Orion Engineered Carbons S.A. (NYSE:OEC) Q3 2023 Earnings Call Transcript
Orion Engineered Carbons S.A. (NYSE:OEC) Q3 2023 Earnings Call Transcript November 4, 2023
Operator: Greetings, and welcome to the Orion's Third Quarter Financial Results 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. Thank you, Wendy. You may begin.
Wendy Wilson: Thank you, Alicia. Good morning, everyone and welcome to Orion's conference call to discuss our third quarter 2023 financial results. I'm Wendy Wilson, Head of Investor Relations. With me today are Corning Painter, Chief Executive Officer and Jeff Glajch, Chief Financial Officer. We issued our press release after the market closed yesterday and we also posted our 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 today on today's call are forward-looking statements. These statements are subject to the risks and uncertainties as described in our filings with the SEC, and our actual results may differ from those described during our call.
In addition, all forward-looking statements are made as of today, November 3. The company is not obligated to update any forward-looking statements based on new circumstances or revised expectation. All non-GAAP financial measures discussed during this call are reconciled to the most directly comparable GAAP measures in the table attached to our press release. I will now turn the call over to Corning Painter.
Corning Painter: Thank you, Wendy. Good morning, everyone and thank you for joining our call today. As you can see on slide three, we remain on track for another year of growth and record results in 2023. We delivered third quarter adjusted EBITDA of $77 million and adjusted diluted EPS of $0.49, the second highest third quarter results we've ever posted for both figures. Beyond this, we also reported nine-month record adjusted EBITDA of $266 million, up 7.5% and adjusted diluted EPS of $1.76. Our nine-month adjusted EBITDA of $266 million is just $1 million short of our entire 12-month adjusted EBITDA just two years ago in 2021. We also delivered strong third quarter operating cash flow and reduced our debt level. At the same time, we continued our share purchases, having bought back 63 million in total since the fourth quarter of 2022, nearly 5% of our outstanding shares.
We have two operational milestones. First, we continue to ramp up our first ever greenfield facility in Huaibei China. Customer qualifications, sales and operations are all progressive. Second, we progressed our final air emission upgrade in the US in the third quarter. I'm happy to say the controls are now operational and final testing is scheduled for this quarter. We'll also be completing an important safety upgrade at the same site. It is great to be on the verge of having this behind us. As is typical of startups, both of these projects had some negative impacts on the third quarter and will also impact the fourth quarter in terms of margins and in the US on sales. This, combined with lower power prices in Europe and lower loading drove the drop in specialty gross profit per ton this quarter.
However, none of this casts a shadow on the strength of our specialty business. In fact, this is important progress for us. We can now better support our Chinese customers with product made in China for China and reallocate reactors in the US and Europe for those local markets. Another important milestone for us was securing German and EU funding for further developing a climate neutral process for producing carbon black from alternative sources such as the molecular recycling of tires. This was an arduous and competitive process, and we greatly appreciated the confidence of the German government and the EU. I'd like to take a moment to talk about the role of people and culture in our performance under pressure. As you know, we expected to have a stronger manufacturing environment resulting in higher volumes this year.
We set the bar high, even though our adjusted EBITDA is up 7.5% year-to-date, the team is disappointed. Despite this, the people of Orion progressed some difficult challenges this quarter and delivered excellent results given the manufacturing economies we operate in. Why? I would say the commitment and engagement of the Orion team, we actually measure engagement using a third-party firm. We have improved this measure by 1100 basis points since 2021, a huge improvement and a rare accomplishment according to the firm. Beyond that, the Orion team consistently reports customer focus as a near universal top priority. I believe this, along with thoughtfully allocating capital, has enabled us to succeed despite a soft manufacturing environment and an ever-changing world.
You can see this has paid off in our financial results. They're not as high as we would like, but we compare very well to other manufacturers. If you follow other specialty chemical companies, you know we are one of the few that remain on track for stronger year-over-year performance. This is a testament to the great team here and our long-term strategy. On the operations front, specialty demand reflecting the broader manufacturing economy continues to be subdued. We are using this as an opportunity to push new customer qualifications, upgrade our plants, introduce new products to the market. We've achieved a number of recent wins in the battery, wiring, cable and coatings markets. A good example of a new product is our recently announced launch of PRINTEX Kappa 10, a high quality conductive additive that will address surging demand from producers of lithium ion batteries for electric vehicles, energy storage systems, and consumer applications.
The new product is produced in existing reactor systems that have been upgraded initially in Europe and soon in Asia. It marks an important expansion of Orion's portfolio of conductive additives. In addition, in the quarter we opened a new battery innovation center and have added additional leadership to our conductive additives team. There are mixed views these days on the speed of the conversion to EVs and the ultimate size of the market. For us, however, this is nearly all upside and we are confident of profitably securing our product in this important market. In rubber, as I mentioned earlier, we believe the industry restructuring is evident in our results and will continue. Tire capacity continues to expand in the Americas and Europe, and this simply tightens the market.
Although we've seen some weakness in truck traffic reflecting destocking in a less than robust manufacturing environment this year, the underlying trend is with us. Additionally, the EU ban on Russian carbon black begins mid-year 2024. While some Russian carbon black is being bought in the EU today, one large rebuking distributor, meaning that they have the ability to transfer imports from Russia into trucks and rail cars was recently barred from doing business, reminding everyone of the danger in that business model. Let me provide an update of what we think is happening downstream, starting with rubber on slide four. First, on the bottom of the page, you can see that people are driving and the trucking, while still negative, has improved from being down 15% to 19% last quarter.
Moving up the slide, OEM tire demand weakened in the quarter, I don't think that's a surprise for anyone. Finally, at the top of the slide, while replacement truck tire volumes remain weak, passenger car and light truck replacement volumes have improved significantly from being down 6% last quarter. In general, according to the US TMA data, US tire shipments were up 4% year-over-year in August, however, tire manufacturing is lagging that recovery. Now, all this is based on US data. However, we continue to believe the picture in the EU is similar, albeit perhaps with higher level of tire imports. With that, I would ask Jeff to provide additional insights into our financial results.
Jeff Glajch: Thank you, Corning. Starting on slide five, we have used this slide for a couple of quarters now. It provides a good visual representation of our multi-year growth. In 2023, we expect at the midpoint to grow EBITDA 7% versus 2022 despite lower volumes. Our return on capital employed, ROCE, progress has continued over the past few years during a time when we made our substantial air emissions control investments. The ROCE levels we achieved were slightly -- were significantly in excess of our weighted average cost of capital. At the conclusion of the third quarter, the trailing 12-month ROCE stands at 17%. This key metric keeps us aligned with our shareholders as stewards of their capital and with the long-term sustainability of the company.
On slide six, you can see the consolidated results in the third quarter. Volume in the quarter was flat with an increase in specialty due to our new capacity in China coming online, offset by lower volumes in EMEA and in the Americas. The contractual price improvements in rubber partly offset the decrease in revenue, which was due to lower oil pricing, which as you know, is a pass through to our customers. While our profitability metrics were close to last year's level, there were headwinds in the quarter. Cogeneration profitability was down because the comparable the third quarter of 2022 had extremely high electric prices in Europe. We knew this was likely to be a significant drag on earnings as we mentioned it back in August. The startup of Huaibei also affected our gross profit and GP per ton metrics in each business.
Finally, we had some cost absorption issues in specialty. The sum of these lowered gross profit GP per ton and adjusted EBITDA by approximately 4% each versus Q3, 2022. Despite these headwinds, the third quarter this year was still solid and as Corning mentioned this quarter was our second highest Q3 ever just $3 million of adjusted EBITDA behind last year. Slide seven provides the year-to-date results for the company. Weaker volume in rubber across most markets, as well as the lower oil price pass through drove revenue down 9%. This revenue drop was partly mitigated by stronger contractual pricing. The higher contractual pricing benefited gross profit per ton. The gains in GP per ton that we had seen in the first half of 2023 were tamped down some due to the Q3 headwinds I mentioned previously.
Year-to-date EBITDA was up over $18 million or 8%, adjusted diluted EPS up $0.06. We achieve these gains despite volume decreases and the significant drop in cogeneration profitability as power prices drop in Europe relative to the extraordinary high power prices last summer. On slide eight, in Q3, the benefit of the price/mix improvement was driven by contractual pricing gains in rubber that were more than offset by lower volume and lower cogeneration profitability. The latter of which shows up in the cost column. On slide nine, specialty in the third quarter had increased volumes primarily from our new plant in China. Our other markets remained relatively subdued due to the continued softness in demand in those geographies. Gross profit per ton decreased compared with the Q3 level last year due to both geographic and end market mix of sales as well as the lower cogeneration profitability.
Importantly, for the specific mix of products that we sold in the quarter, our pricing has continued to remain stable. Slide 10 shows the key factors affecting adjusted EBITDA for the specialty business compared with last year. As noted earlier, mixed adversely effective results as did the significant reduction in cogeneration profitability and some fixed cost absorption. Slide 11 -- on slide 11, Q3 rubber volume decrease was affected by lower demand in EMEA and the Americas. We experienced higher gross profit and GP per ton driven by the contractual price increases. However, this was partially offset by lower cogeneration profitability and startup related impacts in the quarter. Q3 GP per ton was $386, which -- while lower than the past two quarters was still above the Q3 2022 level of $364.
The Q3 2023 level will likely be the low point for the year and we expect it to revert well above $400 in the fourth quarter. Slide 12 shows the key factors affecting adjusted EBITDA for the rubber business. Strong contractual pricing was clearly the key driver. However, much of this was offset by lower volume and reduced cogeneration profitability. We believe the lower volume is a combination of fewer end customer purchases and an increase entire imports into European markets. On slide 13, you can see the effect that our improved cash flow has had on our debt. We have reduced our net debt by $102 million in the first nine months of 2023 to $756 million. Our debt to EBITDA ratio now stands at 2.29 times down from nearly three times in mid-2022.
We've also repurchased $59 million worth of shares this year and $63 million in share buybacks since we started our program in late Q4 2022. This represents nearly 5% of our outstanding stock. We will continue to look opportunistically to repurchase shares with a portion of our free cash flow. Additionally, we announced during the third -- early in the fourth quarter that we renewed our senior secured revolving credit facility, which was intentionally reduced from €350 million to €300 million as a result of the company's stronger cash flow. The credit facility has a five-year term and was oversubscribed by 20%. Our goal is to continue to strengthen our balance sheet, reduce our total net debt, and improve our net debt to EBITDA ratio. We have made substantial progress in all of these areas over the past year.
Before I pass the call back to Corning, on slide 14, I would point out the dramatic increase in our discretionary cash flow conversion as we have stepped up our profitability and nearly completed our EPA projects. I expect the dramatically improved conversion rate that we have seen in 2023 to continue in the coming years. With that, I'll turn the call back to Corning to discuss our 2023 guidance.
Corning Painter: Thanks Jeff. The topic of destocking has come up in the Q&A with investors over the last year, so I'd like to add a bit more color. In general, it is hard to speak with certainty about this as we are well removed from the end customer and comprehensive data is elusive. However, we recently had a chance to review a third-party analysis of the impact of destocking on the chemical industry. By looking at comments made by retail, packaging and personal care companies who are close to the consumer, they estimate that destocking will be a headwind into the second half of 2024. Naturally, there's a fair amount of uncertainty and assumptions in this kind of analysis, which puts a premium on being agile and responding to market changes quickly.
In the face of the market uncertainties, we believe our business has proven to be resilient and as Jeff and I have both said earlier, we continue to believe this will be another year of earnings growth. We also believe we are in a strong position going into 2024 with the majority of our Americas and EMEA rubber demand essentially committed. Again, our demand is not immune to destocking and the business cycle, but tires do wear out. Beautiful black cars increasingly powered by batteries continue to be made and black Elysia wear is hot. We're confident in our business and we are maintaining our adjusted EBITDA guidance midpoint, while narrowing the range to $330 million to $340 million. This guidance is up over 7% at the midpoint and implies a slightly stronger Q4 this year.
Our adjusted EPS guidance range is $2 to $2.10 cents per share is up 5% year-over-year at the midpoint. In closing, I would say, first, we are on track for our third consecutive year of earnings growth and a record year despite lower demand than in 2022. Second, with the ramping up of our Huaibei facility, Kappa 10 conversions, expanded customer applications, facilities, debottleneck activities, and the construction of the new acetylene base plant in La Porte, Texas, we are positioning our specialty business for further growth. Third, the fundamentals of the tire and rubber carbon black industries in our key markets continue to evolve favorably and we expect this to continue in the foreseeable future. Fourth, the US air emission systems at our final plant are operating as we speak.
We expect to complete the third-party stack test this quarter. With this capital spending nearly behind us, we can use our cash flow to more directly improve shareholder value. I continue to be encouraged by the future I see for Orion, for our shareholders, our employees, and the communities we serve. We've been on our journey over the past few years to improve our performance and increase returns to shareholders. And we are seeing the results come to fruition this year, and I expect it to continue into 2024 and beyond. Thank you. Operator, please open up the line for questions.
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