Cabot Corp Q1 FY2021 Earnings Call

Ladies and gentlemen, thank you for standing by, and welcome to the Cabot’s First Quarter 2021 Earnings Conference Call. Please be advised today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Steven Delahunt, Vice President, Treasurer, Investor Relations. Thank you. Please go ahead, sir.

Thank you. Good morning, and welcome to the Cabot Corporation First Quarter Earnings Teleconference. With me today are Sean Keohane, CEO and President; and Erica McLaughlin, Senior Vice President and CFO. Last night, we released results for our first quarter of fiscal year 2021, copies of which are posted in the Investor Relations section of our website. The slide deck that accompanies this call is also available in the Investor Relations portion of our website and will be available in conjunction with the replay of the call. During this conference call, we will make Forward-Looking Statements about our expected future operational and financial performance. Each forward-looking statement is subject to risks and uncertainties that could cause actual results to differ materially from those projected in such additional information regarding these factors appears under that any forward-looking statements in the press release we issued last night and in our annual report on Form 10-K for the fiscal year ended September 30, 2020, and subsequent filings we make with the SEC, all of which are also available on the Company’s website. In order to provide greater transparency regarding our operating performance, we refer to certain non-GAAP financial measures that involve adjustments to GAAP results. Any non-GAAP financial measures presented should not be considered to be an alternative to financial measures required by GAAP. Any non-GAAP financial measures referenced on this call are reconciled to the most directly comparable GAAP financial measure in the table at the end of our earnings release issued last night and available in the Investors section of our website. I will now turn the call over to Sean Keohane, who will discuss the key highlights of the Company’s performance. Erica McLaughlin will review the business segment and corporate financial details. Following this, Sean will provide closing comments and open the floor to questions. Sean.

Thank you, Steve, and good morning, ladies and gentlemen. Welcome to our first quarter 2021 earnings conference call. I’m very pleased with the exceptional operating results we have reported as we saw a strengthening recovery across our end markets. For the quarter, we generated record adjusted earnings per share of $1.18 and segment EBIT of $140 million. The results were driven by improving demand trends, robust unit margins, disciplined operational execution, and strong performance in our targeted growth initiatives. I would like to recognize the extraordinary employees of Cabot, whose teamwork and commitment made it possible for us to meet the dynamic needs of our customers while maintaining the safety of our people and our communities. The COVID pandemic has challenged our normal ways of working, but I believe our strong culture of connectivity and collaboration enabled us to distinguish ourselves in the marketplace, and we will continue to build on these strengths into 2021. During the quarter, we saw strong volumes in the tire and automotive markets as the recovery momentum continued globally with a sharp rebound from the lows experienced last spring. We are pleased to see that miles driven trends have improved, though still generally lag pre-COVID levels. In terms of automotive builds, a similar trend has taken hold. With both end markets still below prior peaks, we are optimistic about our growth runway as the economic recovery strengthens. As highlighted in previous calls, we experienced real strength throughout 2020 for products sold into the infrastructure, packaging, and consumer sectors, and this continued in our first fiscal quarter of 2021. Our strong product portfolio, global reach, and technical support have enabled us to capitalize on favorable infrastructure trends in wire and cable, pipe, and geomembranes. Additionally, the COVID pandemic has changed certain consumer behaviors, and these trends are supportive of our packaging and consumer-driven applications. While the underlying end market trends are favorable, there likely was some level of channel replenishment in the quarter as the combination of sharply rising demand and low inventories in most value chains created upward pressure on orders. We are also seeing tightness across transportation modes globally, and the supply chain uncertainty is likely causing customers to build some inventory to mitigate disruptions. I would like to spend a little time now on China. Our previous comments had suggested some softening in that market; however, we are seeing real strength there now. China was the only major economy to avoid a recession in 2020, and the market there was very strong for us in Q1, as PMI hit 57 and industrial production surged. As we look forward, our belief in the fundamentals of the China market is strong and our long-standing strategic assumptions remain sound. Given that almost 40% of the world’s tires are produced in China and 50% of the world’s silicones, our differentiated position there means we are extremely well positioned for growth. We believe that the feedstock markets will be in balance over the long term, which should provide a foundation of stability over time. And finally, we expect environmental pressures will continue to intensify and Cabot’s leadership in sustainability will position us in a differentiated way relative to the competition. Looking at our segments, Reinforcement Materials generated record EBIT performance in the quarter, driven by very strong results in Asia, as our focus on margin paid off. Our global footprint and focus on operational excellence are the foundations of our customer value proposition, and I believe we are seeing benefits of that in our results. During the quarter, we completed the negotiation of our Reinforcement Materials customer agreements for the calendar year of 2021. We are pleased with the outcome, which was broadly in line with our 2020 agreements in terms of pricing and share. This is a positive development as we negotiated during a period of low volumes and extremely uncertain forward visibility. By maintaining our share, we will participate in the demand recovery with our customers. We are also very pleased to see the significant step-up in results in the Performance Chemicals segment. The segment delivered EBIT in the first fiscal quarter of 54 million, up 32% compared to the first fiscal quarter of 2020. This was primarily due to higher volumes across all applications, strong product mix from automotive applications in specialty carbons and compounds, and progress in our targeted market growth initiatives. Despite the pandemic, we continue to advance critical strategic initiatives that we believe will create long-term value while staying committed to our balanced capital allocation framework. In Suzhou, China, we are in the process of converting this acquired plant to manufacture specialty carbons. The strategic project will provide growth capacity for our high-value specialty carbons grades and complement our footprint so that we are balanced geographically. This project is progressing well, and we remain on track for completion in early calendar 2022. In the battery space, the integration of Shenzhen Sanshun Nano into our Energy Materials business is complete, and sales of our conductive carbon additives are growing at attractive rates. Customer adoptions and sales with the top 10 global battery producers continue to build momentum, and we believe this business will grow to become a meaningful profit contributor for Cabot. We are also making important progress to grow our Inkjet business. Our investment focus over the last couple of years has been in the space of packaging, as that sector begins a transition from analog to digital printing with Inkjet technology. Our sales are growing in the packaging space, and we are well positioned with product adoption at many of the leading printer OEMs. We expect the penetration of inkjet technology to accelerate over the next three years, and we believe we are extremely well positioned. These investments are critical in supporting our earnings growth targets, and we have been disciplined in our choices and execution so that we balance growth along with cash return to shareholders. In addition to our growth investments, sustainability and ESG leadership have long been a strategic priority for Cabot, and their importance is growing in the eyes of our stakeholders. I’m pleased to highlight two achievements this quarter that demonstrate our industry-leading position. First, we received a platinum level rating in recognition of our sustainability efforts from EcoVadis. EcoVadis is an independent assessment organization that evaluates company sustainability programs in the areas of environment, labor practices and human rights, ethics, and sustainable procurement. Many of our customers utilize EcoVadis to confirm performance of their supply chain partners. Our platinum rating confirms that Cabot is ranked among the top 1% of companies in its peer group in the manufacturing of basic chemicals. We are also proud of being named one of America’s Most Responsible Companies 2021 by Newsweek Magazine. This is the second year that Cabot has received this recognition, which was developed in 2020 to highlight the most responsible companies in the United States across 14 industries. This accomplishment recognizes Cabot’s reputation and programs in corporate governance, community engagement, and management of environmental performance as well as transparent reporting. Sustainability leadership and corporate responsibility are integrated into the business strategy and daily management of Cabot. By leading in this area, we will ensure that all stakeholders are part of our success. I will now turn it over to Erica to discuss the financial results of the quarter in more detail. Erica.

Thanks, Sean. I will start with discussing results in the Reinforcement Materials segment. The Reinforcement Materials segment delivered record operating results with EBITDA of $88 million compared to the same quarter of fiscal 2020, driven by improved pricing and product mix in our calendar year 2020 tire customer agreements and with spot customers in the Asia region. This improvement included our ability to raise prices ahead of rising feedstock costs in Asia that drove strong unit margins. Globally, volumes were up 1% in the first quarter as compared to the same period of the prior year, primarily due to 13% growth in Europe and 9% higher volumes in the Americas, as key end market demand continued to recover along with some level of inventory replenishment from the draw-downs earlier in the calendar year. Asia volumes were down 8% year-over-year, largely due to a scheduled plant turnaround and our decision to balance pricing and volumes in order to improve margin levels. Looking ahead to the second quarter of 2021, we expect stronger year-over-year EBIT in the second quarter as compared to the prior year, driven by higher year-over-year volumes. Looking sequentially, we expect volumes to remain solid, slightly higher than the first fiscal quarter. We anticipate that margins will moderate from the levels seen in the first quarter as feedstock costs increase and we will not experience the same pricing tailwind in Asia ahead of costs. In addition, we anticipate an increase in fixed costs sequentially, as volumes increase and we spend a bit more on maintenance activity. Now turning to Performance Chemicals. EBIT increased by 13 million as compared to the first fiscal quarter of 2020, primarily due to higher volumes and improved product mix in the specialty carbons and compounds product lines. Year-over-year volumes increased by 9% in both the Performance Additives and Formulated Solutions businesses, driven by increases across all of our key product lines from higher demand levels and some level of customer inventory replenishment during the quarter. We experienced strong demand related to automotive applications, which drove the favorable mix in the specialty carbons and compounds product line. These favorable impacts were partially offset by weaker pricing and product mix year-over-year in our fumed silica product line. Looking ahead to the second quarter of fiscal 2021, we expect stronger year-over-year EBIT in the second quarter as compared to the prior year, driven by higher year-over-year volumes. Looking sequentially, we expect EBIT will moderate somewhat from the first quarter as raw material costs increased in the specialty carbons and compounds product lines, and we expect higher costs associated with the drawdown of inventory levels in the quarter. Moving to Purification Solutions. EBIT in the first quarter of 2021 was flat compared to the first quarter of fiscal 2020. The reduction in fixed costs resulting from the sale of our mine in Marshall, Texas and the related long-term supply agreement was offset by reduced demand in mercury removal applications and higher costs associated with the reduction of inventory levels related to the transition to the long-term supply agreement. Looking ahead to the second quarter, we expect to see a sequential EBIT increase from improved pricing and product mix for specialty applications and lower fixed costs. I will now turn to corporate items. We ended the quarter with a cash balance of 147 million, and our liquidity position remains strong at approximately 1.5 billion. During the first quarter of fiscal 2021, cash flows from operating activities were 21 million, which included a working capital increase of 99 million. The working capital increase was largely driven by growth-related net working capital, as accounts receivables increased with higher sales and inventory increased from purchases of higher-cost raw materials. The change in net working capital also included the final payment of $33 million related to the prior year respirator settlement. Capital expenditures for the first quarter of fiscal 2021 were 29 million. For the full year, we expect capital expenditures to be between $175 million and $200 million. This estimate includes continued EPA-related compliance spend and capital related to upgrading our new China carbon black plant to produce specialty products. Additional uses of cash during the quarter included $20 million for dividends. Our operating tax rate was 30% for the first quarter of fiscal 2021, and we continue to anticipate the fiscal year rate will be between 28% and 30%. I will now turn the call back over to Sean.

Thanks, Erica. We are very pleased with the record results in the first quarter of 2021, with volumes recovering from the COVID-related lows we experienced in fiscal 2020 and the great execution across the organization. We achieved record-setting results in reinforcement materials and much improved performance in the Performance Chemicals segment. This is a great start to our fiscal year. As I look to the second quarter, there are some tailwinds that benefited our results in the first quarter that we don’t expect to repeat. Based on the underlying business performance, we expect adjusted earnings per share in the second quarter to be in the range of $0.90 to one dollar. While I expect our second quarter adjusted EPS to moderate from the first quarter, I believe this level of expected earnings in the second quarter reflects how well our businesses are performing in the current environment. January volumes were strong, and we anticipate the underlying demand in our key end markets will remain robust during the quarter driving year-over-year EBIT growth across all segments. On the cash side, we anticipate our cash and liquidity will remain robust. Net working capital increases should moderate from what we saw in the first quarter with more consistent volume levels going forward. As the fiscal year unfolds, we expect the environment will remain uncertain, and there are several factors that we will be managing closely. The first is the level and timing of COVID-19 vaccine distribution across the world and its impact on the economic recovery. Infection rates remain very high in many parts of the world, and the stability of economic growth will depend on favorable trends in reducing the level of infection. Next is global logistics, where we have begun to see some negative impact in terms of availability and cost of transportation in our supply chain. This influence is being felt across global value chains and may take some time to fully stabilize. And finally, the movement of pricing and input costs, particularly in the spot markets in Asia. We have demonstrated our ability to execute well over the past year no matter what the challenge, and I have confidence that this will continue in the year to come. In closing, I want to thank and recognize our global Cabot team. Our Company’s true character has been showcased during these times of adversity. I’m proud of how the team has responded with great resilience and a focus on our customers, our communities, and one another. Our exceptional first quarter results are a true testament to our Company’s capabilities and that position us well for a successful 2021. Thank you very much for joining us today. And I will now turn the call back over for a question-and-answer session.

Thank you. Our first question comes from Mike Leithead with Barclays. Your line is open.

Great, thanks. Good morning guys. I guess first question, the outlook commentary and sequential guidance was very helpful. Just curious, as we think about beyond the second quarter here, would you anticipate further cost inflation that needs to kind of be worked through and absorbed or is your fiscal 2Q kind of a normalized level of margin and customer buying and inventory levels that we can kind of model going forward?

Yes. So Mike, I think we feel good about the Q2 guidance that we have given. I think visibility, right now, remains challenging because of the factors that I highlighted that we will be watching carefully and managing through the balance of the year. But I think the Q2 level underscores how well our businesses are performing in the current environment and gives you a view of some of the things that we don’t expect to repeat from Q1. Again, we will be managing these factors in the balance of the year carefully because there are certainly some challenges out there. I talked about one of the factors being transportation. I think globally, supply chains are tight, in particular, ocean freight, and just getting bookings and the impact of that tightness is something that I think every industry is experiencing right now. So we will have to manage those things. And if we experience impacts from that, we will have to work on getting recovery of those things. But I think those are the key factors that we will be watching as we go through the balance of the year.

Got it. That is helpful. And then just maybe two related questions on Asia and China, in particular. First, your Asia reinforcement volumes, I think, were down 8% in the quarter. What I would have assumed China demand is strong, so why was that? And second, with some of the recent kind of Chinese lockdowns and everything going on there, how would you characterize the buying activity for your products in the region heading into Chinese Lunar New Year maybe this year versus a typical year?

Yes. So I mean, China, in terms of the economy is performing very well. Obviously, the only major economy to avoid recession in 2020. If you look at the Q4 GDP in China, I think it was up 6% or 6.5% year-over-year. If you look at some of the other indicators that we find have a good relationship to our business, things like PMI or composite leading indicators, these types of metrics. Those were quite robust in China, and we are seeing our business respond in a similar way. I think specifically to your question in the quarter around volumes in China, our focus and emphasis have been on price and margin over volume in the near term here. We executed on that in the quarter, and that is why you saw a bit weaker volume there because of our emphasis on price and margin. However, the economy in China remains pretty strong. The uncertainty around lockdowns and COVID impacts, of course, is a global uncertainty, and we will have to watch and manage that as we go through the year.

Great. Thank you.

Thank you. Our next question comes from Josh Spector with UBS. Your line is open.

Yes, hi thanks for taking my question. And congrats on a solid first quarter here. To follow-up on Mike’s first question. You gave some explicit items that you bridge sequentially in reinforcement, the feedstock cost tailwind fades and higher fixed costs. Are you able to bucket those and give us more of an absolute number of what that actual impact is sequentially?

Yes good morning, Josh. Let me try to help a little bit here on the Q1 to Q2. I will try to walk through the two different major businesses: Reinforcement and Performance Chemicals. In Reinforcement first. Q1 was a record EBIT in the quarter, driven by strong demand, pricing, and product mix in Asia and from our calendar year 2020 agreement. You will recall that the December quarter was the last quarter of those agreements from last year. The quarter also benefited from the timing of price increases in advance of the flow-through of rising feedstock costs as well as we had been keeping a very intense management of costs here as the outlook in terms of demand has been uncertain. Together, these two factors amounted to about $20 million of EBIT that we would not expect to repeat in Q2. In Performance Chemicals, we are pleased to see the segment recover strongly in Q1, largely due to our work to grow our targeted market segments, along with continued pricing actions, controlling costs, and executing on our growth initiatives. In Q2, we expect sequential EBITDA in Performance Chemicals to moderate a bit from Q1 as higher raw material costs in specialty carbons and compounds flow through. We also expect an increase in costs from a planned drawdown of inventory. We estimate the combined impact of that to be roughly $10 million in that segment. That being said, January volumes were strong in both businesses. We anticipate solid volumes for the quarter. These would be the major movers to bridge you from Q1 to Q2.

Thanks. That is really helpful. I appreciate that. Just on the Performance side, and specifically looking at fumed silicas, Erica mentioned still pricing pressure down year-over-year. But can you comment sequentially on how that business improved or maybe didn’t improve and what your expectations here for that business over the next couple of quarters?

Yes, sure. So that is right. On a year-over-year basis, you are still seeing that challenge. But on a sequential basis, we are seeing some improvement here. In terms of volumes, we are seeing recoveries, as demand in end markets like auto and construction are improving. We have implemented actions to restore pricing, and I think I commented on this in the past that this is a focus area for us. These actions are starting to take hold, particularly in China, which we are pleased with. We still have more work to do there, but pleased with what we are seeing so far taking hold. The fundamentals of the business remain very attractive, and the FMO business has historically been a business with very strong profitability and EBITDA margins at the higher end of our portfolio. Overall, we remain positive on this business and will continue to work through the near-term challenges, but some pricing actions are beginning to take hold, particularly in China, which is good.

Okay. Great. Thank you.

Thank you. Our next question comes from David Begleiter with Deutsche Bank. Your line is open.

Thank you good morning and a very nice quarter, so congrats. Just on this year’s contract tire negotiations, can you just comment on anything unusual in these negotiations? I guess you got a little bit of pricing year-over-year. Any color you can provide on those negotiations?

Yes. So David, we are pleased with the outcome of the annual negotiations with our tire customers. Overall, despite challenges of negotiating during an acute market weakness and with forward-looking uncertainty as a result of COVID, we ended in a position where we broadly maintained pricing and share as compared to 2020. I think on balance, this is an outcome that we are pleased with this year, again, given the challenges in volume during 2020.

Very good. And just on Performance Chemicals, obviously very strong Q1, albeit Q2 as well. Can we get back to prior period earnings of upwards of $200 million in this business in the segment going forward, do you think?

Yes. If you look back to the 2017, 2018 period, this business was around the $200 million EBIT level annually. We are pleased to see our hard work and efforts beginning to pay off here, a lot of focus on target market segments, managing pricing, and controlling costs. For the business to get back to that sustained level, we will need to see continuing strength in demand. For example, in automotive, which is an important end market here, we are still below peak levels of auto builds. We will need to see continued recovery of the auto sector there as one factor and continued progress on my commentary on FMO as we see stabilization of supply and demand economics in FMO flow through and better pricing. Overall volume recovery related to COVID, automotive continuing to improve, which drives important high-value mix, and continued progress in FMO. When all of those take hold, I believe the business will be back at that level, around $50 million a quarter, or about $200 million annually.

Thank you.

Thank you. Our next question comes from Laurence Alexander with Jefferies. Your line is open.

Good morning. Can you give a feel for mix effects for the balance of the year and how you think they will play out over the next couple of years? I’m just thinking about - are you seeing a faster recovery in lower-margin or higher-margin products? Is there an offsetting catch-up effect? Secondly, can you characterize where we are in terms of the growth of the tire replacement market in China? How much of your business there is currently into the replacement market?

Yes. The last couple of years, we have had a negative mix impact because auto has been weak, but recovering there is certainly improving the mix, though we are still short of prior levels in terms of auto build. Additionally, we are very focused on what we call our targeted market growth initiatives here in the Company. We are going after key markets where we think we have got a differentiated position that offers strong margins. So my sense over the next couple of years is that mix should strengthen as auto continues to improve and our target market efforts pay off. Regarding the tire replacement market in China, it consists mostly of passenger cars and trucks, with both of them having a significant replacement component of around 75% to 80% being replacement driven. In the truck segment, the replacement cycle is mature, but in the passenger car side of things, that replacement cycle is still building. The car park has grown significantly; however, not all of that car park has hit the replacement cycle yet. Thus, we think there is still a further room to go in the passenger car side of things before it reaches a mature run rate of replacement. As for our business, we focus on where the target places for us to participate.

Great. To just follow up on the mix question, the last time that we had such a strong truck cycle, I think carbon black operating leverage to that cycle was a much bigger part of the story. Has something changed in terms of the content per vehicle or how the business is balanced or the kind of mix of product on the automotive side that serves to temper the operating leverage this time or the relative dynamics between the two markets?

No, I don’t think so. A couple of years ago, there was a boost to the truck tire market in China because of regulations on overloading trucks. This obviously forced more trucks into the fleet to transport the same amount of goods. Despite the movement of goods and continued strength in infrastructure, I believe that outlook remains pretty stable.

Thank you. Our next question comes from Chris Kapsch with Luke Capital Markets. Your line is open.

Good morning. Sort of a follow-up to that prior discussion just now, but a bit more on a global look versus China specifically. Can you characterize or distinguish what your RM volumes look like in truck tires versus passenger car tires versus OTR during the quarter? To the extent you have granularity there in terms of the growth by each of those segments?

Yes, Chris, we don’t break that out in terms of reporting, so I think the specifics around that are unavailable.

Okay. The comment about the quarter may have benefited from inventory replenishment demand. What threshold have you reached, given that you are shipping Carbon black into your major customers via rail car? There must be limited space for them to increase inventory. Can you provide any sort of color as to how much you think that dynamic may have contributed during the quarter?

Yes. We probably saw some level of inventory replenishment in Q1, though visibility here is challenging due to the lack of published data. While we have good visibility on our silos and what we sell to our customers, the restocking dynamics often present uncertainties downstream. That being said, companies were cautious about rebuilding stocks until demand stabilizes. Overall, while some inventory replenishment was present, it was not material to the story in Q1.

Okay. That is helpful. Lastly, I think the Department of Commerce implemented tariffs on imported tires from some Southeast Asian countries, Thailand, Korea, and a couple of others. Do you have any sense for how that may affect potential higher production in the U.S. and your volumes domestically, or is it just a zero-sum game where an absence of benefit here may be offset by a benefit over there? Any insight into how that dynamic may play out?

Yes, the preliminary determination against some countries in Southeast Asia is similar to previous actions against China. In terms of our impact, given our manufacturing locations, tariffs on tires in one geography may shift demand from one region to another, causing a minor impact on regional earnings but not significantly impacting our overall earnings due to our global footprint. My view on tariffs is that they likely lead to higher consumer prices without fundamentally altering supply chains for tires.

Got it. Lastly, I noticed that while you mentioned strength in China, your RM segment volumes were up in Europe and Americas but down in Asia. How do you reconcile that? You focused more on higher-margin products and not chasing volume in China, but the delta in volume variances seems significant.

Yes. To summarize, we are focusing on price and margin over volume in China in the near term, which impacted the weaker volume. That said, we completed a scheduled turnaround that took some production capacity offline. Now that maintenance work is done, we are poised to support higher volumes moving forward.

Thank you. I’m currently showing no further questions at this time. I would like to turn the call back over to Sean Keohane for closing remarks.

Great. Thank you very much for joining our Q1 call today and for your continued support of Cabot. We look forward to speaking with you again next quarter. Have a good day. Stay safe. Thanks.

Ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect.