Elementis plc (ELM) Earnings Call Transcript

Ladies and gentlemen, welcome to the Elementis 2022 Interim Results Presentation. My name is Nadia, and I'll be coordinating the call today. [Operator Instructions] I will now hand over to your host, Paul Waterman, CEO of Elementis to begin. Paul, please go ahead.

Good morning, and welcome to the Elementis 2022 Interim Results Call. Thank you for taking the time to join us today. In terms of the agenda, I'll start with highlights and business segment performance. Ralph will review the group financials, and then I'll take you through the outlook and priorities. Following this, we will take your questions. On Slide 5, the key messages for this morning are straightforward. Overall, our financial performance was much improved, driven by strong performance in Coatings & Personal Care. As we expected, performance was weak in Talc, with underlying strategic progress more than offset by challenging market conditions. Cost inflation is a big challenge, but we have responded quickly with successful pricing actions that reflect the quality of our business. Our performance improvement has driven a reduction in leverage from 3.0 to 2.4x net debt to EBITDA, and we're focused on making further progress in the second half. Looking forward, while we are mindful of developing macroeconomic environment, we see our full year performance coming in towards the top end of market expectations. And finally, you should anticipate an update on our Chromium strategic review around year-end. I'll start with safety on Slide 6. At Elementis, we're absolutely focused on putting the health and safety of our employees first. In the first half, there were 4 recordable injuries, 2 lost time accidents and no reportable spills. This was an improvement versus prior year, but not the 0 injuries goal that we are targeting. That said, we reached some notable milestones in the first half. 83% of our sites work safely with no recordable injuries. And our new plant in India reached over 1 million worker hours of injury-free construction a great achievement. To drive further improvement, we'll continue to invest in training our people and maintaining our assets. Recent initiatives included our second Global Safety Week campaign, involving all Elementis staff focused on promoting safety awareness to strengthen our safety culture and support our path to 0 injuries. Turning to our headline financial performance. In the first half, we saw a strong performance despite a challenging backdrop. Sales rose 6% to $478 million driven by new business success, improved mix and pricing actions. Operating profit increased 21% to $66 million with underlying revenue growth more than offsetting cost inflation, driving a margin improvement from 12.0% to 13.7%. Earnings per share rose 29% to $0.071 per share and leverage reduced from 3.0x to 2.4x, driven by higher earnings and a $22 million reduction in net debt. Turning to the supply side on Slide 8. There are 3 key challenges in the first half. First, raw material and energy supplies continue to be interrupted and often more expensive, resulting in significant cost increases. In response, we found alternative suppliers rapidly qualifying more than 10 in the first half. We've also implemented hedging strategies and where necessary, implemented price increases. Second, due to port congestion and limited container availability, and of course, higher fuel costs, freight rates continue to increase and moving raw materials and products has been more complex than usual. We responded by using air and overland transportation where possible. Booking shipping far in advance and implementing surcharges. And third, tight labor markets and continued lockdowns in China have challenged our global supply chain, productivity investments to automate our plants the use of temporary labor and the flexible use of our production assets have optimized our operational performance. Overall, our global supply chain responded well and I'm pleased with the reliability of supply we have been able to provide customers. Nonetheless, these challenges are not going away, and we will need to stay focused on overcoming them. Turning to Slide 9. We have continued to implement our innovation, growth and efficiency strategy. On innovation, we launched 10 new products in areas such as industrial coatings and skin care. New products accounted for 14% of sales in the first half compared to 13% in the prior year. We're on track to reach our target of 17% by 2025. Our technical service team has also been key to ensure continuity of supply to our customers, rapidly qualifying alternative raw materials and supporting multiple production process changes. In addition, we've continued our open innovation efforts, launching several products with our partner, NXTLEVVEL. In terms of growth, we closed $36 million of new business driven by wins across Coatings, Talc and Personal Care and putting us well on track for over $50 million of new business this year. Overall, our Coatings business delivered record operating margins of 21% that supported 37% earnings growth. This performance was driven by innovation-led market share gains in decorative coatings, where our customers have particularly valued our product performance. We grew 32% in this space. Personal Care revenue was up 23% with strong growth across all major categories and geographies, along with encouraging momentum in our strategic focus areas of Asia and skin care. On efficiency, we continue to make progress. The ramp-up of our new AP Actives plant in India remains on schedule. This, combined with further progress from our continuous improvement team, I mean we are on track for $10 million of cost savings by 2023. And finally, while we've built some short-term inventory to ensure security of supply and to support our growth, we're making good progress on our ambition for $10 million of working capital savings by 2023. Now let's look at the performance of our businesses by segment. Starting with Personal Care on Slide 11. Revenue rose 23%, driven by strong growth in cosmetics and AP Actives. As consumer activity normalized, and we executed well on our strategic priorities. Adjusted operating profit rose 42% to $26 million, with higher volumes and improved product mix, driving margins to just under 25%. Looking at Personal Care market demand in more detail on Slide 12. COVID-19 had a significant impact on our business as people work from home traveled less and more limited social interactions. In the first half of 2022, I'm pleased to report activity continues to normalize. In Europe, one of our key regions accounting for approximately 40% of revenue retail sales of cosmetics and antiperspirant deodorants are pretty much back to pre-COVID levels. However, as you can see from the graph, when pricing is excluded, market volumes are still slightly below 2019 levels. So there's some recovery left. Turning to Slide 13. We've continued to make strategic progress. In skin care, our goal is to deliver $10 million of incremental sales over the medium term. In the first half, revenue grew 23%, driven by recent new product launches. Our new business pipeline is very healthy at $15 million. In India, the ramp-up of our new AP Actives plant is progressing as planned with full production expected towards the end of Q3. Once complete, this will create the most advantaged and resilient AP Actives supply chain in the world, while also offering better access to faster-growing Asian markets. And on innovation, recent new product launches supporting critical performance attributes are gaining traction. In Asia, we grew revenue 18% in the first half, a good result considering that China was in lockdown for an extended period. To continue to drive growth, we've invested in our capabilities. New Hectorite gels that comply with JSQI regulations in Japan open a significant market for our business. And we've made further investment in our sales teams with several hires in India. Our technical sales and marketing head count of 15 in the region is nearly 3x the level of 2020 and will continue to further increase over time. To expand a little on skin care, as many of you know, the traditional focus of our Personal Care business has been oil-based color cosmetics, such as lipstick, mascara, and foundations. Hectorite clay, our key raw material is also well suited for using water-based applications, such as skin care. To grow our presence in skin care, we've launched 8 new products since 2019 across 2 ranges. BENTONE HYDROCLAY and BENTONE LUXE. These clay-based products are the highest quality and purity. Their uniqueness lies in their ability not only to thicken water but in the texture, they impart during and after application. Being cold processable, they significantly reduce our customers' energy costs and they offer high levels of formulation flexibility. And finally, they are natural or naturally derived, which is a very important advantage. These market-leading attributes mean that since 2019 and despite customer innovation slowing during the pandemic, we've rapidly grown our skin care presence and are making very good progress against our medium-term target of $10 million of incremental sales. Turning to Coatings on Slide 15. Sales increased 9% on a constant currency basis to $209 million, with volume weakness in China offset by $17 million of new business wins successful pricing actions and an improved product mix. Coatings adjusted operating profit rose 37% to $44 million, with margins reaching a record level of 21% and as revenue growth more than offset input cost inflation. On Slide 16, some additional detail on our performance. By region, the performance was strongest in North America, which rose 47% and linked to notable new business success for our premium decorative rheology modifiers. In Decorative Coatings, we grew 32%, clearly outpacing the market, supported by our differentiated innovation-led product offering, and reliability of supplies to customers. This innovation focus and reliability of supply also drove 45% growth at our global key accounts. I'll come back to this in a minute. While we grew strongly in the Americas and Europe, Asia declined 27%. China, which accounts for approximately 70% of our sales in the region was the primary weak spot due to COVID-19 lockdowns and weak industrial activity. Outside of China, we saw good progress in markets such as Vietnam, India and Thailand. Taking a step back and looking at performance since 2019, the Coatings team have made great progress in improving the business, driven by several factors. First, we've accelerated innovation and improved product quality. In the first half of 2022, we launched 4 new products across key focus areas of Waterborne industrial additives and high-performance adhesives and sealants. This is a continuation of a multiyear effort. Since 2019, we've launched 27 new Coatings products. Second, new business momentum continued to build. We generated $17 million in the first half, driven by our high-margin growth platforms, which grew 23%. Since 2019, we've generated $70 million of new business. And third, we're investing to support future growth. In the first half, we tripled our low-temperature organic thixotrope production capacity in Taiwan. We've debottlenecked NiSAT production at our New Martinsville facility, increasing capacity by 30%. In addition, by year-end, we will double NiSAT capacity at our Livingston, Scotland facility. These actions will support further decorative coatings growth. Finally, our global key account management program is another crucial building block of our success. Established in early 2017, this structure enables Elementis to drive innovation and strengthen relationships at our most important customers. Today, we have 15 joint development projects running, roughly 3x the level of 2019. This partnership mentality and innovation focus, combined with our reliability of supply, enables us to grow faster with the biggest coatings companies in the world. And in the first half, we grew revenue 45%. So very encouraging first half progress in Coatings, driven by steady ongoing strategic progress, and there's more to come. Moving on to Talc on Slide 19. While sales declined by $4 million to $73 million, on a constant currency basis, sales rose 4% with successful pricing actions and $8 million of new business wins offsetting expected market volume related weakness in automotive and paper applications. While pricing actions offset variable cost inflation, adjusted operating profit declined from $8 million to $3 million, with margins impacted by lower volumes. On Slide 20, looking at Talc performance in more detail, there were demand challenges in the first half for this predominantly European business. First, as a result of semiconductor shortages and in the Russia-Ukraine conflict, European automotive production declined around 12%. This takes the total decline in unit auto production to approximately 30% since 2018. For Talc, automotive represents approximately 30% of total sales. So this was a tough backdrop. Second, paper represents 8% of sales. And in the first half, volumes were down 48% due to a strike at our main customer in Finland. And finally, on energy, Talc is a European-based business with processing facilities in Finland and the Netherlands that use mainly electricity. While we responded with price increases that offset variable cost inflation, electricity inflation will continue to be a significant challenge for the business. For the second half, we see an improved level of margins and earnings. While we do not expect European auto to recover this year, we will benefit from the restart of production at our key paper customer, the timing of technical ceramics orders, an additional $8 million of new business wins and the positive impact of implemented price increases. Taking a step back, the core fundamentals of the Talc business remains strong. We're the #2 player in a global niche market with only 3 players of scale. We have a fully integrated value chain with global reach, starting with long-life Talc deposits in Finland through the unique processing and formulation capabilities, supported by quality and technical service that's highly valued by our customers. And Talc follows a performance additive logic. It represents a small percentage of formulation cost but adds critical performance attributes and is value priced by segment, which, in combination with high service levels, generates strong customer loyalty. Looking forward, the growth opportunities for the business are unchanged. There remains significant opportunity to grow in both Asia and the Americas, which currently represent under 20% of revenue. We also expect to continue growing market share in high-value industrial applications, such as Coatings, long-life plastics, technical ceramics and the emerging Barrier Coatings segment for recyclable paper packaging. And we're on track to exceed our target of $20 million to $25 million of revenue synergies by 2023, with $21 million of synergies already delivered across Talc and Coatings. Moving to Chromium on Slide 22. Revenue rose 1% to $91 million, with strong pricing momentum largely offset by reduced production volumes linked to unplanned maintenance required at our Castle Hayne site. As a result, operating margins were 4.6%, modestly down in the prior year period. And finally, with regard to the strategic review we announced in April, we expect to provide you with an update around the year-end. Before moving on, it's worth expanding a bit on the business dynamics. First, while underlying demand in the market remains strong, particularly as high-margin areas such as aerospace start to recover, our production volumes were impacted by the unplanned maintenance. Since June, production rates have recovered, so we anticipate an improved performance in the second half. Higher market demand, combined with supply chain challenges at several of our customers has pushed global utilization levels up from 85% in 2021 to around 90% at present. As a result, market prices have continued to sequentially increase and the market fundamentals are encouraging. However, a word of caution on raw materials. Key raw material costs on chrome ore and sulphuric acid continued to increase. While we are pricing accordingly, this is a dynamic situation. And given the contract structure of a material percentage of our business, there will be some time lag impact. And I'll now hand over to Ralph to cover the financials.

Thanks very much, Paul, and good morning, everyone. Turning to group revenue on Slide 25. Revenue rose 6% on a reported basis. Excluding the impact of currency headwinds, as a result of the strength of the dollar versus the euro and RMB, constant currency growth was 9%. While volumes declined 11%, this was focused on a few key areas. Over half the volume decline was due to Coatings China, whilst the Talc business saw volumes hit by weak European auto production and the shutdown of a major customer in paper. And Paul has just been speaking of the issues in Chromium supply. These factors were partially offset by $36 million of new business wins. Revenue grew 15% due to pricing as we successfully responded to managing surging unit cost inflation. And mix rose 5% due to the impact of recent new product launches and growth in the highest quality parts of our product portfolio. Looking at group adjusted operating profit on Slide 26. This rose by 21% on a reported basis and 25% on an underlying basis with input cost increases more than offset by pricing actions. Let's take a look at cost and pricing in a bit more detail. In 2022, prices have continued to move up across every major input cost from packaging to energy and raw materials. As a result, we're seeing approximately 20% unit cost inflation across our circa $400 million annual spend on raw materials, energy and logistics. To manage this, we took several steps. Across disrupted supply chains, we rapidly qualified alternative suppliers. This typically takes some time given we provide customers with very specific product formulations. However, where it has been possible, our process engineers and technical teams have acted with speed. Second, we've increased prices. Such significant price increases are crucial for our performance and importantly, they've been accepted without any material business losses. Moving into the second half, we will keep pricing under review. And if warranted, we'll take further action. Although we are seeing some deep pockets of inflation, we continue to make progress towards our $10 million of savings targeted for 2023. The new AP Actives plant in India is a key pillar of these savings and is on track for a full start-up in late Q3 this year. This plant will help to create a lower fixed cost base and optimize tariffs on key raw materials. Our team of global process engineers are also driving our continuous improvement program. In the first half, they completed 45 projects, including the debottlenecking of production in our new Martinsville plant and installation of enhanced water sensors in Talc. The team have another 75 projects in the pipeline over the next 12 months, and these activities are anticipated to deliver $3 million of savings in 2022. And finally, in procurement, we increased our strategic purchasing, better leveraging our scope and scale and revisited pockets of spend where it's cheaper to make than buy. Turning to cash flow. There are a few points to highlight. On working capital, we saw an outflow in line with our typical seasonality and also revenue growth. The size of the outflow of $49 million is also reflective of our decision to secure several key raw materials and ensure continuity of supply to our customers. In the second half, we anticipate a more normalized working capital profile. Capital expenditure was $22 million and our guidance for the full year remains $50 million to $55 million. Tax-related payments declined on the prior period from $24 million to $11 million. Last year saw the $20 million impact of the EU State Aid case. The U.K. lost its appeal to the EU in June this year but has subsequently stated it will appeal. Bottom line, while we're still confident of getting the $20 million back, we don't think it will happen anytime soon. Net cash flow in the period was $8 million resulting in a net debt of $393 million and a leverage ratio of 2.4x. Taking a step back on leverage, we've made some significant progress on debt reduction since 2019, taking it from $509 million to $393 million today. We remain committed and focused on moving further and faster and getting to our medium-term target of 1.5x. Fundamentally, Elementis is a strongly cash-generative business, and we expect further debt reduction in the second half driven by earnings delivery and working capital improvement. On the topic of debt, I also want to flag on Slide 31, the recent successful refinancing of our term loan with maturity extended from 2023 to 2026, plus an additional further year extension if needed. Our $375 million revolving credit facility is unchanged, and our blended cash cost of interest remains around 4%. Finally, a word to reaffirm our capital allocation priorities. First, we will invest organically to grow our business. Capital expenditure will be approximately 6% of sales, and we're focused on growth and productivity opportunities. Second, debt reduction continues to be a major priority. We see a clear path to get to under 1.5x leverage while simultaneously investing in growth. Third, on shareholder returns, we suspended dividend payments during 2020 given the COVID-related demand uncertainties. We recognize the value of dividends to our shareholders and intend to reinstate payments when further progress has been made on reducing financial leverage from its current position. I will now hand back to Paul to wrap up.

Thanks, Ralph. I'll finish with a few comments on strategic priorities before turning to our 2022 outlook. First, as you can see on the slide, there's tremendous self-help that comes with delivering on our innovation, growth and efficiency strategy. Our aim is to launch 20 new products annually, staying focused on helping to overcome our customers' biggest performance challenges. This level of innovation will support further growth at our global key accounts and support our ambition of 17% of revenue coming from new products by 2025. On growth, our aim is to secure a $50 million of new business each year across our strategic growth areas in Coatings, Personal Care and Talc. This progress will be supported by capacity expansion of high-value products. accelerating distribution in Asia and the globalization of our Talc business. And finally, we want to ensure our organization continues to become more efficient and more agile. Our key focus areas are: completing the ramp-up of our new India plant, further leveraging our continuous improvement capability for incremental costs and working capital savings and strengthening and simplifying our digital footprint. Turning to our outlook for the rest of 2022. First, in an unpredictable fast-changing world, it's incredibly important that we continue to remain laser-focused on the quality of our execution. What we refer to as controlling what we can control. Second, we expect the global supply chain environment will remain challenging and that higher levels of inflation will continue beyond 2022. As we've demonstrated in the first half, we'll continue to be flexible to be focused on cost management and to take timely pricing actions to defend our margins. And finally, while we're mindful of emerging global economic risks, we're confident that with steady demand, our full year performance will be towards the top end of consensus expectations, and we will make further progress reducing debt and leverage. And with that said, Ralph and I'd be happy to take your questions.

[Operator Instructions] And our first question today is from Nicola Tang of BNP Paribas Exane.

The first was on the Coatings side. It looks like you've had very strong performance in terms of margins. Record high margins, it looks like when I look at that sequential annual chart. Could you talk a little bit about how sustainable you think this is? It sounds like some of those drivers are initiatives you've been putting in place for the next few years. But could you perhaps talk about how we should think about the second half and then beyond? And then the second question was on pricing more generally. When I look at that 15% pricing, you mentioned also that you were being proactive in implementing surcharges in areas like logistics. So could you just clarify, I guess, how much of that pricing might be linked to sort of surcharges? And if or when we see eventually a normalization or a normalization in terms of the raw material cost or input costs, how much of this price do you expect to hold on to going forward?

Thanks, Nicola. I think I'll take a shot at the first question, Ralph, maybe you can talk to the second, and we could compete with the third. I think in terms of how sustainable the 21% Coatings margins are. I mean, look, as we tried to say in the presentation, where we've come to is a function of a whole lot of work that's been going on over the past 3 years, high-grading the product portfolio, a great focus on higher margin new business against our growth platforms and getting cost efficiency, running the business smarter. I would say though that that's probably a bit of a high watermark in first half of 21%. I think in the second half, we see some seasonality, the business generally split somewhat weaker in the second half. Obviously, in our minds, there's some questions around how demand will develop certainly Americas, Europe, but also China is really an uncertainty that's only growing over time. So we think probably high teens in the second half. But I think looking forward, 2023 into the intermediate term, the strategy is working very, very well. We're not going to slow down. The new products keep coming, the new business keeps coming. Right now, our growth platforms are 33% of our revenues in Coatings, and we expect in the next 4 to 5 years, that will exceed 40%. So the margin structure, I think of the Coatings business continues to improve. And obviously, you'll continue to be driving efficiency, et cetera. So to be around 20% in Coatings is our ambition, frankly, whatever the weather. I think that's where we'd want to go. Ralph, you want to talk to the pricing question?

Yes. I mean most of the 15% price increases were actually price increases. They do include some surcharges, but vast majority were price increases, which we do expect to stay. On surcharges, quite a bit of that was in the Talc business, where we have about 40% of our costs are in energy and logistics and they've seen very sharp upticks. We've taken price rises in Talc in the fourth quarter of last year, the first quarter this year and the second quarter of this year, and that's a blend of both price rises and surcharges. But the large part of the price increase that you see there is really straightforward price increases.

Yes. And I think on the third question around ability to hold price increases I mean if you look at our portfolio, you have to sort of put Chromium to the side. It always has quite a bit more pricing volatility. But the specialty businesses, these are highly customized products, a small percentage of cost, very important to product performance and generally get formulated in over quite a good period of time. So that gives us, I think, more leverage on ability to hold pricing. The more innovative your portfolio is obviously the better leverage you have. I think the only slight caveat is when there are substantial cost changes that happen in a really short amount of time, you're in a little bit of a different conversation than if costs come off over 2, 3 years, that kind of thing. So -- but overall, I feel reasonably optimistic in our ability to hold pricing.

And our next question comes from Sebastian Bray of Berenberg.

I could -- I just start with a few technical ones. The -- what's -- given the refinancing of the capital structure undertaking of the term loan, what is the change in the annual interest rate guidance and your interest cost guidance, I should say, does it go up by about $3 million or $4 million. So are we talking now somewhere in the mid-30s. I'll pause there.

Yes. I mean, I guidance remains at the moment, sort of $20 million to $25 million of interest expense. Just a word on the refinancing, just to be clear that RCF say exactly the same return loan that we've gone for $300 million. We've got some hedging in place on that in terms of interest expense, both in terms of the euro component of it and the U.S. dollar component, and we've got some optionality on enhancing that interest cover next year as well, given some of the uncertainties around the balance sheet. So I think we're reasonably confident that the cash cost of interest expense will be 20 to 25. We do have some other interest expense for finance cost items about $3 million, which are to do with things like provision on environmental provisions.

That's understood. Can I ask where do we stand at the moment in terms of profitability of the deodorant business? Is it -- how do we compare to relative to the time when the business was acquired in 2018?

Yes, Sebastian. I mean, it's a highly integrated business these days. I mean, in the sense that our top customers are pretty much all the same. [indiscernible] has significantly increased our leverage, frankly, in selling traditional hectorite into this application as well as in cosmetics. So we don't really break it out. But I would say we're pretty happy with the profitability at this point. The recovery of the whole deodorants category has been quite nice actually this year. There's a tremendous amount of innovation that we're bringing to the category. That's manifesting itself and an awful lot of new product sales to top customers. The other thing that we have going, obviously, as I talked -- we talked about in the presentation, the India plant coming online to really create massive leverage for us in terms of lowest cost producer in the world and obviously the ability to grow. So we're very pleased actually with how it's performing.

And the split between price and mix in Personal Care? Am I right in saying that most of the 23% growth was price or?

Ralph, you can pull the number. I would say from a volumetric standpoint, we were up mid-single digits -- there's certainly -- yes, certainly, there was pricing actions that had to be taken. We kind of look at the amount of new products we're launching. We did $8 million of new business I think as I pointed out in the presentation, I mean, the growth -- the key strategic areas of skin care in Asia are continuing to progress really, really well. So the quality of the Personal Care business gets better and better over time.

That's understood. And sorry, last one. Why not turn on the Talc machine? Why write it off of the bioleaching facility?

Yes. So -- so Sebastian, we currently do produce Nickel concentrate as a byproduct of Talc. The previous owners, they installed some Nickel bioleaching equipment trying to get more nickel, but it never really got started up, we certainly didn't buy half of that asset had about $23 million of book value. Look, when we were reviewing this asset in detail in the first half, we decided that compared to the other opportunities we've got, they just didn't [indiscernible] in the bar in terms of sort of safety and operational risks and also in terms of the resources required to keep the asset going well in the location it was in Finland. There will be a significant diversion of resources versus the opportunity to go elsewhere. So on that basis, we decided not to sort of operate the plant and to write off the book value of it.

And our next question comes from Andrew Stott of UBS.