Earnings Call Transcript - OLN Q3 2022

Operator, Operator

Good morning, and welcome to Olin Corporation's Third Quarter 2022 Earnings Conference Call. Please note, this event is being recorded. I would now like to turn the conference over to Steve Keenan, Olin's Director of Investor Relations. Please go ahead, Steve.

Steve Keenan, Director of Investor Relations

Thank you, Jay. Good morning, everyone, and thank you for joining us today. Before we begin, let me remind you that this discussion, along with the associated slides and the question-and-answer session that follows, will include statements regarding estimates or expectations of future performance. Please note that these are forward-looking statements and that actual results could differ materially from those projected. Some of the factors that could cause actual results to differ from our projections are described without limitations in the Risk Factors section of our most recent Form 10-K and in yesterday's third quarter earnings press release. A copy of today's transcript and slides will be available on our website in the Investors section under past events. Our earnings press release and other financial data and information are available under press releases. With me this morning are Scott Sutton, Olin's CEO; and Todd Slater, Olin's CFO. Scott will make some brief remarks, after which we will be happy to take your questions. I'll now turn the call over to Scott Sutton.

Scott Sutton, CEO

Thanks, Steve, and good morning to everyone. The Olin team is all about delivering on opportunities. We have two major opportunities before us. I'll start with opportunity number one. We are experiencing recessionary conditions, and the opportunity is to show Olin will perform remarkably different than history may indicate. Over the next 4 quarters, we forecast delivering more than $1.1 billion of levered free cash flow. This is remarkably different. Don't worry that we had to pull back from the EDC market, while prices crated, creating a major PBC value morass, and don't worry that we had to optimize our epoxy participation to support our advanced partners while Asia liquidity temporarily lowered others. These necessary activities are respectful of our core theme to focus on value, set our market participation based on the weak side of the ECU, and by liquidity where necessary to lift the value of the ECU, which we did in the third quarter. Similarly, Winchester did not participate in large replenishments to the channel load but instead lifted the outlook of the storied brand by preserving value. The whole Olin team is poised to march our way through all these challenges and come out recession tested on the other side. We are the leader, and we demonstrate it every day. Opportunity number two is to multiply the value of our recession levered free cash flow. We have reduced our share count by 14% over the last 12 months and by 10% over the last 6 months. We continue to deploy our levered free cash flow towards share repurchases and have a runway of $1.9 billion left on our share repurchase authorization. A possible outcome is that our share count is reduced to $100 million in a couple of years. Our post-recession normalized levered free cash flow is expected to be more than $1.5 billion by band. The possible outcome being $15-plus per share of levered free cash flow. We have an excellent high-value capital allocation plan before us, and we'll drive it every day. Supporting these two opportunities is an investment-grade balance sheet, which we are committing to maintain. And more importantly, the best team in the business - Olin employees united in a leadership value quest. I really can't thank them enough. So with that, we're happy to take your questions now.

Operator, Operator

The first question today comes from Kevin McCarthy with Vertical Research Partners.

Kevin McCarthy, Analyst

Scott, you put forth updated guidance for the fourth quarter, but also affirmed your EBITDA guidance range for a recession case scenario. As you see these markets develop and unfold here, what do you think are the biggest sources of variability either on the upside or the downside as we move through the cycle?

Scott Sutton, CEO

Well, you're right. Kevin, we have reaffirmed our recession case guidance, which we see happening over the next year, already entering it now. There's going to be lots of ups and downs across the product portfolio. As you know, we run a contrarian model where we let our market participation be based on a weak market or the weak side of the ECU. So you've seen EDC, for example, go from really high pricing to really low pricing, and those kinds of things are going to happen. But because we focus on the ECU, likely to be more balanced in totality. What there could be some alarm about, Kevin, is that we may have to take a couple of quarters down in order to support the shoulder quarters being able to deliver more than $1 billion of levered free cash flow across the whole year. I mean, no market segment really has good fundamentals right now. So there’s going to be some volatility.

Kevin McCarthy, Analyst

And then I know you're throttling back on volumes in an effort to support the market. That effort appears to be succeeding. But nevertheless, can you talk about what your operating rates were in the quarter in chlor alkali and epoxy and how you see that utilization progressing here in October?

Scott Sutton, CEO

Yes. Well, maybe instead of all of those operation rates, I'll at least share with you what we're doing in epoxy. If you were to think about the equivalent operating rates, all of our resin production facilities, we're running below 50% there in order to preserve value. And remember, our recession case said that we could move the whole company down to that level. And so I would just say we have plenty of room left across the rest of the company to make our recession prediction come true.

Operator, Operator

The next question comes from Hassan Ahmed with Alembic Global.

Hassan Ahmed, Analyst

I just wanted to revisit the Q4 guidance, particularly in light of recessionary conditions and the like. I mean look, I understand Q4 tends to be seasonally weak. You guys have consistently talked about certain sort of markets, be it EDC, be it epoxy conditions over there being even below trough conditions. But if I were to annualize the lower end of your Q4 guidance, I still come up with, call it, $1.75 billion in EBITDA, which obviously is kind of the midpoint of the $1.5 billion to $2 billion of the guidance range for a trough that you guys have given. So with the conditions evolving the way they are, I just wanted to sort of get your take on how comfortable you guys continue to be with that trough EBITDA guidance range.

Scott Sutton, CEO

Yes. I mean, look, it's still our guidance range. And in fact, it's been our guidance range now for the last three quarters as we've really been preparing this window to show that Olin delivers a different level of free cash flow than we did before. I will say, of course, I understand you're annualizing in the fourth quarter, and you're right, I get exactly to that conclusion, even though the fourth quarter has traditionally weak factors on top of all the extraordinary factors that are going on in the world right now. I will just caution that we may experience one or two quarters that are lower than that in order to set the value equation right for the rest of the year, though. I mean we're not going to hesitate to take the proper actions in advance to make sure that value doesn't decline. We're not having to do that yet, but it could certainly happen as the recession plays out.

Hassan Ahmed, Analyst

So Scott, sort of following up on that, one of the pushbacks that I get is around sort of chlor alkali pricing, right? Obviously, pricing has been sort of firm to up both for caustic and chlorine. But one of the fears or investor concerns tends to be that, look, U.S. housing is weakening, PVC market is very weak. If we go into a recession, obviously, industrial production will affect cost take as well. So in that sort of an environment, how comfortable are you that pricing for chlorine and caustic at the very least will not go down?

Scott Sutton, CEO

Yes. And this setup is exactly what's happening now, right? I mean PVC has become very weak. And unfortunately, you see that PVC players chase the strong side of the ECU. In other words, they're chasing caustic volume, and they're willing to destroy their central value theme and the central long-term value theme of being in the PVC business, sell just a little bit of incremental EDC or even VCM into the marketplace. This is exactly opposite to our model. And of course, we take exactly the opposite tactic, right? We don't participate as much in the chlorine and derivative side under that case. So we don't participate as much in the vinyls side. And that tends to improve both sides of the ECU. And you see that materialize with both rising caustic prices and lifting chlorine prices. I think the summary point underlying all of that is that it's not the biggest concern that demand drops on both sides of the ECU because we exploit the difference between the relative conditions on each side of the ECU. So total demand can drop yet the difference between the quality of those markets can actually widen, which is where we do well.

Operator, Operator

Next question comes from Alexi Yefremov with KeyBanc Capital Markets.

Aleksey Yefremov, Analyst

Scott, I am sure you noticed that there have been significant increases in caustic nominations in Europe, reaching $950 per ton or more. However, we have also observed a decrease in power and natural gas prices in Europe. What is your outlook for the European caustic price in the fourth quarter? How might that impact Olin, in your opinion?

Scott Sutton, CEO

Well, I mean, the caustic pricing in Europe is likely to stay elevated. I think the factors on the other side of the equation are that there's a lot more material moving out of Asia and out of China trying to take advantage of that arbitrage gap. So we do see volumes moving that way. At the same time, costs have probably temporarily come back down. But the reality is that as Asia demand may recover over the course of the next year, I'm not saying that's beginning now. But when it does recover, those trade flows tend to have pressure to go the other way at the same time, I think we all know that we have a long winter to go through in Europe and the conditions that drove the elevated energy pricing probably still persist. So net-net, through all that, you're likely to see Europe stay fairly elevated.

Aleksey Yefremov, Analyst

And going back to the domestic caustic market, how has demand been in the last few months, how has the third quarter and October perhaps trending on a year-over-year basis relative to normalized demand?

Scott Sutton, CEO

Yes, all of our volumes are down compared to last year. The demand for caustic soda in relation to supply has been stable, but we are seeing some weakening factors in those markets, so it is unlikely to improve. However, it's important to note that what's truly significant is the relative quality of the markets on either side of the ECU. The differences between them are where we can create value.

Operator, Operator

The next question comes from Mike Sison with Wells Fargo.

Michael Sison, Analyst

I'm curious about the volume declines in cab and epoxy down with 1729. What do you think are the fundamental reasons for these volume declines? Additionally, if your volumes remain flat and your ECU PCI improved, should your EBITDA have increased year-over-year?

Scott Sutton, CEO

Yes. If you’re asking about the fundamental decline in the marketplace, it’s likely to be less than the decline in Olin volumes because Olin typically compensates for those shortfalls in demand from a production standpoint. We may not fully cover it from a sales perspective because we sometimes purchase liquidity from the marketplace to bridge that gap. Therefore, you will see our production decline more than the overall marketplace decline. Our sales volume will also decrease more than the marketplace decline, but the reductions in our sales volume are not as significant as those in our production volume.

Michael Sison, Analyst

Okay. When I look at the last recession, it seemed that caustic prices increased from 2008 to parts of 2009. It appears we might see a similar situation arise again. Could you provide some historical context about why prices went up last time and what you anticipate for potential increases over the next six to nine months?

Scott Sutton, CEO

Yes. Well, I mean, when demand declines dramatically on the chlorine and chlorine derivatives side relative to that sort of global industrial demand for caustic, there's just not enough caustic to satisfy that demand, even though that demand has declined a good bit. The PVC producers sort of run out of runway, trying to find a home for either the Vinyls intermediates or the PVC that supports that caustic production and it declines substantially. So yes, it’s not impossible that we end up back in that same situation.

Operator, Operator

The next question comes from Frank Mitsch with Fermium Research.

Frank Mitsch, Analyst

The buyback levels were quite impressive in the third quarter following a strong second quarter. You mentioned, Scott, that the company could potentially have a 30% lower share count in a few years. Considering that you've made it clear we are entering a recessionary environment, what can investors expect regarding Olin's buyback pace in the short to medium term?

Scott Sutton, CEO

Yes, Frank, we plan to allocate most of our levered free cash flow towards share repurchases. We've been doing this for most of the year, and it's what we are aiming for in the fourth quarter and into next year. Our balance sheet is strong, and we have a newly expanded liquidity arrangement while committing to maintain our investment grade status. We can maintain these metrics even during a recession, which leaves all options open for us. This certainly includes buying back as many shares as possible. Therefore, with an expected $1.1 billion of levered free cash flow, most of it will be directed towards share repurchases.

Frank Mitsch, Analyst

That's great to hear. Regarding the potential recessionary scenario for EBITDA, you mentioned that cash flow could involve $50 million in restructuring costs or actions. I'm interested to know if this is something you're planning for in the near future and what that might entail.

Todd Slater, CFO

Frank, this is Todd. That would include restructure. That $50 million includes restructuring costs as well as other costs such as some of the small investments that will be made in the joint ventures that we expect to start early next year. So that’s all encompassed in that kind of number.

Operator, Operator

The next question comes from Arun Viswanathan with RBC Capital Markets.

Arun Viswanathan, Analyst

When you think about the levels for 4Q EBITDA looking around $450 million at the midpoint. How much of that decline, say, 15% to 20% sequentially, would you attribute to seasonality? And I guess as you look into Q1 or '23, would you consider kind of Q4 as a bottom level of profitability and maybe some improvement from Q1 or into Q1? Or how should we think about the next couple of quarters?

Todd Slater, CFO

Todd here. Regarding the Winchester operations, it's common for our facilities to have holiday seasonal shutdowns. Typically, the fourth quarter is the weakest for Winchester. So when discussing seasonality, it's important to note that the decline in the fourth quarter for Winchester is primarily due to seasonal factors. In the Epoxy business, the strategy focuses on value over volume. However, in the fourth quarter, particularly in the Northern Hemisphere, construction activity decreases, which leads to a notable reduction in epoxy demand. Seasonality plays a significant role here as well. For the chlor-alkali sector, aside from some demand for bleach and seasonal items that are more prevalent in summer, chlor-alkali doesn't show significant seasonal trends; its variations are largely influenced by maintenance turnarounds.

Arun Viswanathan, Analyst

Okay. And if I could just ask a follow-up. It appears that caustic soda, as you noted, continues to be relatively tight mainly because of the supply side. Could you just elaborate on that? I mean, are you still seeing kind of strength in Europe, just given the weaker industrial activity? And when you consider that you're already operating your epoxy and other assets maybe at recessionary levels. Are you doing the same in chlor alkali at this point? Are you staying at that 50% operating rate? Or maybe you can just elaborate on the utilization in chlor-alkali.

Scott Sutton, CEO

Yes. Yes. I mean the first part of your question there, right? I mean demand is definitely down and declining in Europe is just that supply has declined more than demand. So that’s the situation in Europe. No. I mean we have a lot of room in our broad core alkali assets to continue to withdraw from certain points of the market if we need to do that. I mean, our expectation is that we do need to do that, right? With recessionary conditions only getting worse really from this unprecedented combination of events, right? You have the China long-term demand locked down. You’ve got Europe demand really crippled by the war. Now the U.S. has got to do what it’s got to do to smash inflation. We’re likely to have to turn down some assets at a point over certain points of the next 12 months.

Operator, Operator

The next question comes from Steve Borm with Bank of America.

Unidentified Analyst, Analyst

This is Alerian filling in for Steve. Firstly, I wanted to ask about Winchester. You previously mentioned that the channel was somewhat overstocked, and your volume participation in Q3 was limited. However, I see from your slides that you plan to implement a price increase for Q4. What is the rationale behind raising prices? Should we be preparing for potential competitive pricing pressures as the channel restocks? Additionally, could you provide an update on the situation with Russian supplies and the current impact of the supply-demand balance in North America?

Scott Sutton, CEO

Yes, sure. I would just go back to the first point you made, and maybe I would restate it differently, right? I mean the channel has become overstocked or overfilled. It's just that the channel was starved for a very long time. And the channel has returned to closer to normal inventory levels. It's still not there yet. And that happened principally in the third quarter, and we just didn't really participate as much as others in trying to get the channel stock back to a more normalized level. By the way, normalized demand in ammunition now is much higher than it was 2 years ago. So we'll have some selective price increases bear in Winchester on certain products. It's not necessarily across the board, but those have been communicated, and it's in undervalued items that have a high demand. So that logic still fits, and it's the same logic that's really applied to Winchester over the last couple of years where we've had broad price increases before. The fundamentals are still excellent in that business because consumer demand is much higher than it was 2 years ago, military and law enforcement demand is higher than it was a year ago. And then there's been changes in the import situation where Russia used to be the largest importer. That's still clearing out through the channel, but no more imports are happening of Russian ammunition.

Unidentified Analyst, Analyst

Okay, perfect. I also want to discuss green hydrogen. There was a joint venture with Plug Power at St. Gabriel. Can you confirm if the hydrogen you plan to produce and sell to Plug Power will not require additional investment? Additionally, could you share your vision for how this business fits into Olin's portfolio in the long term?

Scott Sutton, CEO

Yes, yes. And so this is our second arrangement with Plug Power. This joint venture in St. Gabriel will use hydrogen that's already being produced today and may be used in a less efficient way. So what that does is minimize the base investment to get the molecule. The joint venture still has to build and operate liquefaction facilities to be able to distribute the hydrogen to fuel sale uses. So there's still some investment. It's a pretty minor investment. Next steps are very interesting. All those two existing arrangements we have are maybe 4% or 5%, the hydrogen that we already produced today. So there’s an opportunity to replicate this or even modify it at many different sites.

Operator, Operator

The next question is from Joshua Spector with UBS.

Unidentified Analyst, Analyst

It's Chris Perrella standing in for Josh. I was interested in hearing about your strategies for hedging natural gas costs for the fourth quarter and into next year, and at what price level.

Todd Slater, CFO

Yes. Chris, this is Todd. We are actively hedging natural gas as it makes up about 70% of our fuel source for power. A quarter ahead, we are heavily hedged and typically maintain a rolling four-quarter program. So, we already have part of 2023 covered with active hedges.

Unidentified Analyst, Analyst

All right. And then to your earlier comments about flexing down the chlor alkali rate to protect value and cash flow on the shoulder seasons. Is the expectation for that to sort of hold the chlor-alkali rate, your operating rate steady into the first quarter, assuming EDC and epoxy stays where they are now?

Scott Sutton, CEO

Well, look, without getting too specific, Chris, I would just say that there's going to be shifts and changes in our production rate relative to the liquidity that we buy out of the marketplace. And we've already said that limited our participation in the vinyls chain. And it's certainly not impossible that we choose to limit that participation even further as we enter 2023.

Operator, Operator

The next question is from Matthew Blair with TPH.

Matthew Blair, Analyst

I had a question on the epoxy feedstocks. It looks like propylene and benzene are coming down quite a bit in Q4. Would that be a feedstock benefit to epoxy in Q4? Or do you have hedges and to really think about this as potentially flowing through into 2023?

Todd Slater, CFO

Matthew, this is Todd. As we consider the situation, particularly in North America, costs have decreased since the third quarter, which lowers our overall expenses. However, once we expand our view to the international market, you'll start to see the advantages of those reduced costs for Epoxy in the first quarter.

Operator, Operator

Next question is from Angel Castillo with Morgan Stanley.

Alyssa Steinberg, Analyst

This is Alyssa on for Angel. I guess you've mentioned that you're throttling back production to maintain value. But are you seeing your peers remain as disciplined here?

Scott Sutton, CEO

Yes, it's Scott here. I don't have much to say about the peers. I can say that Olin only engages in the market where there is reasonable value. This means we sometimes have to make significant adjustments to our operating rates to achieve that. I'll represent Olin in this regard.

Alyssa Steinberg, Analyst

Got it. And then we've talked about share repurchases, but I'm wondering what the overall appetite is for M&A and kind of the pipeline there.

Scott Sutton, CEO

Yes. I mean, it's not out of the question that some M&A is possible. What I will say is that certainly in the near term, most of that is low capital-type activities. And as we consider M&A candidates and targets, and potentially even have discussions, a lot of that turns into near-term joint ventures or alliance opportunities. So we've announced a couple of joint ventures. We announced at least one alliance. We've completed other multiple unannounced alliances. And so I expect those kinds of arrangements to continue to materialize over the next year. And it's unlikely that we move to complete any kind of large acquisition as right now, we've got a pretty shareholder-friendly policy of taking almost all of our levered free cash flow and directing it towards direct returns in the form of share repurchases and then maintaining our dividend.

Operator, Operator

The next question comes from John Roberts with Credit Suisse.

Unidentified Analyst, Analyst

It's Matt Scaroni on for John. On Slide 6, you indicate your ability to repurchase shares through an economic downturn. Given some speculation of a nearing recession and your potential cash flow generation during that time, and considering supply-demand projections and the time it takes to add capacity or debottleneck, is there a point where you would look to allocate capital towards growth instead of purchases?

Scott Sutton, CEO

Yes, Matt, you will not see Olin expand its base production capability. In fact, over the last two years, we have reduced more than 1 million tons of production capacity. Therefore, we do not have any need to direct capital toward base growth projects. However, as our levered free cash flow increases from the current level of $1.1 billion in a year, there will be opportunities to acquire existing assets, engage in joint ventures with current assets, and form additional alliances. This could require some of that capital, but all of this must compete with the value of repurchasing shares. In today's environment, none of these options can compete with the value of share repurchase.

Unidentified Analyst, Analyst

That's helpful. And then my follow-up is just on the epoxy market. Have you seen any change in behavior since the end of September, either in terms of buying dynamics or selling dynamics?

Scott Sutton, CEO

I would say the same core trend continues. Despite the demand shortfall in China, we are still expanding our assets there. We have observed that traditional trade flows have temporarily shifted, with much of that material now going to the U.S. or Europe instead of being imported into China. This situation has not changed. The positive aspect is that the rate of change has moderated somewhat, providing a degree of stability. Additionally, we have established relationships with a group of advanced customers who appreciate the Olin solution and recognize that our epoxy resin has a lower CO2 footprint compared to the material currently leaving China. So, there has been some moderation in that regard.

Operator, Operator

The next question comes from Kevin McCarthy with Vertical Research Partners.

Kevin McCarthy, Analyst

I just had a few follow-ups. Scott, we're hearing or reading more about low water levels on the Mississippi River. Are restrictions on barge movement having any meaningful impact on either Olin or the industry that we should be thinking about? Or is that really just immaterial?

Scott Sutton, CEO

Yes. Kevin, I mean it’s not immaterial. So there is some impact. It’s causing logistics change to have to be rearranged a bit. For Olin, perhaps it’s a little less impactful. I think the thing to worry about actually is this rail strike. I mean if that rail strike really occurred, I would just say that it’s equivalent to the mother of all hurricanes that we’ve ever experienced. That disruption on top of this nagging barge issue going up the river system, would be a real concern.

Kevin McCarthy, Analyst

Interesting. Secondly, Scott, I think a few quarters ago, you had publicly discussed potential or at least exploration of a PVC resin partnership. Are those efforts active or dormant or extent? How would you describe your discussions at this stage?

Scott Sutton, CEO

Yes. Well, I would just say that there are multiple active discussions around that. I would also say that for the moment with the contemporary decline in PVC attractiveness that something may not materialize for a little while there. Interestingly enough, through all that, there's more interested parties. It's just that we haven't found the right setup that delivers what we expect out of that, and we expect more than VCM or PVC. We expect an expansion of our ECU business through that.

Kevin McCarthy, Analyst

And then last one, if I may, for Todd. I think your press release indicated a tax benefit of $36 million and change related to the release of deferred tax liabilities. Can you just elaborate on what transpired there?

Todd Slater, CFO

Sure, Kevin. Thanks for the question. In the third quarter, we recognized just under $37 million in benefits related to a legal entity liquidation. This is a non-cash tax benefit from the liquidation of an acquisition entity we created over 10 years ago, which was no longer necessary. From a bookkeeping perspective, we were able to eliminate that liability and acknowledge the income.

Operator, Operator

The next question is from Eric Petrie with Citi.

Eric Petrie, Analyst

In your bottom-up bill that you provided $400 million from merchant chlorine pricing upgrade versus 2020, did that include or exclude the reset of chlorine in the TiO2 next year?

Scott Sutton, CEO

Yes, Eric, it includes all those items. The good news is that the total number is likely a bit lower than the actual result will be once we transition into 2023 from 2022.

Eric Petrie, Analyst

Okay. And then, Scott, I was wondering if you could comment on your participation currently in caustic soda exports? And how does that compare to the industry? Or are you seeing better opportunity parlaying volume?

Scott Sutton, CEO

Well, without giving any specific numbers, of course, we always participate in the export market. We've also been a purchaser of liquidity in the export world. If you think about our Blue Water Alliance joint venture that we've announced with Mitsui. The idea there is to become the largest manager of liquidity in the world. That means that we'll target being 1 day, the largest trader of chlor-alkali molecules in the world. So I would just say it's a heavy point of focus for us, and we use it effectively to run our model.

Operator, Operator

As there are no further questions, this concludes our question-and-answer session. I would like to turn the conference back over to Scott Sutton for closing comments.

Scott Sutton, CEO

Right. Well, I would just say, look, thanks to everyone for joining the call, and we'll wrap it up with that.

Operator, Operator

Thank you for attending today's presentation. You may now disconnect.