Q2 2023 AdvanSix Inc Earnings Call

Participants

Adam Kressel; Director of IR; AdvanSix Inc.

Erin N. Kane; CEO, President & Director; AdvanSix Inc.

Michael Preston; CFO & Senior VP; AdvanSix Inc.

David Cyrus Silver; Senior MD & Director of Equity Research; CL King & Associates, Inc., Research Division

Vincent Alwardt Anderson; Associate; Stifel, Nicolaus & Company, Incorporated, Research Division

Presentation

Operator

Good morning, and welcome to the AdvanSix Second Quarter 2023 Earnings Conference Call. (Operator Instructions)

Please note this event is being recorded.

I would like now to turn the conference over to Adam Kressel, Vice President of Investor Relations and Treasurer. Please go ahead.

Adam Kressel

Thank you, Alan. Good morning, and welcome to AdvanSix's Second Quarter 2023 Earnings Conference Call. With me here today are President and CEO, Erin Kane; and Senior Vice President and CFO, Michael Preston.

This call and webcast, including any non-GAAP reconciliations, are available on our website, at investors.advansix.com.

Note that elements of this presentation contain forward-looking statements that are based on our best view of the world and of our business as we see it today. Those elements can change and the actual results could differ materially from those projected, and we ask that you consider them in that light. We refer you to the forward-looking statements included in our press release and earnings presentation. In addition, we identify the principal risks and uncertainties that affect our performance in our SEC filings, including our annual report on Form 10-K as further updated in subsequent filings with the SEC.

This morning, we will review our financial results for the second quarter 2023 and share our outlook for our key product lines and end markets. Finally, we'll leave time for your questions at the end.

So with that, I'll turn the call over to AdvanSix's President and CEO, Erin Kane.

Erin N. Kane

Thanks, Adam, and good morning, everyone. Thank you for joining us and for your continued interest in AdvanSix.

As you saw in our press release, AdvanSix delivered solid earnings and cash flow results in the second quarter amid a continued dynamic macro environment and against a record second quarter in the prior year period. The performance further illustrates the value and resilience of our diversified chemistry company.

Our team executed on strong in-season demand for plant nutrients, albeit in a lower nitrogen and raw material pricing environment. They navigated unfavorable nylon industry supply and demand conditions and an increased low-priced imports, while continuing to experience balanced North American acetone supply and demand dynamics in our chemical intermediates portfolio.

Our long-term confidence is reflected in continued share repurchases through July as well as our announced 10% increase in our quarterly cash dividend for the third quarter.

We continue to make meaningful progress on our sustainability initiatives and ESG performance. We will soon publish our annual sustainability report, which highlights the terrific work happening around the organization integrated with our overall strategic priorities, including the recent launch of our 100% post-consumer recycled nylon, which I'll speak to later on this call. I encourage you all to take a read through it later this month.

Looking ahead, our diverse end market exposure and integrated, efficient and cost-advantaged business model provides resiliency, particularly in an evolving global macro environment. While we anticipate seasonality impacts within our plant nutrients business and demand weakness in certain market segments within our nylon solutions and chemical intermediates product lines, we remain confident in our demonstrated ability to execute and perform through various macroeconomic cycles.

We are highly focused on what is in our control, including driving superior operational and commercial performance to meet the evolving needs of our customers, building capabilities to strengthen our innovation and portfolio resiliency and executing against a balanced and disciplined capital deployment framework.

Our organization's collective efforts are centered around driving best possible outcomes for our business in the current set of industry conditions while supporting sustainable long-term shareholder value.

Now let me turn the call over to Mike.

Michael Preston

All right. Thanks, Erin, and good morning, everyone.

I'm now on Slide 4, where I'll provide a summary of the second quarter 2023 financial results. Overall, our results were solid, considering the current environment and against a record prior year comparison.

Sales of $428 million decreased approximately 27% in the quarter. Pricing was unfavorable by 25% overall.

Market-based pricing was unfavorable by 19%, primarily reflecting lower nutrient values reducing ammonium sulfate pricing as well as lower nylon pricing. Raw material pass-through pricing was also a headwind, down 6% following a net cost decrease in benzene and propylene.

Volume declined approximately 2%, primarily driven by soft end market demand impacting portions of our nylon and chemical intermediates product lines. This was partially offset by higher domestic ammonium sulfate volume to meet in-season customer demand compared to the prior year period, which was impacted by unfavorable weather conditions.

Adjusted EBITDA was $66 million, and I'll highlight the key year-over-year variances on the next slide.

Adjusted earnings per share was $1.25.

The effective tax rate was 24.4% in the quarter, consistent with our full year expectation for an effective tax rate of approximately 24%.

And finally, free cash flow was approximately $16 million in the quarter. Cash flow from operations of $35 million decreased roughly $61 million versus the prior year, primarily due to lower net income and the unfavorable impact of changes in working capital driven largely by the unwinding of ammonium sulfate prebuy cash advances this year versus prior year, when there was no 2021 year-end prebuy.

Capital expenditures of $19 million in the quarter increased $2 million versus the prior year.

Let's turn to Slide 5. Here, we highlight the key drivers of our second quarter adjusted EBITDA performance year-over-year. Pricing over raw materials was roughly a $44 million headwind. Tracking our key variable-margin drivers, ammonium sulfate on a net price over natural gas and sulfur basis was down year-over-year, as significantly lower pricing was only partially offset by a reduction in input costs.

Performance across our caprolactam and nylon portfolio over our key raws was also negative year-over-year, reflecting unfavorable supply and demand dynamics, pressuring global pricing in a lower raw material environment.

And lastly, chemical intermediates price-over-raw spread increased year-over-year, largely reflecting acetone margin over falling propylene costs.

Volume and sales mix were approximately $2 million favorable in the quarter, largely reflecting higher plant nutrient sales, as previously discussed, partially offset by soft market conditions for our nylon and chemical intermediates products tied to continued weak demand in building and construction and for consumer durables.

We also saw an approximately $4 million favorable benefit from planned plant turnarounds year-over-year.

Finally, all other items netted to a roughly $1 million unfavorable impact.

Now let me turn the call back to Erin.

Erin N. Kane

Thanks, Mike. I'm now on Slide 6 to discuss each of our product lines. Starting with nylon solutions, we've seen continued global pricing pressure on the back of unfavorable supply and demand industry conditions and increasing Chinese exports. The Asia caprolactam-over-benzene spreads averaged roughly $800 per ton in the second quarter of 2023, remaining roughly flat on a sequential basis but down significantly year-over-year.

The global composite price-raw spreads underperformed the Asia spreads once again as a slower-growth Chinese economy is leading to excess supply moving to other regions at lower prices. China exports are at an all-time high, and we're seeing the most acute challenges through the engineered plastics space, where not only low-priced nylon, but also [compounded] material, is coming into North America at an increasing rate. This comes at a time when demand overall has remained soft, leading to further margin compression.

Across our other key end markets, building construction indicators have been mixed, and we've yet to see a volume or price recovery in the fiber and filament space, where we serve our carpet customers, or in wire and cable, which has exposure to residential applications.

Lastly, packaging, while a more resilient end use for our business, has seen some demand softness tied to inflationary pressures impacting buying behavior in certain applications like bone and meat and protective packaging.

Moving to chemical intermediates, industry-realized acetone prices over refinery-grade propylene costs continued to improve year-over-year in the second quarter. While acetone demand downstream has seen some softness, particularly into the large buyer end applications, we see supply as generally balanced. This has been supported by stable acetone imports into the U.S. and persistent lower phenol global operating rates on reduced demand into epoxy resin, polycarbonate and nylon value chains serving building construction and other industrial applications.

We also continue to monitor propylene costs, which ended the quarter at their lowest levels since early 2020 on ample supply.

Our integrated operating model continues to serve us well in industry dynamics like these.

And lastly, in plant nutrients, we saw nitrogen fertilizer pricing decline through most of the first half of the year, amid lower energy costs and increases in global supply availability. As we have noted in the past, ammonium sulfate pricing tends to be less dynamic than urea, and we had seen smaller price reductions through the winter months. As anticipated, in-season customer demand picked up through the second quarter, supported by favorable underlying agricultural fundamentals.

From a crop perspective, corn prices have seen some volatility, with changes in projections of estimated planted acres and the ongoing drought concerns impacting potential yields.

In the export market, we saw more cautious buying behavior out of places like Brazil as nitrogen prices fell, and although pricing has seen some recovery entering 3Q, it remains well below prior year levels.

So overall, while we navigate through a multi-quarter reset here as well as the third quarter seasonal dynamics in North America, which we'll discuss on the next slide, the underlying fundamentals continue to support firm fertilizer demand moving forward into 2024.

Our plant nutrients portfolio, now with plans for further expansion of granular ammonium sulfate production, is a leader in the space and continues to support overall company performance and results.

Let's turn to the next slide. We thought it would be helpful to spend a moment refreshing everyone on the seasonality impacts we typically see in our ammonium sulfate business. Ammonium sulfate fertilizer does experience quarterly sales seasonality, reflecting both geographical and product sales mix considerations, based on the timing and length of the growing seasons in North and South America.

The North American fertilizer season runs roughly from July, when the value chain begins restocking fertilizer, through June, when most application for the year's planting is completed. The new season fill begins in the third quarter and proceeds sequentially into the following spring, which is the peak period for key crop fertilizer application.

As a result of this pattern, North American ammonium sulfate demand and pricing, particularly for a higher-value granular product, are typically strongest in the first half of the year through application for the spring crop and then decline in the second half.

To better illustrate the sequential seasonality considerations, the chart on the left-hand side of the page depicts the average price change of Corn Belt ammonium sulfate, as published by Green Markets, by quarter over the period from 2010 through current.

As you can see, the trend reflects the dynamics just discussed. On average, we've seen industry prices in the Corn Belt decline roughly 10% from the second to the third quarter. And while there are a range of results across the quarters depending on the environment in any given year, we've seen sequential declines into the third quarter in every year since 2010, except for 2021. The third quarter sequential declines over that period have ranged from a low-single-digit decline to decreases of roughly 30%.

Now historically, these declines correspond to a sequential consideration of $10 million to $15 million lower pretax income, on average, in a given third quarter relative to the second. However, in 2023, we anticipate the seasonality impact to be above the higher end of the historical range typically seen.

I'd now like to turn to Slide 8 to discuss the launch of our new 100% post-consumer recycled, or PCR, Nylon 6. Launched with a global pouch form in June, this new portfolio of products builds on our introduction of post-industrial recycled, or PIR, resins and films in 2021. Our effort here is to meet growing demand for environmentally friendly products by incorporating materials built on recycled monomers reclaimed from waste streams. Our approach uses an industry-accepted [mass-balanced] approach that is third party-certified annually.

With more than 10% of our total resin capacity available to be sold with a PCR or PIR certification, this is another terrific opportunity for us to boost differentiated product growth while providing our customers a cost-effective path to sustainability.

We're targeting customers across a wide range of applications, driving our value proposition across food and medical packaging that requires FDA compliance, automotive, carpeting, thermoformed and shrink packaging for meat and cheese and bag-in-box packaging.

The new PIR and PCR Nylon 6 materials offer the same excellent properties as conventional nylon products. They are drop-in replacements with no costly requalifications or cost to consumers and provide a solution to help companies meet their sustainability goals.

We're in the process of finalizing a life cycle assessment comparing our conventional Nylon 6 with our recycled offerings. We expect that it will show a significant carbon footprint reduction, positioning this product to further contribute to our customers' decarbonization goals.

Now to put this in perspective in a packaging application, nylon's inherently larger footprint relative to polyethylene becomes an advantage when optimizing the overall package's carbon footprint. As an illustrative example, if you assume use of these products in a typical multi-layered (inaudible) application, the recycled Nylon 6 could potentially deliver an approximately 30% reduction in overall carbon footprint when compared to Plastics Europe's published numbers.

Now let's turn to Slide 9 to wrap up before moving to Q&A. Our outlook for 2023 remains largely consistent to what we have shared previously. We continue to expect performance this year to demonstrate the resilience of our business model and our ability to navigate through the challenges of an uncertain environment.

We expect favorable underlying agriculture and fertilizer industry fundamentals to continue. However, typical seasonality will be a key consideration to our expected sequential performance in the third quarter relative to the second.

North American acetone supply and demand conditions remain balanced, given lower phenol industry operating rates globally, while headwinds in consumer durables and building construction end markets persist across our nylon and other chemical intermediates product lines. This is expected to continue having implications for both price and volume.

Operationally, we are highly focused on the execution of our upcoming third quarter planned plant turnaround, which supports our ability to safely operate at higher utilization rates relative to our industry. We continue to expect the pretax income impact of planned plant turnarounds to be $25 million to $30 million in the third quarter of 2023, totaling $28 million to $33 million for the full year.

So overall, we are executing to a set of focused priorities, all of which are aligned to driving the critical measures that underpin compelling returns on capital and attractive long-term total shareholder returns.

With that, Adam, let's move to Q&A.

Adam Kressel

Great. Thanks, Erin. Alan, can you open the line for questions?

Question and Answer Session

Operator

(Operator Instructions) Our first question comes from Vincent Anderson, of Stifel.

Vincent Alwardt Anderson

So purely hypothetically, how would a trade case against Nylon 6 from China compare to acetone or ammonium sulfate, just given trade data doesn't disaggregate Nylon 6 from other nylon products?Is that something that based on your prior experiences would be feasible?

Erin N. Kane

Thanks for the question, Vincent. We want to keep all of our options open here. And certainly, ensuring fair trade practices is important to us as we continue to monitor the industry dynamics here.

Our assessment is underway. And as you pointed out, we've been in this position in the past, in both our ammonium sulfate and acetone businesses, in trade cases like these around the world. And we'll leverage our prior experience to petition for fair trade if it's determined that that's the most appropriate action.

Vincent Alwardt Anderson

Okay. All right. And then can you just quickly remind us what types of agricultural products the U.S. (inaudible) going to? And how did it perform this quarter, given we've seen some pretty severe destocking in crop protection kind of everywhere else in the chemicals world?

Erin N. Kane

Our experience here would be the same. As a reminder, we go into the herbicides down the glyphosate chain with our [Mepa] product offerings. And certainly, on the ag chemical side, there were and we did see more destocking that occurred based on the import levels that happened late last year. And so we have seen that impact certainly in demand through what would have otherwise been a strong season like we saw in dry fertilizer, as basically down the chain and retailers and growers work through that higher inventory. But again, I think the underlying fundamentals generally support an opportunity set here as we come through into the next season.

Vincent Alwardt Anderson

Great. And if I could just ask a couple of quick ones on the recycled content. So if I remember correctly, your PIR nylon is (inaudible) with zero kind of internal manufacturing process waste, for lack of a better term. But what is the feedstock for the post-consumer recycled nylon?

Erin N. Kane

If you think about the opportunity set that we have with our customers and in their value chain, we can take opportunity sets of monomers and back from them in their streams as well. And so it's an expansion, if you think about that envelope, opportunity set to be able to bring it back into our chain.

Vincent Alwardt Anderson

Okay. Okay. That makes sense. And then does [Obin] already have food packaging products developed and ready to market with PCR nylon? Or is that your next step?

Erin N. Kane

Certainly, as we work with them in concert and create that opportunity set. So in BOPA, that's going to be in certain types of applications. Those are typically more mono-oriented-type packaging. The multi-film would work through our partners in some of the other converters.

Operator

Our next question comes from David Silver, from C.L. King.

David Cyrus Silver

Okay. Great. I have a few admittedly scatter-shot questions here. First question would have to do with your balance sheet and, in particular, inventories. So your second quarter ending inventory balance is sharply higher than a year ago, and I'm guessing the units difference is greater than the dollar difference just given the shifts in product pricing. So certainly, some of that is related to your upcoming turnarounds which may be underway now. But could you just maybe talk about your comfort level with the inventories as of June 30? And then, in particular, did the buildup of inventory have a meaningful impact on your reported results in the second quarter? In other words, did it improve your unit margins if you produce more than you're shipping?

Michael Preston

I mean, good question. So when you look at the inventory number, as you point out, we ended the quarter with $226 million of inventory. And that was pretty flat relative to the first quarter, Dave, about a $1 million increase and up about $10 million since the end of the year. So again, from a sequential basis, not much of a change.

But as you point out, definitely a change from a year-over-year perspective. And when you break that down, looking at roughly a $70 million increase in inventory from a year-over-year perspective, raws were up in that $15 million range. And we do have a lot of timing with respect to cumene and based on the rotations and when we receive those. So that can -- it will certainly fluctuate from quarter-to-quarter.

But the balance is really in the finished goods and the work in process. And as you point out, as we head into the turnaround, the plant turnaround, here in the third quarter, we'd clearly like to head into those with higher inventory balances so we don't disrupt sales and ensure continuity of sales to our customer base. And so that's critically important to us.

And as we roll through the turnaround in the third quarter here and through the second half as we come out of that, we would expect there to be a reduction in inventory, and that is what we are planning for here in the second half.

And then as we've sort of pointed out, we have been faced with some soft demand conditions for nylon and certain intermediate products tied to building and construction as well as consumer durables. That's also been a consideration. And we continue to sort of optimize to navigate as we progress here in the second half.

But we are expecting a reduction in inventory as we head through the turnaround in the second half of the year.

David Cyrus Silver

Okay. Great. And I would like to ask you about your CapEx plans for this year. So no change in your targeted full year level, but I guess if you were just to divide that by 4, the first half of the year you're kind of trailing the pace at which your full year CapEx spend would play out. Can you just maybe talk about how you get from here to there? In other words, with the turnaround and everything and a number of diverse initiatives included in that somewhat larger spend this year, maybe just talk us through the back half of the year and how that spending might progress.

Michael Preston

Good question. In the first half, just to put some numbers around it, our CapEx spend in the first half was roughly $44 million. And we're still guiding to a $110 million to $120 million amount for the full year, which means that the second half spend has to ramp up quite a bit. About 2/3 of the annual spend, roughly, is in the second half. And as we execute the turnaround, a lot of the capital equipment that we've been planning for will be installed and our CapEx will increase as a result. And so we do expect a ramp-up here in the third quarter and then another ramp-up in the fourth.

And we talked about some of the projects that we're focused on this year which is resulting in the increased and elevated spend. Some of those critical infrastructure projects that we've talked about, particularly some of the dock we have at our Frankford facility which we're performing some upgrades to and some other projects as well.

So that is driving the spend for the year and what we expect here in the second half, David.

David Cyrus Silver

Okay. One question, to go back maybe to the nylon chain and the market dynamics right now and, in particular, China, there's a lot of consensus on the fact that China is exporting a lot of nylon that they can't place domestically, nylon and its precursor. But I was just wondering, in your opinion, are there other nylon chain products that they are also -- you're seeing the same type of opportunistic export behavior perhaps out of China? And I'm thinking of ammonium sulfate, firstly, but anything else that you think is kind of filtering into the markets that we need to keep an eye on?

Erin N. Kane

I can provide some context in the chain. As you point out (inaudible) in our remarks, China export volumes globally now sort of equate to 3x the size of Chesterfield's capacity, right? So the equivalent of 3 of our nylon plants are now being exported globally from China.

And certainly, I'd just say that is in a slower growth environment for them and certainly pressuring opportunity sets into Europe, but then also into North America. And [the share] predominantly coming in, in the engineered plastics space, and then that is also carrying downstream to where plastic engineered compounds made of Nylon 6 are also coming in, pressuring and competing with our customers.

We extend that to sort of the broader chain. Obviously, global flake, caprolactam is being exported as well. And then the result in ammonium sulfate, which we have seen for a number of years now. And Chinese AS production and exports, effectively as they have expanded their capacity inland for caprolactam (inaudible) ammonium sulfate. Ammonium sulfate has been flat in domestic consumption there. So effectively, with every addition that they have added, that ammonium sulfate is being exported globally. And that has reached nearly [13] million tons if you think about it. So it's a significant consideration in the global marketplace. And that is predominantly -- and they are heading into Brazil, Southeast Asia.

And so that's just a little bit of context in that regard, right? So I can certainly expand if there's anything more as a follow-on, but that is what we're seeing in the value chain.

David Cyrus Silver

And as you answered earlier, I mean, there tends to be a bit of a crazy quilt of trade restrictions and whatnot that go both ways, which kind of complicates this more, complicates the analysis.

Erin, big-picture question here. So I'll preface my remarks by saying I'm not a professional economist, but I've been a careful observer for a long time. And I would just again stipulate this is kind of a 2-phased or schizophrenic economy, the industrial economy that we're in, that I haven't really -- I have a tough time finding a comparison, just with the puts and takes, as I look around.

But in your opinion, is the United States now in an industrial recession? In other words, are the negatives broad enough that they're outweighing the positives that are out there? And if so, how does that change how you operate maybe tactically over the next few quarters?

Erin N. Kane

Well, I mean, as you point out, there is data that underpins the backdrop of the macro environment that we are operating in. We are in a business of producing great chemistries and essential chemistries that are used on the value chain for consumer goods and essential products that impact millions around the world.

But the reality is you've got S&P global manufacturing PMI that has contracted for 11 months in a row. You have U.S. manufacturing PMI as of July that has contracted for 9 straight months in a row. The evidence of destocking, reduction of global operating rates I think is certainly a strong indication of the dynamic that you are suggesting.

And as I point out, we've been here before. This is a business that we have continued to focus on the core first principles. And in environments like this, our cost-managed business model and efficiency comes into play. We are fortunate that we are able to run disproportionately higher utilization rates accordingly. So that supports our through-cycle profitability. And we continue, as you know, to focus on the areas of opportunity to expand the underlying earnings of this business through smart capital investments, through our bolt-ons on M&A. And effectively, our cost focus as well will need to come into play if this is to continue to be extended.

But certainly, this is not something that's just happening. This is a dynamic that has been progressing now in some aspects of our business for the better part of a year.

Operator

This concludes our question-and-answer session. I would like now to turn the conference back over to Erin Kane for any closing remarks.

Erin N. Kane

Thank you all again for your time and interest this morning.

Despite a dynamic set of industry conditions and a record comparison in the prior year, we are proud that we delivered solid earnings and cash flow results in the second quarter of 2023. Our results once again demonstrated the strength of our business model and our position as a diversified chemistry company.

While there are puts and takes across our end markets and broader macro uncertainty, we are focused on executing what is in our control, including a rigorous commitment to operational excellence, continuous enhancement of our long-term growth capabilities and making smart and disciplined capital deployment decisions to drive higher returns.

With that, we look forward to speaking with you again next quarter. Stay safe and be well.

Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.