Q3 2022 Eastman Chemical Co Earnings Call
Good day, everyone and welcome to the third quarter 2022, Eastman Chemical Conference call Today's conference is being recorded.
Cool is being broadcast live on the Eastman website Www Dot Eastman don't come.
We will now turn the call over to Mr. Greg Riddle of Eastman Chemical Company Investor Relations. Please go ahead Sir.
Thank you Maximo and good morning, everyone and thank you for joining us on the call with me today are Mark Costa Board Chair and CEO wanting to Clayton Senior Vice President and CFO and Jake Laroe manager Investor Relations.
Yesterday after market closed we posted our third quarter 2022 financial results news release, and SEC 8-K filing.
Slides and the related prepared remarks in the Investor section of our website Www Dot <unk> dot com.
Before we begin I'll cover two items.
First during this presentation you will hear certain forward looking statements concerning our plans and expectations actual events or results could differ materially certain factors related to future expectations are or will be detailed in our third quarter of 2022 financial results news release.
During this call in a preceding slides and prepared remarks and in our filings with Securities and Exchange Commission, including the Form 10-K filed for full year 2021, and the Form 10-Q to be filed for third quarter of 2022.
Second earnings referenced in this presentation exclude certain noncore and unusual items.
Filiation to the most directly comparable GAAP financial measures and other associated disclosures, including a description of the excluded and adjusted items are available in the third quarter of 2022 financial results news release.
As we posted the slides that accompany the prepared remarks on our website last night, we will now go straight into Q&A vaccine. Please let's start with our first question.
Thank you. Mr question today comes from Vincent Andrews from Morgan Stanley . Please go ahead. Your line is now open.
Thank you and good morning, everyone and congratulations.
The announcement with Pepsi very exciting news.
Maybe you could just talk about the balance of the customers.
The facility I don't know if you can name any of the other ones are just sort of tell us how many they are and are they contracted similarly at this point or what's left to do there.
So Vincent great great to hear from you and we're really incredibly excited about the Pepsi co.
Contract and their commitment.
It is a significant volume.
That plant is the baseload for the plant we have very active conversations going on with several other customers.
But we're not in a position at this point to sort of talk about those discussions, but we do believe that perhaps the agreement.
Consistent with what we are.
Attempting to achieve with the PDT market is.
Great endorsement and proof point about the value proposition that we can bring to solving the plastic waste crisis and create economic value for our shareholders at the same time.
So we're excited about working with them going forward.
And if I could just ask a question get your point of view on all the Destocking that's going on.
I know the prepared comments there was some thought that hopefully will end by the end of the year, but what exactly are you hearing from customers in that regard and how do you think we'll know that it's it's over other than it just being over like what signposts are you looking for.
So it's a great question and it's one that as you know and everyone knows it's a little difficult to call in the in the moment on what's going on in demand.
Relative to Destocking.
I think you've got to take it market by market alright, So the place where we have the greatest headwind is in retail discretionary spend around the planet.
Especially in Europe , and the U S.
Once you had happened I think it's been well documented is.
We all knew there was going to shift from people moving back to a more services travel leisure from sort of just buying consumer goods.
The COVID-19 situation, but I don't think anyone really understood the significance of that combined with extreme inflation on how much the pivot could turn into being so people staying committed to travel as we all know from the airlines.
But with this extreme inflation affordability for everything else in their life was very constrained and so they've really cut back on anything that's a discretionary spend.
And then you had all these ships loaded with all kinds of.
Consumer goods.
On the ocean, causing towards it all showed up in the second quarter and you saw here Walmart target best buy et cetera.
I have a huge problem on retail inventory to sales that continues to now.
Fortunately the wholesale change supplying it doesn't have that much of an inventory, but you still have a huge amount of destocking occurring at the retail level and you can see that flowing through and impacting some of our customers like whirlpool or electro luxe and the announcements that they have out there. So you get a pretty significant decline that is both a demand and a significant destocking event.
That's occurring as we are in this fourth quarter and I'd say, that's the one part of the market. It's a little hard to call to say when that sort of combined destocking demand situation plays itself out.
When you look at the broader set of what's going on.
Are there other factors impacting the market, so you've got Europe , and stagflation, where high energy costs and high inflation is driving a drop in consumer demand, but energy costs are staying high and you've got China with no Covid policy constraining you know consumer behavior in the P&C industry, that's been in trouble for over a year.
U S building construction markets are doing well either as you can see in all the.
Housing data that's been coming out recently, even in the third quarter GDP numbers. So.
That impacts a lot of demand across our portfolio.
<unk> is not off as much especially in North America is quite sort of there's a lot of momentum in that market of houses still being completed and painted.
And appliances being bought forward, but you can see that coming off as you go into next year.
And then you even have even stable markets.
Is that.
The P&G in other markets out there who are doing well.
We're still looking at their inventory and going to destock high cost inventory to generate cash we ended the year and position themselves for lower prices in the future. So.
<unk> got modest destocking going on in stable markets.
I think we will play itself out by the end of the year.
You've got Europe , and China, which has been challenged for a while so that destocking I think is largely playing itself out by the end of the year.
So it's more of a you know.
The earlier phase of that Destocking in change.
For for what's going on in the marketplace. So.
Those are sort of the way we see it around the world.
And then you've got positive right. So the automotive trends are good and <unk> got recovery that we're already seeing as a benefit in the third quarter and sequential improvements into the fourth quarter.
You've got the EV trends, where we make a exceptionally large amount of money relative to an ice car you know two and a half three times as much value to us.
Those are becoming more part of the mix it gives us another mix upgrade.
And you've got consumers that are still in the financials as consumers artificial system, they're still relatively healthy.
That sort of balances out some of these trends.
So we think that.
Good amount.
50% of the Destocking plays itself out through the end of this fourth quarter.
And so that means as you look at next year.
With the Destocking being more more behind us.
And returning to sort of what we're thinking about as mild recession terms.
The demand improves in a meaningful way as you get past the fourth quarter.
From our primary market demand point of view and then on top of that as we look at next year.
Innovation happening across our marketplace, that's going to drive a lot of growth.
And you've got.
The lack of the outages that we had this year there.
Hit us by about a $100 million of missed volume mix.
They'll put us well below market demand. This year. So there's a lot of upside in that available capacity and a lower planned shutdown schedule in a meaningful way next year that gives us more volume to sell so it's a lot of reasons that as we get through this quarter and put some of this destocking behind us that volume next year will be better.
Even in a mild recession.
Okay.
Good thanks, so much.
Our next question comes from David Begleiter from Deutsche Bank. Your line is now open. Please go ahead.
Thank you good morning, Mark I'm, a 150 of cost you've targeted for next year, how much is structural and how much is somewhat temporary.
<unk> the lower <unk>.
Cut down costs or turnaround costs next year versus this year.
Good morning, David Thanks for the question this is Willie.
We think about the 150 I would look at it in two buckets are roughly $100 million, we expect to be on the manufacturing front.
And obviously as we've talked about inflation being a key factor as you think about the demand that we had in the first half of 2022, along with the outages that drove a lot of inefficiency.
And we expect that to be a large component as you think about contractors as you think about the level of over time, So I do view that as structural as we get back to operating in a Ah caused a more controlled demand environment that we'll be taking a significant amount of that type of cost out of our system that will be all.
Call. It a lower amount of planned turnarounds that'll be I'll call. It a smaller portion of that $100 million that we see in the manufacturing space.
As it comes to the Nonmanufacturing, that's about a third of the actions that we see and in many cases what I.
I would say is the level of consulting spend discretionary.
So that's more of I would say variable versus structural in the current environment. As we can expect to continue to invest in the growth programs as well as just highlighted.
With the third.
Project, gaining momentum with our circular investments, we will balance that out of 150 structural.
Slash discretionary to ensure that we can continue those investments.
Very good.
And we're guessing as slide 12, looking at initial 23 guidance, perhaps okay. It looks like Youre looking at perhaps a modest maybe 5% type EPS growth year over year is that in the ballpark.
Yes.
Good question, Dave, we're not going to be giving quantitative guidance about 2023 versus <unk>.
Versus this year, which we still have to finish out.
But what I would say as we look at the tailwind and the headwind.
And a mild recessionary environment.
We think we're in a good position.
It's obviously, a very dynamic time right now whether it's what's going to happen in China, Ukraine were inflation et cetera, you know theres a lot of uncertainty and uncertainty goes back to a true trade war and 19 pandemic in 2020.
What we know is you know the market is challenged as I, just said around the short term and the recessionary environment that is out there.
Manufacturing world seems to be enduring.
And I do think a lot of the Destocking will play itself out.
So we're really focused on what we can control.
And I think the volume growth side of things is in a good position with over $400 million of new business revenue closes on innovation.
Got a lot of tailwind, whether it's the multi functional layers growing in evs.
Tremendous success, we're having in our paint protection films.
Brokers seeing et cetera shield in food and beverage cans or you know.
Really seeing a lot of growth continuing even into semiconductor environment for high purity solvents, as we expand the product portfolio there and.
So timber coated film coating items et cetera, so a lot of innovative growth going.
Do think there.
There was a meaningful tailwind that comes out of the lack of unplanned outages that we had this year next year.
And then less planned outages, obviously helps as well so that's one component.
An equally important component is spread improvement right. So when you think about what we've been through in the last two years strike you had about $1 3 billion of inflation in 2021.
And we had pricing in place there.
Most of it but we still had some spread compression in the specialties in the back half of 'twenty. One. So when we started this year, we had a view that we're going to have $500 million of inflation. This year, we have pricing in place to deliver a much greater than $100 million of spread improvement in the specialties. We.
We didnt plan on having.
The other 900.
Millions of dollars of <unk>.
Inflation through the rest of the year. So a total of $1 4 billion.
When you when you sort of pick our view of the fourth quarter here.
<unk> headwind and the teams have done a phenomenally good job of keeping pricing going with the strength of our value propositions in the specialties to keep pace with all of that inflation and of course chemical intermediates. You know has done well in the first half of the year.
But while we kept pace, we didn't recover the spreads that we were aiming to get.
From what were you sort of gave up in the back half of 'twenty one.
So there is that opportunity that's still in front of us and with inflation being as high as it now that opportunity is much greater and how raw material and distribution cost could fall and what the spread tailwind will be next year.
We're going to continue to have very strong discipline in pricing because we are committed to getting our margins back to 2019 levels for all of this inflation started.
So I think that's a pretty significant upside and I think an equally significant upside.
There's a real change in the fibers business as.
As we've told you we faced a lot of inflation and increasing operating costs in the fibers business in 'twenty, one and 'twenty two.
And that's pushed our margins down.
Pretty significantly.
And there was a recognition with our customers already this year that those costs are needed to be recovered for us to be a reliable and sustainable supplier to them and you've already seen us have a lot of price increases this year, but its only covered a portion of that inflation.
As far as the recovery goes and we've already succeeded in locking in contracts with Cigna.
Difficult portion of our customers with prices that will allow us to significantly improve our earnings relative to this year in fact, so much so that we believe it would offset what.
What we've said in our prepared remarks about the normalization of chemical intermediates. So thats a significant improvement earnings taking us back many years into where that business will sit and be much more.
Sustainable more profitable more cash driven business.
And then as we just discussed you've got the one or two of those cost actions. So a lot of tailwind.
<unk> that offset those headwinds that we have with the pension cost and gross spend.
Currency.
So interest expense. So net net I think in a mild recession will be greater than this year, but I'm not about to quantify how much.
Very helpful. Thank you.
Thank you. Our next question comes from Jeff Zekauskas from Jpmorgan Chase. Please go ahead. Your line is now open.
Right.
Thanks very much.
Hi.
What is the financial terms of.
Your agreement with Pepsi.
How do you how do you price the material to them or how did they buy it from you.
Thanks, Jeff So we're very excited about this commitment with Pepsi.
And.
We don't discuss the specific contract terms with any of our customers and in this case in particular.
We view our contracting approach.
For the circular economy is a competitive advantage.
Can't tell you what is the contract is aligned with our certain of our contracting strategy that we've discussed.
With investors in the past.
These agreements really demonstrate.
The molecular recycling.
Central part of solving the plastic waste crisis.
Sure our collaborations with mechanical recycling industry.
And we really view this in a Pepsi commitment, which is one of the most significant and most successful brands in the world.
They see the value.
And what we're doing both from an environmental point of view and it also demonstrates that when you have an economically viable platform. When we meet these terms in this contract strategy. So when you think about the principles that are behind the contract strategy for these types of contracts.
We'll have margins to annuity and how.
<unk>.
<unk> products are sold to them in a structured relative to what goes on in the marketplace.
And these contracts will be long term and have a settlement in this case, a sufficient base load for us to commit to this third plant.
So.
We can see.
A clear vision of the cash flow necessary to you.
To provide the appropriate return on investment on that so it's a really exciting situation. We find ourselves in I would say that back to Vince's question Theres a lot of companies out there and we're excited we have over 1000 sss.
We're ready for our first plant, we're going to be.
Starting up in the spring of next year.
Wide range of specialty products.
Brian engagement in Europe is incredibly strong.
Both in specialty as well as N P T.
And I think it's really a significant proof point when we get this contract that.
And there has to be a pathway for hard to recycle materials back to food grade sort of truly have a circular economy.
In that marketplace that we can partner with mechanical recyclers.
The central part of solving this problem that we can do this at a lower carbon footprint.
And make sure that we have a very minimal impact on our communicated communities that we operate in and importantly, we need to make sure. We don't move to other materials classic is by far the most carbon efficient product out there for these applications.
And if we don't use plastics and we're going to have a huge impact negatively on climate and if we start moving to glass aluminum as soon as other products and frankly, many application there just isn't an alternative material that's going to work for the brands.
So for US we think this is a big part of the circular economy, and we feel great about.
Working with type C.
Anchor clients.
Okay.
And then for my follow up.
Okay.
In chemical intermediates.
Are you closing.
One of your smaller crackers permanently or.
What are you doing with your closure and can you discuss what's going on with propylene spreads.
It doesn't look like people can make money, taking propane to propylene at this particular point in time.
How is the propane propylene dynamic affected Eastman during the year relative to last year are now relative to previous quarters.
Okay. Jeff This is Willie I'll answer the first part of that question as we think about our operations. So as we've highlighted earlier given the one the amount of inflation that we've seen this year in working capital.
Two raw materials, we're looking at that in concert with the demand that we see and we've highlighted the destocking that we expect.
In late Q3, and we're seeing here in Q4, so as we're in a planned turnaround for one of our crackers at our Longview, Texas site.
We're taking that opportunity to keep it down the remainder of the year to ensure that in our olefin stream.
We bring our inventories back in line and there will be also move through some of the higher cost.
Both from an energy and raw material front and get that through this year. So that we're better positioned in 2023 from.
Both in operations and supply chain and working capital standpoint.
As we think about.
Propylene and propylene margins.
I would highlight is again.
We've continued to optimize our operations we've made the investment in the refinery grade propylene that is continuing to play off quite well as the CEO in the current economic environment and also again, our propylene derivatives have continued to perform strongly in the first half.
Half.
And while those margins normalizing some in the second half as we had expected.
This is still a very strong part of chemical intermediates and is delivering the cash for the company.
I'd also add Jeff that our teams on the commercial side are doing just an excellent job of pricing discipline. So we don't sell propylene right, we sell derivatives and those prices, we were able to hold those prices flat.
Two Q2 sequentially through the third quarter.
And then there will certainly be prices coming off in some of these customer contracts our cost pass through contracts or tied to propylene that so you'll see prices starting to come down in the fourth quarter, but our view is if pricing discipline in times of sort of economic transition like this is incredibly important.
Versus chasing demand, that's frankly, not there because theyre destocking anyway.
So from a from an earnings and cash point of view, we're managing that tradeoff between volume and price in a market, where we're waiting to see where primary demand really settles.
And holding on to value as long as we can.
Okay, great. Thanks, so much.
Okay.
Our next question comes from Duffy Fisher from Goldman Sachs. Please go ahead. Your line is now open.
Yes, good morning.
First question Mark when you look at.
What your expected sales for the fourth quarter and look at what your planned operating rates or did you bring operating rates down enough that you don't think youll build inventory or what will you do with your inventory throughout fourth quarter. You know if the numbers hit the budget you have planned.
Duffy we are expecting this is really we're expecting a decline in sequential.
Revenue and volume numbers were.
Sure.
<unk> operate righting rate not only for that but we're looking to take our inventory quantity is down somewhere between five and 10% on top of that.
Obviously, we've highlighted the steps that we're taking with our.
Our olefin strains, but we're managing that across the enterprise in the portfolio.
The utilization rates and the impact on our P&L from from that is.
Banked into our guidance.
At this point what I would also highlight is what we see here in October .
From an order and demand pattern is basically in line with our expectation.
Mind.
We made a decision.
Cash is an incredible important part of any company is certainly in our value proposition and it's obviously a very challenging here when it comes to cash with working capital.
The inflation that we're trying to manage.
But we are focused on generating cash in the fourth quarter and taking the actions necessary to do that.
<unk> for lower cost raw materials that we're going to be purchasing that we believe where do you see the trends now in the marketplace of raw materials coming off.
C already fall during the first quarter.
Ourselves even better for that in January .
Okay. Thanks, and then the issues you've had with shipping out of the east coast the port issues.
What's the resolution to that.
You found kind of alternate routes, but maybe more expensive ones doing trucking or rail to get to other ports as we get into the first half of next year is that something that's going to continue.
To be a headwind for you guys or do you have solutions outside of.
Hopefully the ports themselves just getting better over time.
First of all the ports themselves are getting better and with the reduction in demand.
In the U S as well as in other economies the amount of trade occurring.
A lot of what we were shipping in containers out of those ports has lowered itself. So the logistics extraneous or are not a major factor in the fourth quarter and we don't expect it next year, where in fact, we expect to see significant distribution cost tailwind for US next year relative to this year for two reasons one.
But demand is as tight as it was and all the challenges we had in keeping customer supplied we used a lot of different expensive modes of transportation to make sure we honored our commitments to our customers.
And so those those modes were higher costs, some of which we passed on and pricing, but you know some of which is something we're not going to use next year.
Pick up cheaper position.
And how we transport products from a mood point of view and then of course distribution rates are coming already coming down and you can see it on major routes.
The dramatic drop in container costs.
Between China and here. So we really do think this goes from a significant logistics constraint on volume limitations. This year that we couldn't serve even though demand was there and very high modes and rates are to a meaningful tailwind next year as we optimize our operations and our distribution.
Two sort of softer environment.
Great. Thank you guys.
Thank you. Our next question comes from Frank Mitsch from Fermium. Please pause. Please go ahead. Your line is now open.
Hey, good morning folks.
One of the more surprising thing I want to come back to the to the fiber as contracts for 2023 because it.
It seems impressive that you were able to drive that much profit growth.
<unk> already signed up for next year.
And also in the prepared remarks, it said that it is going to bring the levels back to sustainable investment levels.
Are you, indicating that perhaps we might see capacity expansions.
In this business.
And any any other color you could do you could give us in terms of why why we're seeing such a step change for 2023 would be helpful.
Yes, so to be clear, we're not intending to add tow capacity. So that's just to make sure. We're clear about that when we talked about getting sustainable.
Margin levels, it has to be a reliable supplier.
And when you look at the situation, we had a view of the market declining 2% to 3%.
So year over year, and it has now changed to being sort of flat to down 1%.
Partly because the overall market just isn't declining as much as people thought.
Equally important.
Heat not burn market is growing phenomenally fast so companies like Philip Morris and any other brands had these very successful heat not burn products.
And they still used quite a bit of a toe.
So I'm thinking hadn't included you know how that would offset.
The total decline in sort of the traditional products. So when you put it all together you've got a much more stable end market situation and I think what people expected.
Second and this is unique to Eastman is.
Textile growth has been fantastic.
We continue to see strong interest in our product when you think about our product is made from half.
Certified.
Sustainably certified forest wood pulp and the other half now being recycled plastic it's just to create value proposition on the beginning of life.
And then the life concerns about micro fibers from textiles, ending up in the ocean are certified to biodegrade.
That's a very strong.
Our value.
The value proposition for the marketplace.
And we're seeing just great brand engagement on that.
So you've got growth in that that's more than offsetting the decline in tow that we see so our assets are tight.
And then.
You combine those two facts with less supply being available because what we have done actually is repurposed some of our tow assets to making textiles right. So that took some capacity out of the marketplace.
Other companies have.
Optimize their capacity, whether it's in Mexico or now because of the Grant award in Russia.
You've got.
Less supply than existed several years ago.
So in that conversation our customers really want to make sure we're going to be a very highly reliable supplier to them to meet their needs.
For that to be the case, we need the margins at a better level than where they're at right now.
So we were able to get price increases this year and add on pretty meaningful price increases next year to get us back to a more appropriate margins for this business.
So when they say okay.
Okay awesome.
Yeah.
So just one of the thing I wanted to mention is that the contracts also include provisions to adjust for changes in variable cost.
Which we didn't have in the past.
So that makes them a little bit more.
Predictable too on how theyre going to perform.
Got you got you.
And I also wanted to ask about you know in this environment. It. It's very helpful to have an asset footprint that skews more towards the U S than Europe , but you still have a lot of assets over in that part of the world. We're starting to see some other companies talk about rationalizing capacity in that part of World and I'm wondering what you are.
Your thoughts are on on a long term viability of your assets over over in Europe .
So.
First of all when it comes to Eastman about 75% of our production from a volume point of view is in the United States right Joe.
That's a significant COVID-19 advantage for us on an energy cost basis relative to other markets and you have to remember that 55% of revenues outside the U S.
And most of what we sell in Europe , and China in particular, our specialties.
No.
And how we serve our global markets are in very strong cost position, obviously currency is not helping that at the moment, but long term I think that energy position is going to be a strong competitive advantage.
When it comes to Europe , our asset base in Europe is a lot smaller than it used to be after we sold the tires adhesives business, which has significant assets and energy intensive assets.
In Europe .
So with what's left now we have.
Our inner layers plants.
Small.
Performance films plant, which are more electricity, driven and not that energy intensive.
Our most energy intensive asset is our amines facility in Belgium.
The segment, that's most impacted by us as ASP when it comes to high energy cost.
For that segment are about 35% of their production is based in Europe .
And so they're seeing a pretty significant energy headwind. If you just look at the fourth quarter, it's probably a $20 million headwind.
That they are facing on a year over year basis.
Relative to where they were a year ago.
It's just that segment.
None of these assets are in a position, where we were concerned about them being economically shut in because the costs are so high.
And we feel we have a very good plan in place, especially in Belgium.
To view that we will get to natural gas supply that we need through the winter.
On top of it lots of teams working to make sure everything is got supply agreements in place. So we don't get rationed.
And we don't have a concern around the economic impact from a viability of the assets.
Got you. Thank you so much.
Yep.
And our next question comes from Matthew <unk> from <unk>.
America. Please go ahead. Your line is now open.
Good morning, everyone.
So I believe you have some euro denominated debt maturity is approaching.
Does it make sense to take that out with USD debt and.
How.
How are you thinking about the term loan.
I guess as well what are the implications for next year's interest expense with all of this and does this kind of shift your commitment to the buyback.
Yes.
Okay.
I would highlight is to your point, we've got a roughly $750 million.
Euro coming due in May of next year, I would say our treasury.
Treasury team is proactively looking at how they will manage that you.
You can expect us to probably put some things in place here in Q4 and finish things off in early Q1.
As we've seen rates move compared to that it's probably call it roughly at $25 million to $30 million headwind on a year over year basis based on the rates that we see now.
As we think about the share buyback.
We're still committed to the $1 billion that we outlined for this year.
And also as we think about.
Cash flow of strategic cash available as we look into 2023 was what Marc outlined.
I see operating cash flow at a normalized working capital environment and also with the ability to increase our.
Cash earnings potentially being $3 million to $400 million higher on an operating cash flow basis, so asset with that with our dividend that puts us at a $1 billion plus of strategic cash for our organic growth strategy as well as bolt on and share repurchases in 2020.
And you've got to believe in 2024 that we're back to that $1 6 billion of operating cash flow.
Thanks, Willie and I guess.
Yes.
Following the agreement with enter zero.
What percent of your France facility is now feedstock locked in our contracted are scared.
So.
We've said the near zero contracts worth about 20000 times and we're building.
In two phases of 150000 tonne plant. So it's a good step, but it's not a huge percent of the plant I would say we have other agreements under discussion right now.
That would get us close to what we need for startup and and feel very good about that.
The progress, we're making it's pretty remarkable when you think about that we're locking in contracts.
For when these plants start out you know in the $25 26 timeframe.
And getting these commitments and most importantly, what I'm most excited about.
Is the fact that these conversations with these mechanical recyclers are coming to the viewpoint that we need to collaborate together.
And of course cycling is vital to solve the plastic waste crisis, they have a low energy footprint and where they can.
Jake.
Waste back mechanically.
Into applications is great and that's what should happen.
Unfortunately, there is a huge amount of pocket packaging waste out there as well as textile and carpet waste that cannot be easily mechanical recycles, especially when I'm talking about going back to food grade.
There's real limitations on what you can do the mechanical recycling back to food grade and so we've become in a central partnership to really create a circular economy.
And that sort of high value packaging market.
And they see that also you know there is a long term viability question with mechanical recycling.
The polymer degrades over time, and really have sensor performance quality issues. After several heat cycles, and we can take that the greater polymer and bring it back to life through our facility.
And so it's a partnership that really allows mechanical recycling companies have long term future allows plastic to have an infinite life and how it can be recycled out of a much lower carbon footprint than the current process. So.
He noticed an acknowledgement that this system requires collaboration to really you know Brittany keeps the most carbon efficient material.
And use in a way that doesn't impact the environment.
Understood. Thank you.
Okay.
And the next question comes from Alexia <unk> from Keybanc capital markets. Please go ahead. Your line is now open.
Thanks. Good morning, everyone can you discuss what share of the third methanol facilities covered by the Pepsi agreement is this enough for you to make E and if so when are you planning to break ground.
So we're not going to disclose the volume.
As I said before we don't discuss specific contract terms with our customers in this case.
What I can tell you is this this commitment was key milestone we need to achieve to feel we could have confidence in the economics to move forward.
And starting the engineering work and.
And the planning to construct this plant in the U S. So of both.
The contract terms the length of the contract and the size of the contract.
<unk> gives us confidence to start aggressively moving forward in the construction of this airplane.
So that's you know that's where we needed to be in and we're excited about this partnership and I would also note that there is a lot of other customers who are very interested in this capacity.
So we're we'll be accelerating those conversations now that we've got the sort of baseball position set.
To get you some additional customer announcements.
Thanks, Mark and stainless recycling you know it looks like.
Burgeon plastics prices are.
In many cases and so as you know the feedstock for mechanical recycling.
Does that change your discussions with potential suppliers of feedstock and also with potential customers for your recycled materials in any way basically the current market conditions.
Yeah, I don't think it's changing anything significantly you know, there's obviously going to be ebbs and flows.
With supply and demand in the packaging industry, which compared to consumer durables is a far more steady industry. So what I also like about the circular platform is.
It improves our revenue coming from much more stable end markets from.
From a demand point of view, which is a nice upgrade to our portfolio.
But when it comes to sort of the trends in prices, especially in the economic chaos, we've had of extreme inflation and then now.
Companies, hoping for cheaper price prices in the future you're going to see a lot of you know short term volatility.
We don't see any of our customers getting distracted by it because theyre looking at how do they have.
<unk> in 2025 and 2030 right. That's what all these discussions are about it's not about what is my composition of Virgin versus our pet in 2022, right. That's just not how to think about it if they think about how I built a roadway to 2025 and hitting those commitments, but in the short term if I need to save a little money I'm gonna make tradeoffs, what I'm buying today.
But they're not they can't back off of their commitments and in Europe , It's not a it's not a choice for the brands, it's a mandate and government legislation. So in Europe . If you don't hit your recycling targets youre starting to pay some pretty significant taxes.
That's a real bad look for brands not talking to recycling content and solving it by paying a tax coming up short on their targets. So.
In Europe , you've got very.
Sort of structural reasons that they have to stay committed to others.
Theyre going to solve this problem and.
Mechanically recycling infrastructure is not remotely capable of providing enough.
Recycled material.
Two the packaging industries, Thats, where our value proposition shows up.
Thanks Mark.
The next question comes from P. J <unk>. Please go ahead. Your line is now open.
Yes, hi, good morning.
Mark I have a question another question on inventory as it relates to cash flows.
Cash flow from operation is down more than 50%.
Pointed out the hit from a working capital being $500 million.
So.
My question is how much of that is from your actual cost going up from what he does and how much of it is from level of inventory is going up and you know when can you describe what inventories got to in terms of days and what do you think that will go.
So that's my first question. Thank you.
Hey, Thanks P J for the question.
Highlight.
As as we went into the second half of the year, we had some large turnarounds as we've highlighted here in both Q3 and Q4. So we were building inventories going in in the second half.
I would highlight at that point, it was probably roughly half raw material energy inflation and have quantity.
We brought those quantities back down through Q3, and we'll be expecting.
That my year end effectively the entire increase as raw material and energy inflation.
So, bringing our <unk> numbers back in line with the prior year and.
I mean, if you think about the first eight months.
Trying to ship things as fast as we can make it and serving market demand really.
Through most of August .
That was how does related in and raw material availability related inner layers that constrained our ability supply markets, but.
Demand was great.
It was just the logistics or production constraints and getting it all served.
But the market has obviously shifted pretty dramatically in September and through this quarter.
Destocking.
Okay.
Thank you and I appreciate your discussion off a mild recession in your prepared comments you.
You mentioned, the aliens citic, and hydride and plus besides us to kind of hold up even if all defense decline.
Aliens and plasticizers had been cyclical in the past. So why do you think they will hold up in a mild recession here.
<unk>.
Yeah sure. So you know one of the things that's.
Been a important evolution of our portfolio in Ci.
Is the growth in functional amines. When you look at that business tied to AG, which is obviously, having a good year. This year and expect to have a good year next year and so we are tied to AG demand.
But it has phenomenally attractive and very stable margins because most of the almost all of that businesses and cost pass through contracts. So.
That business didn't have market tightness driving spreads up in the last two years and it's not gonna have market loosens driving spreads down because our CPT.
So that's just a great business.
And really quite attractive.
Just like the care chemical business in AFP.
When it comes to asset yields.
You've got a business silicon hydride relative to other asset yields is actually very stable in its margin. So again it didn't have a fly up in margins in 'twenty, one 'twenty, two and it's not going to have a big decrease in margins when the market softened.
Just the nature of those end markets like pharma and food applications are more stable.
And what happens with them on a margin basis and margins will certainly come off a bit there, but they will be.
More than offset by much higher volume.
Had significant restraints on volume this year to fuel production, because we had some significant planned shutdowns and then the outages impacted their production run rates as well so.
Without the plant shutdowns in and sort of better operations, we have significant volume upside that we're confident we can place in the marketplace.
To sort of asset yields would be relatively stable to this year.
And then, especially plasticizers, which are ours are a benzoic derivative products again, historically very stable.
And reliable and when you put those three together.
That's 50% of the EBIT of the segment right. So general plasticizers in our case the otp.
As well as all the other olefin derivatives is the other half.
And when you look at that part.
The most volatility usually comes from the bulk ethylene as opposed to the derivatives.
And you know you can go do the math and see that the margins and the bulk ethylene are already incredibly low one reduce it as much as possible as Willie said using our G P to sort of minimize ethylene production.
But the margins you know are sort of our cash costs in the back half of the year were great in the second quarter. So.
Looking at next year, that's not a sequential headwind in 'twenty three to 'twenty, one 'twenty two in any meaningful way.
So it's you know youre, not whittle down to olefin derivatives pricing.
You know coming off but you know when you think about you know that could have the earnings is in these very good businesses that are very stable.
You know the bulk ethylene headwind is behind us to a large extent instead that the amount of decline you can have in the olefin derivatives, even if it's significant it still allows us to be at that sort of normalized $300 million right.
We talked about.
Sure, how we sort of looked through all of that and.
And so we feel that's actually a great performance and a mild economic recession.
This business and in.
And the total portfolio sense will be offset by fibers, which allows especially to drive you know.
Covered earnings growth.
Thanks for the color.
Thank you. Our next question comes from Laurence Alexander from Jefferies. Please go ahead. Your line is now open.
Hey, good morning, So just wanted to flush out how the discussion on pricing and.
So the price initiative driven spread expansions.
Are you seeing any change in.
The volume elasticity of demand in response to price initiatives, particularly in Europe , where I guess, there's some slow down has been going on the most.
Well I think you have to get clear about what is primary demand in the marketplace. What is destocking and then what may be driven by pricing.
Whether it's destroying market demand are losing share to competitors, where you have to examine the price question.
Not seeing them.
Any sort of specific destruction in demand.
Because of our pricing at the consumer level frankly, when you get to the price of our products on the shelf.
You know our component of almost every customer's cost structure is really quite small.
So we're not really a driver of where they go on the pricing on the shelf when it comes to consumers.
When it comes to share.
Share loss.
So we're keeping a very close eye on is our pricing driving any share loss, especially toward the commodities for that matter.
And we're not seeing any of that now it's a little hard to see through that when you've got destocking going on.
So you never know quite what you know is it I'm, just pulling inventory down or shifting share. It takes a few quarters to sort of figure all that out.
But what we can see right now based on the end market information. We have is our what we're seeing in demand draw the lines with what's happening in the market and what the retailers are doing a destocking. So we feel being.
Being very disciplined on price and holding firm on that while we wait for market clarity is the right strategy.
And we have very strong value proposition that allowed us to increase prices to cover $1 $4 billion of inflation this year.
So we're confident we can hold our prices.
You know relative to how raw material and distribution cost decline next year.
To improve our spreads back to a more appropriate level. So you know what.
We're feeling good about that we just need to.
Raw material declines, we're already seeing to continue happening into next year.
And also same on the distribution costs, you'll notice I'm, not saying energy as a tailwind because I think that's a lot less.
Certain on where energy goes and so we're not assuming a tailwind in energy next year.
With all the dynamics going on around the world.
Okay. Thanks, and then just the.
A couple of years ago like one of the debates around the green premium was that as you brought up aimed to bring on larger facilities that premium would compress. So it doesn't sound like that's happening is that right.
Can you characterize how resilience.
Anything as the green premium increasing.
CPG companies realize how tight there supply renewable a recycled product is going to be.
So first I don't think we've ever thought the green premium was going to compress over time at least not over the next decade.
You know because the supply and.
And infrastructure needed to solve the plastic waste crisis.
And a lower carbon footprint, so, we're making both climate and waste better.
It's just significantly beyond what we and others can add.
To solve that drives so simple microeconomics demands going a lot greater than the supply for quite some time so.
So the value proposition of recycled content and polymer is a true specialty product for some period of time here.
And what it uniquely brings to the marketplace.
At some point is it possible that people had a lot of capacity sure.
But that's in a way out in the future for win when that starts sort of exceeding demand.
Thank you.
Yes.
And the next question comes from Kevin Mccarthy from <unk>. Please.
Please go ahead. Your line is now open.
Yes. Good morning, everyone would you discuss your capital budget profile for this year and next it looks as though you took $100 million and in the plan for this year are there any projects that you're rethinking in this environment or is that more of a timing issue.
Whereby it would would shift into 'twenty three.
Good morning, Kevin So.
And thanks for the question so as you think about cash.
Cash flow progression, obviously, we've evaluated our portfolio of capital and we've taken action on both fronts, so they're supposed to timing.
We've highlighted earlier this year.
Some projects are getting pushed out.
As a result of supply chain issues those are resulting in some of those cash flows now.
Falling into 2023. Additionally, again, we've reduced and focused our portfolio.
We're investing to ensure that one that the safety and we maintain our plants well too that we continue to grow our core specialties and then three as we spent time today talking about our circular platform.
And I'll use that to bridge into 2023 expectation, so and what I would say is in a mild recession scenario.
Hum.
Oh.
Where we are currently at 600 million or it could be as much as 100 or 200 million higher as we make.
Progress.
All three of our projects so as Mark highlighted.
Fact that we'll be completing.
Mechanically complete here at the end of the first quarter of our Kingsport methanol at this facility.
And as we make progress on both our French project.
Third project here.
That will be in the U S that will increase the level of capital and we're confident in the cash flow that we're going to generate and allocating a significant portion of that strategic cash.
Two our innovation driven growth model and the circular platform.
The COVID-19 waiting at times like this is staying focused on how you can create value long term and making sure you're positioning yourself for the other side of an economic correction.
To be the winner.
So we're not losing side of that we may adjust the timing of some projects relative to when we expect the demand necessary.
And frankly, the softening economy will make construction costs cheaper.
So it will actually help us out in some of this.
Inflationary element of Capex cost.
Okay. That's helpful. And then secondly for Willy on Slide 12, you referenced pension and OPEC headwind of $100 million.
What is driving that and is there any.
Cash attached to it and in terms of.
<unk>.
So let me first start with our pension plans are well funded.
Tuna and there is no near term cash requirements that we would expect our large U S. Pension plans are still today, roughly a 100% plus abundant.
The key factors here are really are across.
The accounting at the end of the day discount rates and interest rates have gone up. So we will have a gain at the end of the year and our mark to market that comes back and is it higher interest cost in 2023. Additionally, with.
Investment performance this year the asset base will has deteriorated but.
Ultimately that will result in a lower return on asset.
Bottom line is from a cash and.
Funding standpoint, there are no issues I would just attribute this to mark to market accounting and the volatility that we're seeing in both interest and assets here into 2022.
Got it thank you very much.
Let's make this question the last one please.
Thank you. Our final question today comes from Jonathan <unk> from Credit Suisse. Please go ahead. Your line is now open.
Thank you two quick ones here one is since into zero is burning.
Waste plastic youre going to get in Europe , if youre going to pay something just over fuel value for that waste and then secondly in your 2023 guidance, you've got pension costs going up.
I don't think I've heard of anyone actually talking about higher pension costs in 'twenty three yet so maybe you could tell us how that's coming about.
So on the inner zero, we're not to disclose the price we're paying for the materials, but it is a very attractive price.
That supports our economics.
And there is.
The whole spectrum from things that go to waste things, they're going to park benches to.
To some modestly higher downcycled applications and so it's a portfolio we're managing on price to make sure the sort of average comes out and we're seeing that very much on track with the economics of it.
These platforms delivering $450 million EBITDA across these three projects when they're all up and running so.
Feel good about the pricing that we're getting as well as you know where the feedstock prices.
And then on pension all that.
Yes, John .
Last question was on the pension so.
Yes.
And he has been answered.
Got it thank you.
Go ahead Jim.
Okay.
This concludes our call for this morning. Thank you very much for your time and for joining us and your interest in <unk> have a great rest of your day.
This concludes today's call. Thank you for your participation you may now disconnect.
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