Kraton Corporation
Q2 2021 Earnings Call Transcript

Published: 31 Jul 2021

[Operator:]

Good morning, and welcome to the Kraton Corporation's Second Quarter 2021 Earnings Conference Call. My name is Kirby, and I'll be your conference facilitator. I will now turn the call over to Mr. Gene Shiels, Director of Investor Relations.

[Gene Shiels:]

Thank you, Kirby. Good morning, and welcome to the Kraton Corporation Second Quarter 2021 Earnings Call. With me on the call this morning are Kevin Fogarty, Kraton's President and Chief Executive Officer; and Atanas Atanasov, Kraton's Executive Vice President and Chief Financial Officer. A copy of the second quarter news release and the related presentation material that we'll review this morning is available in the Investor Relations section on our website. Before we review the second quarter results, I'd like to draw your attention to the disclaimers on forward-looking information and the use of non-GAAP measures, included in our presentation this morning as well as yesterday's earnings press release.

[Kevin Fogarty:]

Thank you, Gene, and good morning, everyone. The positive momentum in global demand that we experienced earlier this year continued throughout the second quarter, benefiting results for both our Polymer and Chemical segments. While we incurred substantial costs for the planned statutory turnaround at our Berre, France, and site and although we faced continued inflation in raw material costs, the impact of these factors was largely as we had anticipated. As a result, we are pleased with our financial results for the second quarter as they were in-line with our internal expectations. As reported in yesterday's earnings release, adjusted EBITDA for the second quarter of 2021 was $61.8 million. While this was down $7.7 million compared to the second quarter of last year, the decrease is attributable to three primary factors in our Polymer segment that we believe are transitory in nature and that masks the underlying positive momentum underway in the quarter, particularly in our Chemicals segment that we believe is setting the stage for positive full year 2020 results. Specifically, Polymer segment sales volume was up 10.9% compared to the second quarter of 2020, driven by broad-based demand growth across all regions for our Specialty Polymers business and higher sales into paving and roofing and adhesive applications within our Performance Products business.

[Atanas Atanasov:]

Thank you, Kevin, and good morning, everyone. I'll begin my comments on Slide five with a review of the second quarter 2021 financial highlights. In-light of the favorable market fundamentals and positive demand trends, Kevin referenced, and taking into account the impact of specific factors that played during the quarter, the bear turnaround inflationary pressures and tough comparisons against the second quarter of 2020, which benefited from lower raw material prices and the favorable fixed cost absorption associated with strategic inventory build. We're very pleased with our results for both the second quarter of 2021 and for the first half of the year. Moreover, we entered the third quarter well positioned to leverage positive market fundamentals. And therefore, we remain encouraged by our prospects for the second half of 2021 and the year as a whole. During the second quarter of 2021, the rebound in global demand from the second quarter 2020 levels, in which COVID-19 was a factor combined with targeted market development actions led to a strong growth in sales volume. Chemical sales volume was up over 32% compared to the second quarter of 2020, and Polymer sales volume was up almost 11%. The increase in sales volume and higher average selling prices associated with higher average raw material costs were the primary drivers of the revenue increase versus the year ago quarter. Consolidated revenue for the second quarter of 2021 was $493.6 million, up $137.9 million or 38.8% compared to the second quarter of 2020. Consolidated adjusted EBITDA for the second quarter was $61.8 million and while down $7.7 million compared to the second quarter of 2020. More than 100% of the decline is explained by costs associated with the turnaround at Berre, France. Excluding the $16.9 million of turnaround costs in the second quarter of 2021, adjusted EBITDA would have been up $9.2 million or 13.2%. As Kevin noted, the lower adjusted EBITDA compared to the second quarter of 2020 also reflects inflation in raw material and transportation costs and less favorable absorption of fixed costs, driven by turnaround activity, which results in a challenging comparison to the second quarter of last year, during which we'd benefited from declining raw material costs and in which our strategic inventory build gave rise to favorable absorption of fixed costs. Chemical segment adjusted EBITDA for the second quarter of 2021 was $35.5 million, up 126.2% versus the year ago quarter, reflecting higher sales volume in part associated with post COVID-19 recovery and expanded yield margins in all product groups, with these positive drivers, partially offset by higher raw material and logistics costs. Polymer segment adjusted EBITDA for the second quarter of 2021 was $26.3 million, down $27.5 million compared to the second quarter of 2020, with the decrease principally reflecting costs associated with the bear turnaround and the impact of higher raw material and transportation and logistics costs and the change in fixed cost absorption between the two periods.

[Operator:]

Our first question will come from the line of Chris Kapsch of Loop Capital Markets.

[ChrisKapsch:]

Good morning. You mentioned -- you touched upon this in some of your formal comments about the adhesives end market. But it seems like the demand for TOR feeding that end market is notably strong, especially considering that it seems the C5 tackifiers supply is still in surplus. So just wondering, is there's a shortage of Chinese gum rosin that may be contributing? Can you just talk about the dynamics there? What is driving the outsized volume growth for the Rosin Ester based tackifiers? Is it more market strength or is revolution starting to get beyond cannibalization and starting to take share?

[KevinFogarty:]

Yes. Thanks, Chris. Look, I don't think there's one answer. I think there's a multitude of parts that go into that answer. But certainly, your point about gum is true. That structural supply decrease or supply demand coming more in balance is favorable to us. But I'd also remind you that for Kraton, our focus continues to be innovation, driving sustainability through the comments I made earlier about the positioning revolution in front of OEM formulators such that they can appreciate the circular economy impacts of adopting revolution. So yes, we're definitely seeing examples, where customers have opted to switch from hydrocarbon to use revolution and we think there's more to come. And that's exactly how we position it in the marketplace.

[ChrisKapsch:]

And then, my follow-up question is more on the balance sheet. And it's just extrapolating a little bit here, based on your implied second half guidance. If you think about next year and with some excess free cash flow, your leverage could be approaching mid-2s or with some growth maybe in EBITDA, maybe even low 2. So suddenly, you may have excess capital. I'm just wondering what your thoughts are in terms of deploying that excess capital? Are you inclined to implement a dividend or buybacks on the table? What are some of the Board's thinking on that? Thank you.

[AtanasAtanasov:]

Yes. This is Atanas. I think as we -- as we go into next year and face the reality of continuous improvement in our balance sheet and cash flow situation, first of all, we've said that once we reduce debt to below three times, one of the areas of focus that we will look at, and we'll continue to look at is obviously organic growth. And we have a number of projects. And those, as you can appreciate come in at highly accretive low multiples. So that would be a priority for us. Obviously, we continue to invest in our innovation. And with respect to share repurchase, that's something that we'll take to our Board and would be a consideration.

[Operator:]

Our next question would come from the line of John Roberts of UBS.

[JohnRoberts:]

Thanks and congratulations on the EcoVadis Platinum. Is there anything you can tell us about the strategic review that's been reported in press?

[KevinFogarty:]

Well, I appreciate you're asking the question. But at Kraton, we're not in a position to comment on any type of market speculation or rumors. Our focus continues to be on running the business. And we're pretty proud of the results we've achieved so far and optimistic as I just described in our comments about where our business is headed.

[JohnRoberts:]

The comparisons with 2020 obviously are affected by the pandemic. If we compared that second quarter 2019 in pre-pandemic, chemical tons are up 18% and polymers are up 5% in tons I think. Could you give us some granularity on where some of the product lines are on a volume basis versus pre-pandemic levels?

[KevinFogarty:]

Well, I think that you're comparing -- I think you said second quarter of 2019. So perhaps less COVID impact as I look. If I think back on 2019 though, I mean, I can still think about, particularly in our Polymer business, we had a certainly a China impact that was very much mindful for all of us in terms of what was happening with geopolitical challenges. It was also probably not the best paving season that we had in the last few years. So we probably benefit now as you kind of compare that quarter versus this quarter. But overall, I mean, look, this continues to be evidence in our view that the innovations that we are bringing to market are paying off in terms of market positioning. The reliability of our service offering to our customers is something that we don't take lightly and we take very seriously. And we always want to be in a position to be the supplier of choice to our customers. And then, as I think about our Chemical business specifically, I think that the TOFA sales diversification that we've spoken to quite often continues to be a benefit for our portfolio of sales mix. And of course, most recently, we can now add the biodiesel aspect into that sales mix. So I think all these things are as a direct result of what we work on at Kraton in order to position our business to succeed in good times as the backdrop of today's marketplace would indicate, but also to make sure that when there are some challenging headwinds, we do well as we can. And that's kind of how you think about how we came out of this 2020 pandemic year, positioning for our business' future.

[JohnRoberts:]

And I'm thinking oilfield is probably still below second quarter 2019. I didn't know, would any other areas be below second quarter 2019 or everything would be up versus that other than oilfield?

[KevinFogarty:]

I don't know if I can answer this question specifically, because I'd have to go through each of the above segments. But again, I call you to that Slide 10 right now. And I can't remember a time when we've had the market dynamic that we've gotten all green on that stop light chart across each of our key market segments.

[Operator:]

There is another follow-up question from John Roberts of UBS.

[JohnRoberts:]

I guess the mic is still mine. Can you tell us where delta Airline is on utilizing the existing emergency youth authorization for BiaXam? And do you expect any additional state level authorizations or the next thing will be the federal action?

[KevinFogarty:]

Yes. I can tell you that delta continues to position BiaXam and used it in the facilities as expected. So no change there. But as we've said all along, while we're very proud of the Section-18 with the three states involved of Georgia, Minnesota and Utah, we think this is just in many ways a validation of the technology that we have to ensure that we can absolutely take back some into the marketplace with a full potential. And that only comes from a Section-3 full approval from the Environmental Protection Agency. And the good news is we continue to work toward that objective as I said in my comments. And I don't think anything has changed in our view in terms of the market potential of this attractive antimicrobial. And I have said in the past that I think that the markets that -- and there are several markets, including public transportation, delink and construction and healthcare. But I think healthcare continues to present to us probably the strongest opportunity, because of the challenges that that the industry faces overall. And then, secondly, air filtration, where there really is no offering today in terms of antimicrobial protection of the filtered air. There's antimicrobial protection of the filter itself, but not of the filtered air. And those are the kind of target markets we'll be spending a lot of our time working on in the future.

[JohnRoberts:]

And then, secondly, it sounded like there were some timing issues in isoprene. What's going on there?

[KevinFogarty:]

Well, I think there were some supply disruption issues with respect to isoprene that probably shouldn't surprise anybody given the way this year started in terms of the coal snap in the Gulf region. And it's been worked through time. But I'll also say that Asia demand has been really strong, and that's where most of the isoprene in the world is consumed. So those two things. And what it means for Kraton obviously is making sure that through our strategic raw material supply arrangements, we're in a position even when those challenges and headwinds come up to kind of pull levers from other supply sources where we have relationships in order to continue to be able to produce the key polymers that our customers are looking for and they are in high demand these days. So that's probably what it reflects as much as anything. But we've been through this before I'll just say it. As I said in my prepared comments, in terms of the challenges that tight raw material markets present. And believe it or not, if you're sitting in our shoes, it's not all a challenge; it's a lot of hard work. But it's also a lot of opportunity. And we view it as opportunity to really differentiate ourselves in the marketplace through our supply chain optimization efforts as well as the relationships we have with our strategic raw material suppliers.

[Operator:]

Our next question would come from Chris Kapsch of Loop Capital markets.

[ChrisKapsch:]

So the follow-up question on the Chemicals business and notwithstanding an updraft in the cost of CTO feedstock. You're in an advantaged position there with availability. And in this quarter, it seems you derivatized; you ran more of that volume through your refining system versus say reselling the excess CTO you have. So I'm just wondering if -- what was the governor of that decision that is more closer demand or more. And then, with that I assume come some unit cost benefit. I'm just wondering about the sustainability of that benefit as you look forward over the balance of the year and into next year?

[KevinFogarty:]

Sure, Chris. So I mean we're always typically in a position where we're buying more CTO than we consume. That's a good practice for us, good position for us always to be in. As we sourced additional CTO last year, we then went to work on obviously finding new market outlets for the derivative products, because it's in our interest to maximize the amount of material that we push through our refineries. And I think that's bearing fruit this year. And that's kind of what you're seeing in terms of more derivative sales versus CTO direct sales.

[ChrisKapsch:]

And I don't know any comment Atanas on the sustainability of the unit cost benefit from that?

[AtanasAtanasov:]

Yes. I mean, we're very much of the belief that those margins are sustainable. And what you're seeing this quarter is and really year-to-date is becoming more and more representative of what our view is on a go-forward basis.

[ChrisKapsch:]

And then, I just had a question about the raw materials more on the polymer side. Butadiene obviously has sort of doubled recently and there's disruption with some crackers down in the Gulf Coast and so forth. But you don't seem to have -- you have not seemed to have any issues with availability at least regarding feeding your Berre Ohio plant. So I'm just wondering what the strategy has been there? What -- is that -- and has that translated into an advantage for you guys? Thanks.

[KevinFogarty:]

Look, I'll go back to the same comments. The question before you was about -- with respect to security of supply. We've learned over time that security supply is also a function of diversity of supply. And I think we've always not pursued the short-term solutions. We've always looked at things much more long-term in terms of our supply arrangements, so that we can find ourselves in a position when there is a market disruption, as you point out there is today. We're in a much better position to continue to source raw materials. That's not to say that, that's not without effort and not posing some supply chain challenges for our team. I don't want anybody in Kraton to think that I don't see that because I do. They're working tirelessly to ensure our supply chains remain as undisrupted as possible. But nevertheless, I think it reflects some very good planning on our part. And the Gulf Coast is an interesting one. And clearly, most of the betadine comes out of the Gulf Coast, but there are other betadine sources in North America, and that's where Kraton has always tried to leverage that diversification.

[Operator:]

And at this time, I don't see any further questions on queue.

[Gene Shiels:]

All right, Kirby. Well, thank you very much. We appreciate the interest of all of our listeners and participants this morning. And I just wanted to briefly remind you there's a replay of the call that will start later on this morning and will be available through the middle of August. And to access that replay, you can dial 800-391-9846. And that concludes our prepared remarks. Thank you very much.

[Operator:]

Thank you. This concludes the Kraton Corporation's second quarter 2021 earnings conference call. You may now disconnect.