been raised from gold to platinum, the highest possible distinction.

That means we are in the place amongst the top 1% of companies assessed by EcoVadis, one of the world’s largest providers of business sustainability ratings. This ranking is quite prestigious with a well-respected NGO validating our tremendous progress. A huge congratulations to the whole Orion team on this accomplishment. Thank you and well done. Looking at our 2 business units and starting with rubber, our customers are gaining confidence looking towards 2025. This combined with the EU ban on Russian carbon black, which begins in less than two months, shipping challenges from Asia to Europe, the seeming end of the U.S. trucking recession and the industry restructuring on our value chain, all makes for a very promising 2025 pricing cycle. We see customers already gearing up for the negotiations, perhaps preferring to wrap things up before the market strengthens further.

Some are essentially kicking off the negotiations now, while others are in the framing stage, defining parameters for the 2025 negotiation. In terms of framing, for our part, we are open to starting early, but we want to avoid holding volume for a customer and then being left at the altar at the last moment. So, we will be stricter in enforcing time bounded offers, utilizing volume rebates and consider shifting production towards our specialty business to support the strengthening polymer market. In our specialty business, we advanced two significant products in Q1. First, last quarter, we shared that we achieved technical milestones related to the ongoing debottlenecking of our high-performance and unique surface treated gas black grades for the coatings and ink markets.

I am happy to report that technical marketing and customer uptake of the additional capacity is going well, exceeding expectations. Second, last month we also announced the introduction of Kappa 10, a new conductive carbon aimed at batteries with more of a cost-based value proposition. Here, I’m happy to say this product has been qualified by a leading player in the lithium ion battery space and commercial sales of the gut. Turning to Slide 4. With the EPA spending behind us, we will now focus our capital allocation on more financial and shareholder rewarding ways. I see capital allocation as management’s top responsibility after safety. One priority for us is strategic and profitable growth. Here, we recently celebrated the groundbreaking of our new plant in La Porte, Texas that is scheduled to be online in mid-2025.

When completed, this will be the only facility in North America producing high-purity, settling-based conductive additives to support the global shift to electrification. This site will produce conductive additives with about 1/10 the carbon footprint compared with alternative conductive carbon technology. As we’ve communicated in the past, this not only supports formulations for lithium-ion batteries, but is also an essential material in the high voltage cables that are needed to build out electric grids around the world. With that, I would ask Jeff to provide additional insights into our financial results.

Jeff Glajch: Thank you, Corning. On Slide 5 are the consolidated results for the first quarter. Compared with Q1 last year, volume was up in both businesses with specialty volumes increasing in all regions and rubber increasing in Europe and China. Gross profit and gross profit per ton were down. If you recall, as we discussed last year in Q1 2023, we had some timing and one-time benefits totaling $9 million, those did not repeat. We also saw an adverse impact this year from the regional rubber volume mix with less North American and more China volume. On a sequential basis, all metrics were up especially of note a significant increase in gross profit and gross profit per ton, which was up 28% to $4.92. On Slide 6, we look at the EBITDA drivers.

Stronger pricing and volume in rubber was primarily offset by poor regional mix. On the cost side, the $9 million impact in timing and onetime items from last year as previously noted, higher labor costs and operating costs as well as less benefits from cogeneration. On Slide 9, rubber volumes increased in Europe, where we are already seeing the benefit of the upcoming Russian carbon black ban as well as in China, but this was mostly offset by lower demand in the Americas. Compared with Q1 last year, we experienced lower gross profit per ton despite strong contractual price increases. This was due to the timing issues previously mentioned, poorer regional mix namely the weaker North American volume, higher fixed cost and lower cogeneration pricing.

However, Q1 gross profit per ton of $4.35 was well above last year’s average of $409. Reiterating what Corning said, we expect this higher level of gross profit per ton to continue across 2024. Slide 8 shows the impacts in a waterfall chart of the rubber business. Pricing was up $5 million versus 2023 due to the continued structural market improvement. While volume was up 2.5%, the impact of the regional mix adversely impacted EBITDA by $6 million, cost impacts also offset the improved pricing. Just to be clear on this chart, the $5.8 million cost impact is split roughly between cost increases and lower cogeneration price. On Slide 9 is the financial table for specialty. Volume increased across all regions in nearly all markets. Gross profit per ton decreased on a year-over-year basis, primarily due to the prior year timing impacts previously mentioned and higher fixed costs.

As expected, our gross profit per ton was significantly higher than Q4 2023, up 34% to $6.59. While our trailing 12-month gross profit per ton has declined over the past four quarters, our Q1 level is above our trailing 12-month level and we expect the curve will be turning back up as we move into the second half of this year. As we look forward, we also expect specialty volumes to continue stronger as market conditions improve and volume and mix moves toward higher margin products. The surface treated gas black products, which Corning noted earlier are an example of this. Slide 10 shows in the waterfall chart specialty EBITDA as discussed on the previous slide. Increased specialty volumes were offset by the impact of favorable timing items from last year as well as higher operating and labor costs.

Slide 11 shows cash flow for the quarter. We had an increase in working capital, but also lower level of CapEx in Q1, compared with what we expect for the rest of 2024. Debt was down slightly, but since our trailing 12-month EBITDA was lower than our year end 2023 EBITDA, our debt ratio increased to 2.4 times still within our targeted 2.0 to 2.5 range. We are comfortable with our debt level as we made a concerted effort to lower it significantly in 2023. Slide 12 shows our expected range for cash generation and usage in 2024. For this year, the majority of our discretionary cash usage will go towards the port plan. On this table, we have not shown any change in working capital for 2024. This is one area of risk as we saw in Q1, where working capital was up $26 million.

We will monitor this closely as the year continues. With that, I will turn the call back over to Corning to discuss our 2024 guidance.

Corning Painter : Thanks, Jeff. We’re off to a good start and I expect this to be another record year. Turning to Slide 13, we’re reaffirming our guidance. Based on current conditions, we project 5% EBITDA growth in 2024 and 11% increase in EPS. This would be our 4th year of growth. Let me close with a few points for you. First, the industry restructuring which has been underway for years will continue. Tire factories, new tire factories continue to be announced in North America and in Europe. The EU ban on Russian carbon black starts in 58 days. The risks of a far-flung supply chain are obvious. The supply demand balance continues to move in our direction and a strengthening polymer earth market also tightens the rubber carbon black supply and demand further.

Second, specialty demand is recovering. Third, our La Porte facility is on track for mid-next year providing additional opportunities for expanding specialty margins. And fourth, we take capital deployment seriously. We are committed to increasing free cash flow, maintaining a strong balance sheet and deploying your capital wisely, providing increased returns to investments like La Porte, buying back shares or by reducing our leverage. And Ryan with that, please open up the lines for questions.

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Q&A Session

Operator: [Operator Instructions]. Our first question is from the line of Josh Spector with UBS. Please go ahead.

Josh Spector: Good morning, everyone. Corning, I was wondering if you could talk a bit about the volume trends that you’re seeing in the market today and kind of your some of your forward expectations. So, I think your comments seem pretty optimistic or maybe more upbeat, on where demand is at. But it’s pretty clear that your guidance assumption assumes no improvement. So how have things changed and how does that compare versus what’s baked into your guidance? Thanks.

Corning Painter: Sure. So, we have never said that we saw for this year like a hockey stick necessary to achieve our guidance nor did we really think there is the confidence in the marketplace to do that. That said, in Q1, there’s positive developments in it. I’d say in the specialty area, it’s really quite broad across the market. So, for example, some of the higher margin areas like coatings, distributors who are often serving coatings margins or customers those are very high, but so are things like thin film, pipe and so forth. So, you can see that balance in how our GP per ton has developed in specialty. Broadly speaking, we think that it’s going to be continuing on this path. I don’t see customers being able to really stock up and restock in a big way, but I do think the fear of inventory and that sort of thing is down a bit.

On the tire space, you see for example in the North American market increased purchase of tires and that’s in the mid-teens, but you see tire production only up maybe like 4%. So, they’re still suffering for imports, we’re still seeing the trucking volumes while maybe now bottoming, they haven’t really come back stronger. So, over the course of the year, it’s possible that trend I think has stabilized and we’ll have to see the rate at which it improves from here. We do need a little bit of improvement right from an $85 million run rate to hit our guidance. So, there’s some growth expected in our numbers.

Josh Spector: And I guess maybe on that last point, I guess trying to think a little bit more near-term here on second quarter. You had some pretty easy volume comps in specialty and rubber. And I mean, there was some noise in the first quarter from cogen credits last year. But I guess, the simple way to ask this is, do you expect EBITDA up year-on-year in 2Q with the higher volumes with some maybe improving profitability in rubber? Or are there other offsets we should be considering? Thanks.

Corning Painter: So, I think on a clean run rate basis, I think that we’re in a good position for next year with improved margins and improving specialty market. Does that help, Josh?

Josh Spector: A little bit. I guess, I’ll try to talk just on second quarter. I mean, I think volumes could be up something like 10%. I assume that would lift earnings year-on-year. What would be wrong with that thinking?

Corning Painter: Just in terms of last year where and so I’m doing this without having looked precisely at that for you. But I think you have to think about what the power rates were last year and any other sort of timing impacts that can flow in and out of our P&L. So, for example, if a particular input cost moves sharply and quickly then that’s the kind of thing that can have a lag in our pricing models. I mean in general, so Josh I’m not trying to be downbeat. I think that we’ll be looking at a stronger quarter in Q2. I think that’s implied in our guidance without giving out specific numbers.

Jeff Glajch: And Josh, this is Jeff. Just one additional thought. If you think about the midpoint of our guidance relative to the last three quarters of last year or clearly whether it’s in one quarter, but certainly over the course of three quarters we got to have significantly higher EBITDA in the last three quarters to hit midpoint of our guidance. So, we would have to be at $265 million in last year, in the last three quarters, we were at roughly $230 to $231. So, it’s a pretty significant ramp over the three quarters whether you see some of that in the Q2 or it’s more back end loaded we’ll have to see. We did have if you look at last year, we did have a bit of a stronger second quarter and then the third and fourth quarter weren’t nearly as strong. So, you perhaps would see more growth in the third and fourth quarter year-over-year.

Operator: Our next question is from the line of John Roberts with Mizuho Securities. Please go ahead.

John Roberts: Thank you. It’s been a while since we’ve had kind of normal seasonality, I guess. Would you characterize the Q-over-Q, the March quarter versus the December quarter, 10% volume growth overall, 8% in rubber, 15% Specialty, normal seasonal pickup or better or worse than normal seasonal?

Corning Painter: I would describe the specialty as a little bit better than normal. I looked back over the time. There were a few times when we had a bigger, let’s say, EBITDA step change, but that’s when we saw, let’s say, power prices really move sharply in Europe or a special circumstance like that. So, I’d put the specialty at a little bit better than your normal seasonality.

John Roberts: And then industrial rubber has a fair amount of automotive OEM exposure and it seems like in the least in the developed markets, North America, Europe, auto OEM has slowed here. Are you seeing that in your industrial rubber products?

Corning Painter: Well, as I said, we see North America a bit slower and some of that’s probably in the OEM space, some of that I think is also just the impact of import tires on the replacement market. And it’s difficult for us to tease out exactly where that is. But I’d say, North America a little bit less. In Europe, I’m not saying the tire to market is like that dramatically better than North America. It’s just I think the Russian ban has really tightened things up.