Avient Corp Q3 FY2022 Earnings Call

Good morning, ladies and gentlemen, and welcome to Avient Corporation's webcast to discuss the company's third quarter 2022 results. My name is Catherine, and I'll be your operator for today. As a reminder, this conference is being recorded for replay purposes. I would now like to turn the call over to Joe Di Salvo, Vice President, Treasurer, and Investor Relations. Please proceed.

Thank you, Catherine, and good morning to everyone joining us on the call today. Before beginning, we'd like to remind you that statements made during this webcast may be considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements will give current expectations or forecasts of future events and are not guarantees of future performance. They're 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 for historical non-GAAP financial measures 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. Now I will turn the call over to Bob.

Thanks, Joe, and good morning, everyone. On September 27, we issued a press release to provide revised EPS projections for the quarter and the year. Our projections were updated to include the acquisition of DSM Protective Materials, present the Distribution business as discontinued operations, and adjust our outlook to reflect current demand conditions and weaker foreign exchange. At the time, we said that the war in Ukraine and related energy supply concerns had significantly eroded consumer sentiment and demand in Europe, and we have not seen a recovery in Asia from the COVID-19 lockdowns in the first half of the year. Additionally, the economic environment is further challenged by rapidly rising interest rates in the U.S., which have negatively impacted demand trends in the Americas. We believe current global demand is likely further weakened by customer inventory destocking. And all of this remains true today, with further weakness now expected as a result of recently announced COVID lockdowns in China. From a headline perspective, we are reducing our full-year adjusted EPS guidance to $2.60. There's an additional $0.05 change to the pro forma estimate related to modeling, not demand, which Jamie will cover in her remarks. Economists may debate the technical definition of a recession, but that is academic. We are experiencing lower demand for the reasons that I just mentioned, and that's happening now. To help ground us on the state of preparedness, I wanted to spend a few minutes reminding everyone of the portfolio changes we've made in the last few years and acknowledge the tremendous amount of change that has taken place since we last spoke. I'm extremely proud of what we accomplished against this backdrop of challenging dynamics and macroeconomic circumstances. We achieved two key milestones which are part of a much bigger transformational story. I'm very pleased that we have been able to acquire DSM Protective Materials, now named Avient Protective Materials, or APM, and add the world-renowned Dyneema brand to our portfolio. In doing so, we have substantially increased our presence in the composite and fiber space, adding important technologies to our sustainable solutions portfolio. When we announced the deal in April, you'll recall that we also announced we were going to explore a sale of our Distribution segment, and we did this for three reasons. First, I believe there was a perception potentially held by investors and potential buyers that we wouldn't sell Distribution. Announcing the potential sale was an effective way to gauge the broader interest in the business. We publicly put all potential buyers on notice that we were going to run a sale process, which quickly became competitive. The second reason was I wanted to convey the sale as a potential next step on our multiyear journey to becoming a pure-play specialty formulator. Our Distribution business has been part of our company since it was created back in 2000. Though it was not a formulation business, it played an important role in our growth story and certainly helped fund our specialty investments. As you saw from our announcement yesterday, the divestiture of Distribution is now complete. I'm really pleased that Distribution has found a good home with H.I.G. Capital, as they will continue to represent Avient in the marketplace as a distributor for certain materials in our portfolio. The third reason for announcing the sale and ultimately proceeding with it was so that we could remain modestly levered, which would protect us in a downturn while also providing capacity for future acquisitions when the time is right. We did what we said we would do. We are using the proceeds from the Distribution sale to pay down debt. We remain modestly levered, have no near-term maturities of debt, and substantial liquidity. In short, we are very well positioned to navigate these challenging near-term market conditions. Demand is down, and all signs point to a recession. This is reflected in current equity market sentiment as share prices are down, including Avient. Perhaps some element of our particular situation is effectuated by all these changes in the last few months. Recall that just a few years ago, we executed another important portfolio shift, which reminds me of a similar dynamic. In 2019, we divested a legacy business segment called Performance, Products, and Solutions, primarily constituting our Geon brand and PVC-based materials. A few months later, we announced our agreement to acquire Clariant's Color business. At the time, both transactions were well-received until the pandemic hit in early 2020. Although it was a different impetus, a very similar environment ensued with market disruption, volatility, and uncertainty. Despite prevailing market fears during the early days of the pandemic, we confirmed that we would stay the course with respect to Clariant and our strategy. We knew that the Clariant Color acquisition was the right one and that it would create value for the near term and long term. And it certainly has. We bought a business that generated around $130 million of EBITDA, and today, the acquisition plus synergies are adding just over $200 million two years later. EBITDA margins have expanded from around 12% to over 16%. What I think is most compelling about the deal, however, is the combined strength of the legacy Clariant and legacy PolyOne businesses, and that we've been able to create an enterprise that was better prepared to take care of customers during the COVID pandemic and take share. We are the #1 provider of specialty color and additive solutions today. It's an important reminder to stay the course in good times and bad, just as we are right now. Clariant Color and APM are the two largest acquisitions we've done, but we've also established a track record of bolt-on acquisition success. From thermoplastic elastomers to specialty colorants and performance additives to building a now thriving composites business from scratch, acquisitions have played an important role in transforming our portfolio. So have divestitures, which we exited along the way that were more commodity and volume-driven. The following slide provides a snapshot of bolt-on acquisition performance for established deals that we've had for over seven years, and the value creation story is similar to that of Clariant, but rooted in our invest-to-grow approach to integration. We invest heavily in commercial excellence, often an underinvested area of smaller companies we identify, which offers tremendous opportunity for Avient and our customers. We increased sales, marketing, and R&D resources, then trained employees and provided them the tools they need to serve customers with the highest levels of innovation, service, and delivery. The growth and value creation of those businesses are significant. Combined with the historic change in culture, philosophy, and the way we go to market, we really are now a pure-play specialty formulator of sustainable solutions. It's what we've been aiming for all these years, but not because it's a finish line. In fact, I really view this as a launching off point for us as a preeminent global leader in sustainable solutions. Not many people could have imagined back in 2005 that we'd be where we are today. That specialty transformation of our company ran a natural parallel with our goal to improve our end market mix. If you went back to 2006, you can see that the preponderance of our revenue was in housing, auto, and industrial. Fast forward to 2022, and the end markets have changed dramatically. Over half of our revenues now come from consumer packaging and health care. With Dyneema, we are protecting men and women in the military and law enforcement with defense applications. Here's another telling illustration of what moving from volume to value looks like, as segment EBITDA margins have expanded substantially. This is aggregated with a total lift in EBITDA and margins over this time period. As earnings have expanded, so has the cash we returned to shareholders. A few weeks ago, we announced our 12th consecutive year of annualized dividend increases, an impressive record we're extremely proud of. With the recent significant acquisitions of Clariant and APM and our focus on deleveraging, we haven't bought back a lot of shares in the last couple of years, but over a longer time horizon, we certainly have. All told, we have returned over $1.5 billion in cash and dividends and buybacks. It's quite a story of growth and transformation through periods of immense macroeconomic, geopolitical and personal stress, beginning with the Great Recession in 2008 and 2009, including the COVID pandemic which continues to challenge the world, and now, the events of today. This is an incredibly important context to remember as we consider the current market conditions. I believe we've never been in a better position to handle challenges like the ones before us. The reality is that business is down, and we're not immune to it. This is exacerbated in the near term by COVID lockdowns in China and customer inventory destocking taking place to a degree I have not seen before. Much of this may be a correction in post-COVID buying behavior as well as the real effects of inflation and the impact it is having on consumer spending and sentiment. Jamie is going to provide more details on our financial performance as well as how we navigate these current trends.

Thank you, Bob. The transformation has indeed been on full steam for the two years I've been with the company. I truly couldn't be more proud of the latest milestones we've completed since our last earnings call, especially considering the present economic conditions. We updated our projections in our September 27 press release for the reasons Bob mentioned and to exclude intangible amortization. For the third quarter, our EPS from continuing operations of $0.59 was in line with our guidance of $0.58, a decline of 3% as reported but an increase of 5% excluding negative foreign exchange on a year-over-year basis. The third quarter results shown on this slide include one month of Dyneema in the current year. Financing costs are higher than the ultimate run rate we will achieve following the paydown of debt with proceeds from the Distribution sale. That is why the increase in EBITDA does not translate to a similar increase in EPS in the third quarter. What's not immediately evident from this slide are the underlying changes in demand, price, mix, and cost, which we will cover on the next slide. As we walk through the remaining financial slides, we have presented the information on a pro forma basis, which means APM is included for the entire period for both quarters presented. We've updated our pro forma modeling with more detailed information related to APM results in periods prior to our ownership, and some impacts associated with preliminary purchase price accounting. This resulted in a $0.05 change to our full year estimate. As it relates to demand, during the first half of the year, we reported declining demand related to a loss of sales in Russia, COVID lockdowns in China, and lower sales into the outdoor high-performance market. This is more than offset by price, mix, as well as the performance of our other end markets. In the third quarter, demand further declined, resulting in an EBITDA impact of $39 million. With the exception of our business in Latin America, all regions are experiencing a downturn. Latin American sales are up 18%, driven by growth in packaging applications and extending our reach within the region. Europe, as you would expect, has been most heavily impacted as consumer sentiment has eroded with the ongoing war in Ukraine and associated energy supply concerns, causing virtually all end markets to be down. We have not seen a recovery in Asia from the lockdowns in the first and second quarters, and with recently announced lockdowns in Q4, we won't this year. Although the region is experiencing its own economic challenges, this is also likely tied to lower demand in the U.S. and Canada, which is the new news we highlighted in our September 27 release. The U.S. and Canada represent about 40% of sales, and their demand is down 9% year-over-year, with a large portion of that coming from consumer applications, including outdoor high performance. We believe inflation and higher interest rates are significant factors in shifting sentiment in the U.S. and Canada. This is further impacted by customer inventory destocking, which Bob mentioned previously. It's difficult to bifurcate the two, but we are certainly hearing that from many customers across nearly every industry. The impact of these demand trends and earnings was lessened by the net benefit of our pricing actions. In prior quarters, wage inflation has been a significant factor in cost increases, but now we are seeing much higher energy costs, especially in Europe, particularly in our Engineered Materials segment. From a segment perspective, sales are down in both businesses due to lower demand, with Color's top line being more negatively impacted as virtually all of our exposure to Russia imports within the segment. Color has a larger international footprint than the Engineered Materials business, with 65% of the business originating outside the U.S., exacerbating their results due to the strengthening U.S. dollar. Despite lower demand, the exchange was able to increase EBITDA 7% year-over-year, excluding foreign exchange, due to commercial excellence on pricing, as well as lower costs associated with Clariant, synergies, and reduced incentives. From an SEM perspective, pricing and mix have not been able to offset lower demand in consumer applications and higher energy costs in Europe. We added the next slide to highlight the impact of demand on EBITDA by end market. Industries such as defense, energy, and telecommunications are holding up well and are effectively flat. As we move down the table, you'll see relatively small impact from demand on packaging, which is our largest market, as well as health care and transportation. At this time, we believe these three markets are being impacted more by destocking than consumer demand. We believe end markets such as building and construction have been negatively impacted from rising interest rates and overall inflation, which is influencing end customer demand. The end market that has been most impacted, which is listed towards the bottom of this table, has been consumer. About one-third of this is directly tied to outdoor high performance, which is already down this year. The remaining decline is likely a combination of end-user demand and destocking tied to retail inventory reductions. On the next slide, you can see how the current demand is impacting our key growth drivers as well as the impact of pricing power by each. While sales in Sustainable Solutions are up year-over-year due to pricing initiatives, demand is down as customers draw down inventory. A significant portion of our Sustainable Solutions portfolio is within the consumer and packaging space, where we see the highest levels of destocking by brand owners and retail suppliers. We are still confident in the long-term growth profile of this platform despite the short-term destocking we are experiencing in the value chain. Health care continues to be resilient in these challenging economic conditions as sales increased in higher-margin applications, such as drug delivery devices, medical equipment, and catheters. We are starting to see a slowdown in COVID-related applications, such as those used in administering the vaccine, and medical device applications are encountering chip shortages. With respect to composites, we have seen demand growth in energy and telecom, driven at least partially by 5G infrastructure build-out. This, coupled with pricing initiatives, has more than offset the decline in consumer applications. As we mentioned this morning, we expect full year 2022 adjusted EPS from continuing operations to be $2.60 and pro forma adjusted EPS to be $2.95. As a reminder, the continuing operations figures include APM for the period of ownership since September 1, and the pro forma figures incorporate APM's full-year results as well as the full-year impact of using the Distribution sale net proceeds to pay down debt. I'd like to end on that point. We've acquired an amazing business with Dyneema, the world's strongest fiber, at a value that will be accretive to our shareholders. We completed the transformation of our company to be a 100% specialty formulator with the divestiture of Distribution. We've accomplished significant portfolio moves in a short time window and under incredibly difficult market conditions. We did both of these transactions with a keen focus on maintaining a strong balance sheet and investing, even with the economic uncertainty ahead of us. We are using all of the after-tax proceeds from the sale of Distribution of $750 million to retire our 2023 notes and a portion of our outstanding term loans. This will allow us to be modestly levered at 3.1x net debt to EBITDA by year-end. We have ample liquidity today, which will only continue to grow due to the asset-light and high free cash flow nature of our businesses. As Bob has mentioned before, we are in a great position to navigate the current economic environment while focusing on our long-term strategy of growing and investing in our business with a focus on our key growth drivers. With that, I'll turn the call back over to Bob.

Well, thanks, Jamie. Today, I've made some comparisons to the COVID pandemic to illustrate how we have run the company during challenging times. But clearly, today's environment is not exactly the same as it was in 2020. There is more geopolitical tension, energy availability concerns in Europe, customer destocking, and we are all living with what may become one of the longest fallouts from the pandemic, stifling inflation. Demand is down, but we'll get through it. We have a strong balance sheet, as Jamie said. We'll continue to control discretionary spending and accelerate remaining synergy capture from the Clariant acquisition. I see this as an opportunity for us to further differentiate with our customers. We're going to accentuate the unique hallmarks of why they choose Avient as their partner: exceptional customer service and delivery, continuous investments in innovation and utilizing our global team and manufacturing footprint to flex wherever and whenever they need us to in this volatile environment. Doing these things and doing them well keeps us more resilient in the short term, but it's also about building customer loyalty and setting us up for long-term success when demand recovers, and it will. While we are all laser-focused on the economic conditions and performance, it's a good time to step back and remember another important lesson from the pandemic: practicing empathy. There is still a war going on in Ukraine. Many families in Europe are worried about having heat. We navigate this alongside the personal lives of our associates and our customers. So as we work hard to win in this downturn, we will do so with empathy and compassion, always recognizing the bigger picture. With that, we'll open it up for questions. Thank you.

Our first question comes from Frank Mitsch with Fermium Research.

But so you talked about this destock being greater than you've seen in the past, and I'm wondering if you could offer us some color on the pace of the destock that you've seen relative to 3Q and then into 4Q so far? And if there are any material differences by the segments?

Yes. I mean the pace really did pick up. I think the first time we really started to see that was in August. Orders picked up in September. October came in in line with forecast as we adjusted it in September, but then really dropped off again in November. The fourth quarter forecast has got sales being down about 14%. October was about 9%, but November is really up around 16% or so. It does seem to be taking place faster as we get closer to the end of the year.

Got you. Understood. And then, Jamie, I think you indicated that at the end of the year, net debt-to-EBITDA will be about 3.1x. And I'm wondering what your target is for that metric? And what's the game plan to get there and time frame to get there?

Yes. Our overall philosophy is to be under 3x, and that's obviously what we've communicated in other conversations with Clariant, where we started at 3.5x. Now that we're starting at 3.1%, and because of the high cash flow nature of our businesses, we expect to keep on that path to get down closer to under 3%, thus between 2 and 3x.

And then just a follow up, and when you get there, would there be a reconsideration of buybacks at that point?

Yes. I think along the way, there certainly will be. I think we can be balanced in that regard. Obviously, we need to see what next year looks like from an EBITDA and performance standpoint. We are at the front edge of declining demand. We need to put that into perspective of what next year looks like. We have bought back a lot of shares in the past. We just haven't done it in the last couple of years because of these acquisitions. With the share price where it is, it's attractive, and we'll give that some consideration as we go forward, just keeping leverage in mind.

Our next question comes from Mike Harrison with Seaport Research Partners.

I wanted to ask you, Bob, if you can walk through the consumer business and help us understand what's going on there. Our view is that consumer equals defensive. But it seems there are some pieces that are more discretionary and seeing some pressure, while some areas should be more stable. Can you help break that business down for us?

Yes. We can spend more time on this after you have a chance to look at the slides further. On Slide 19, you can see what the EBITDA impact is on consumer at about $15 million. Obviously, that's the most significant. Around $9 million or so that is really probably in the discretionary sector versus the consumer staples; broadly categorized. Outdoor high performance is one. Clearly, when we started at the beginning of the year, we knew that would be down, but it's down even more than initially thought. There is a significant curtailment of consumer spending and sentiment for things in the outdoor industry or even in consumer staples for home appliances and other small items. Hopefully, that helps as a starting point, but give that some more thought, and we can follow up on that slide.

Yes, that sounds good. And I was hoping you could talk a little about additional synergies yet to come from Clariant. You mentioned that Dyneema has some operational best practices that might be leveraged across your composites facilities. Can you talk about how much additional cost takeout there could be?

Yes. There was one connection between APM and Color, and it really isn't one in terms of learning between the two, or if I misheard you, I apologize. With respect to the Clariant synergies, I think there are more things we can do from an operational perspective that we are considering. Putting these two businesses together during the pandemic was a source of strength and we were able to take share. As we look at current demand trends, there's an opportunity to do some more work from an operations perspective that we just weren't able to do in the last couple of years. I think our approach will pay off.

I know this is probably familiar, but we're on track to deliver $75 million of Clariant synergies within 2022. We previously announced getting to $85 million in synergies, so we're definitely on path for that. Whether or not we can accelerate those into a shorter timeframe is where we're headed. We'll update you when we provide full year guidance for 2023.

All right. And just to clarify my question on Dyneema, my understanding is that there were some best practices that they had on their operations, and that you might be able to leverage those into your composites business. Can you take some best manufacturing practices and find ways to improve yields?

Yes. Sorry if I lumped that in with Color; it was my mistake. The Dyneema business does some incredible things. It has world-class technology and innovation, and I think we'll be able to learn from that as the teams spend more opportunities together. That will absolutely come to fruition.

We have a question from Michael Sison from Wells Fargo.

I appreciate the slide regarding the new portfolio being less cyclical. But when you look at the first half, your volumes are down 6%, and the second half looks like double-digit declines. Does it feel that cyclical? I know your goal is to grow 6.5%. Can you provide some color on why volumes seem more cyclical?

First, I’d say relative comment: looking back on the portfolio during the recession of 2008 and 2009, volume was down 36%. To be down 12% now is actually less cyclical. Customer inventory destocking is playing a significant factor in the fourth quarter, and that's the reason you're seeing a significant EPS decline. I still think that 12% is a good long-term view.

What do you think the portfolio would generate in the soft or hard recession? What type of volume declines do you think you'd see?

When we did the modeling during that recession, we projected around 12%. While it may go down a bit more in the fourth quarter because of destocking, I still think that's a good way to think about it. We're at the beginning of this downturn, and some of that will carry into '23 for sure.

So 12% down is for the full year '22, and then what would the second half be?

No, I wasn’t saying 12% down for the full year. I was referencing the present demand dynamic right now between Q3 and Q4. I don't have the math on the top of my head for the full year.

Our next question comes from Angel Castillo with Morgan Stanley.

I wanted to get more color on the destocking you're seeing. Could you give us a sense of what pockets or factors saw more demand compression in November versus where we were in October? And how do you think about how much could be destocking versus just seasonality?

When you look at Slide 19, obviously defense, energy, and telecom are relatively flat year-over-year. The middle three categories are seeing destocking. Transportation is already down, so I think we're seeing some destocking there. The last three are a combination of destocking in consumer and demand. It's very difficult to bifurcate the two; buying behavior has changed dramatically in the last month or two.

Do you expect this destocking to continue into early '23?

I feel the downturn is not sustainable in terms of alignment with consumer demand, as I don't think demand is down as much as what we're seeing. I believe that sometime in early first quarter, that starts to correct itself.

Can you share any positive or negative surprises as you integrate Dyneema?

All good so far. It's just a little over a month, and we're happy with the team joining us. They're pretty energized about becoming part of Avient.

And our next question comes from Laurence Alexander with Jefferies.

The $295 million in pro forma also excludes the contributions from Distribution in the first half of the year, correct?

That's correct.

Among concerns over energy curtailment amongst customers or yourself, is that something that could affect you guys? Do you expect it to affect your customers' production?

The bigger concerns for us are suppliers in Europe, particularly in Germany. I haven't seen that impact us yet, but I know it's being discussed. I would imagine that could ultimately affect customers as well.

Would there be a difference among different end markets? I would think health care wouldn’t be affected, but how about traditional industrial wood?

I’m not sure it's a perfect distinction; suppliers of base materials in Europe will have to maintain supply to essential industries like health care. There will likely be some exceptions if energy needs to be curtailed, but I can't quantify it right now.

And our next question comes from David Huang with Deutsche Bank.

Can you talk about the volume trends you're seeing for Dyneema? Also, how much of the EBITDA margin was impacted by higher energy costs? And what do you expect for Dyneema margins going into Q4 in '23?

Dyneema and the APM business is more energy-intensive than the legacy Avient businesses, and we are feeling that impact in Q3, which will likely remain flat between Q3 and Q4. The margin number you're referencing is accurate, and that's about where I expect things to end the year.

Can you share your playbook for '23? I know you don't give guidance, but what is your confidence level in growing EBITDA in '23?

At this point looking at the fourth quarter and the decline in EBITDA, I don't think EBITDA will increase in the first half of 2023. We haven't given guidance yet, but continuing demand trends will make it a tough hurdle. We're just starting to formulate our view on '23, normally done after our fourth quarter update in late January or February. Demand is down significantly; we are in a recession; this won't be over in 90 days. We have a tough road ahead for a couple of quarters.

And we have a question from Eric Petrie with Citi.

Can you discuss the larger buckets in sustainable solutions like lightweighting? Any updates on recycling solution efforts from your customers?

The first thing I would point out is that it's roughly flat in terms of OI, but packaging is down. You see that favorable pricing and mix more than offsetting demand down. A lot of that is due to destocking more than anything else in packaging. There is still a high energy and interest in using more recycled content and making products more recyclable. There's a change coming due to inflation that might influence consumer perceptions of major brands versus store brands, but that has yet to play out. There are still positive trends on lightweighting and recycled solutions.

How much are earnings down for outdoor high performance year-to-date? When do you think destocking completes?

It's down about $14 million for the full year. Last year's fourth quarter was weak, so we are right on the edge of lapping that, absent any further destocking. I don't think the year-over-year change will be that big in Q4. That was our last question. I want to say thanks, everybody, for joining us on the call today. We look forward to giving you an update after we've concluded our fourth-quarter results. If you have other questions, please give us a call. Thank you.

This concludes today's conference call. Thank you for participating. You may now disconnect.