Q3 2023 Cabot Corporation Earnings Call
Good day and thank you for standing by welcome to the Q3 2023 Cabot earnings Conference call. At this time, all participants are in a listen only mode.
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Please be advised that today's conference is being recorded I would now like to hand, the conference over to your speaker today, Mr. Steve Delahunt, Vice President of Investor Relations and Treasury. Sir. Please go ahead.
Thank you Chris Good morning, I would like to welcome you to the Cabot Corporation earnings Teleconference. With me today are Sean Keohane, CEO , and President and Erica Mclaughlin Executive Vice President and CFO .
Last night, we released results for our third quarter fiscal year 2023 copies of which are posted in Investor Relations section of our website.
The slide deck that accompanies this call is also available in the Investor relations portion of our website and will be available in conjunction with the replay of the call.
During this conference call, we will make forward looking statements about our expected future operational and financial performance.
Each forward looking statement is subject to risks and uncertainties that could cause actual results to differ materially from those projected in such statements.
Additional information regarding these factors appears in the press release, we issued last night.
Our 10-K for the fiscal year ended September 32022, and in subsequent filings, we make with the SEC all of which are available on the company's website.
In order to provide greater transparency regarding our expected performance, we refer to certain non-GAAP financial measures that involve adjustments to GAAP results.
The non-GAAP financial measures referenced on this call are reconciled to the most directly comparable GAAP financial measure in a table at the end of our earnings release issued last night and available in the investors section of our website.
I will now turn the call over to Sean who will discuss the third quarter highlights and the market environment, and our reinforcement materials and performance chemicals segments.
Erica will review the company and business segment results, along with some corporate financial detail.
Following this Sean will provide a strategic summary, and closing comments and open the floor to questions.
Sure.
Thank you, Steve and good morning, ladies and gentlemen, and welcome to our call today.
In our third fiscal quarter, we continued to navigate a challenging macroeconomic environment.
Despite lower volumes in both segments and a tax headwind, we delivered sequential earnings improvement due to the continued strength of the reinforcement materials segment.
Consistent with the commentary in our June announcement, we continue to see weakness in China and soft demand on a global basis across many of our key performance chemicals end markets, particularly in housing and construction sector and across consumer durable applications.
In the quarter, we delivered adjusted earnings per share of $1 42.
Up 7% sequentially.
Reinforcement materials delivered a record quarter with EBIT of $132 million up 17% year over year.
And 8% sequentially, despite the third consecutive quarter of year over year volume declines this.
This level of performance reflects the resilient nature of this business and the structural improvements we have made over the last several years.
EBIT in the performance chemicals segment improved sequentially largely due to cost initiatives across the segment.
Demand in this segment remained challenged as we saw continued weakness in our key end markets with the exception of battery materials.
In the quarter, we generated strong operating cash flow of $243 million and free cash flow of $163 million of which we returned $38 million to shareholders through dividends and share repurchases. Our balance sheet remains strong with net debt to EBITDA of one seven times and we have.
One 3 billion of committed liquidity has recently been extended to 2027.
Our balance sheet and investment grade credit rating gives us the flexibility to continue to advance our long term strategic priorities supported by our disciplined and balanced capital allocation strategy.
Moving to the market environment across both segments, we have been dealing with weak end market demand. So I wanted to spend a few minutes to take you through what we're currently seeing.
Let's start with reinforcement materials were the key end markets are replacement tires and auto OE production.
You will recall that replacement tires account for approximately two thirds of segment volume with OE production and industrial applications driving the balance.
For the first three quarters of our fiscal year, we've experienced year over year volume declines with year to date volumes down 8% in this segment.
The decline is principally driven by a deep inventory destocking cycle and there is some anecdotal evidence that customers are delaying purchases.
When we look at the industry demand fundamentals, we see pretty stable conditions.
For the passenger car replacement market miles driven and the global car Park are generally good indicators for light vehicle replacement tire demand.
In the U S. For example, passenger miles driven is holding steady while the global car car Park continues to expand.
For the truck and bus segment truck tonnage is a good indicator of underlying health and we can see in the U S that this too is holding steady.
The performance of these fundamental demand drivers gives us confidence that volumes will normalize when we exit the current destocking cycle.
Auto production is the other key end market for this business and accounts for approximately 27% of reinforcement materials volumes.
Global Auto production is one area, we are seeing signs of recovery across North America, Europe and China.
This end market has experienced growth in recent quarters and is projected to grow in 2023, providing some offset to the lower replacement tire volumes.
The impact of a pickup in auto production in this segment has seen fairly quickly given the relatively shallow value chain as compared to the replacement market.
In performance chemicals, the external environment remains challenging.
Most of our industrial sector end markets are experiencing weak demand, particularly housing and construction.
And on the consumer application side, we have seen that demand for durable goods and electronics has also been weak.
Manufacturing PMI has historically been a key indicator of demand in this segment.
Currently manufacturing PMI levels in the U S and Europe remained below 50, and China has been oscillating around 50 with several recent data points in contraction territory.
Recent housing data both housing starts and building permits indicates a potential turning point in the U S, but European permits continue to drop and the China real estate market remains stagnant.
Construction and housing demand has a significant impact on our specialty carbons and specialty compounds in fumed metal oxides product lines.
As I mentioned earlier auto production is one area, where we are seeing some promising signs in terms of new car builds.
Approximately 25% of performance chemicals volume is tied to the transportation OE sector. However, we have not yet seen the impact in our sales due to lingering destocking and the depth of this value chain.
Historically this has taken about two to three quarters to see the impact of a turn in auto production translate into higher demand for our products. As this happens we would expect a lift in terms of both volumes and product mix as the automotive sector pull through our high percentage of specialty grades.
And finally, the China EV market continues to recover from a sharp sequential slowdown in electric vehicle sales in the March quarter.
The June quarter saw a sequential growth, though EV sales volumes still aren't back to the level achieved in the December quarter.
Our battery materials volumes recovered in line with this trend with Q3 volumes, increasing 29% on a sequential basis and 50% year over year.
While the volume trend is encouraging the auto EV market in China is experiencing an increase in competitive intensity as auto Oems compete aggressively on price for market share and this pressure is flowing back upstream to the battery producers and material suppliers.
As we transitioned into Q4 and look forward through the balance of the fiscal year, we have experienced pricing pressure that is impacting our margins the.
The impact is concentrated in our China business, and particularly where our products are sold into your batteries for lower priced domestic vehicles.
Where our products are sold into batteries for export to global Oems order customers outside of China, we are seeing stable prices.
Given this dynamic in China, and the continued delay and scale up of one of our Western Auto Oems. We now expect the fiscal year EBITDA to be in the low $20 million range.
As we manage through this unexpected period of turbulence in China, our focus is on three priorities.
First market segmentation to focus our efforts on higher performing batteries, particularly MCM chemistry and on those batteries targeted for western exports.
And we will continue to carefully manage the balance between volume and pricing and third we are aggressively attacking the cost structure across our base products.
Over the long term, we believe that electrification will transform the mobility sector with most growth forecasts for lithium ion batteries and the 25% to 30% CAGR range through the end of the decade.
We also expect that the EV battery market will bifurcate into a China market and our rest of world market.
We expect the market outside of China will Orient more towards higher performing MCM chemistry, which requires higher performing conductive additives.
We also expect that customers outside of China, particularly the global auto Oems will continue its strict qualification requirements and management of change protocols required by the IAA ATF quality management system.
Additionally, we also expect that the trend towards supply regionalization will accelerate in this development provides an advantage to a technology leader like Cabot has a strong global footprint and an ability to scale up capacity in region to meet customer requirements.
Over the next decade, the industry will undergo fundamental change as evs grow in the west battery supply chain, regionalize, and new technologies, such as dry process take hold.
Over this time, we expect that North America, and Europe will grow to comprise approximately 50% of the global battery market.
We remain excited by the long term growth prospects for battery materials and believe it can become a meaningful part of our profitability over time at.
At Cabot, we have the broadest conductive additives portfolio, a leading global footprint and the capability to expand in North America, and Europe to support our customers' requirements.
We believe this value proposition is compelling to customers and we continue to see momentum with the leading battery producers.
I'll now turn the call over to Erica to discuss the segment and financial performance Erica.
Thanks, Sean I'll start with discussing results for the company and then review the segment results.
Adjusted EPS for the third quarter fiscal 2023 was <unk> 42 compared to $1 70.
For 2022 with growth in reinforcement materials offset by declines in the performance chemicals segment.
Discretionary free cash flow in the quarter was $128 million and we ended the quarter with $220 million of cash cash flow from operations was 243 million, which included a reduction in networking capital in the quarter at $71 million.
FX in the quarter was $80 million and we expect full year capex to be approximately 250 Maureen.
Our balance sheet remains strong with total liquidity at $1 3 billion and net debt to EBITDA of one seven times as of June 30.
In the third quarter, we increased our year to date operating tax rate from 25% to 28% driven by an update to the fiscal year forecast and the geographic mix of earnings within the updated forecast.
The increase in the operating tax rate included a catch up expense for the first half of the fiscal year that we booked in the third quarter, which resulted in an unfavorable impact of 10 of adjusted earnings per share this quarter with a catch up.
A total of 17 and the year to date impact.
We expect that fiscal year operating tax rate range to now be between 27% and 29%.
Now moving to reinforcement materials.
During the third quarter EBIT for reinforcement materials increased by $19 million as compared to the same period in the prior year to a record EBIT of 132 million.
The increase was driven by improved unit margins from higher pricing and product mix.
23 calendar year customary agreements.
Higher fixed costs, partially offset by 8% lower volumes globally volumes were down in all regions in the third quarter as compared to the same period of the prior year with declines of 10% in the Americas, 12% in Europe and 5% in Asia.
Looking to the fourth quarter of fiscal 2023, we expect reinforcement materials EBIT decreased sequentially.
Recently lower volumes in Europe , and higher fixed costs, driven by the timing of spend volumes in the fourth quarter in regions outside of Europe are expected to be relatively consistent.
Fiscal quarter.
Now turning to performance chemicals.
EIT decreased by $31 million in the third fiscal quarter as compared to the same period in fiscal 2022.
Decrease was driven by 9% lower volumes and lower unit margins volumes were lower across all product lines, except battery materials, and most notably and was a 23% year over year decline in metal oxides volumes.
Our volumes in fumed metal oxides are driven by weaker demand in silicones applications and the impact of partner and downtime.
Lower margins were driven by a less favorable product mix and battery materials and specialty cartons.
Looking ahead to the fourth quarter of fiscal 2023, we expect EBIT in performance chemicals to be up sequentially.
Higher volumes in our battery materials and inkjet growth factors, while volumes in our larger product lines are expected to remain consistent with the levels experienced in the third fiscal quarter.
We expect pricing pressure in the EV value chain in China as Sean discussed in the near term impact battery materials results.
Now moving to our cash performance our outlook for the rest of the year is for continued strong cash generation and will continue to enable our growth investments as well as returning cash to our shareholders through dividends and share repurchases.
Year to date, we have generated $457 million in operating cash flow. We have spent $166 million year to date for capital expenditures, which included spending on growth investments as well as maintenance and compliance projects.
As we have talked about before returning cash to shareholders is a critical component of our capital allocation strategy and has been supported by our operating cash flow. We raised our dividend by 8% in may and year to date, we have $65 million in dividend. In addition, we repurchased $48 million of shares year to date for <unk>.
<unk> of $113 million of cash return to shareholders.
Year.
Our outlook for cash remains positive for the year.
<unk> strong operating cash flow to continue.
Current assumptions on oil prices debt levels are sound and are expected to stay around the current level of net debt to EBITDA at one seven times.
That's really a forecast for capital expenditures is approximately $250 million.
We also expect to continue to return cash to our shareholders. In addition to our quarterly dividend, we anticipate increasing the amount of share repurchases in the fourth quarter given the strong cash flow forecast I will now turn the call back over to Sean.
Thanks Erica.
Moving to the fourth quarter outlook I am pleased with how the Cabot team continues to respond despite the challenging macroeconomic environment.
<unk> materials segment posted record results in the third quarter and is on its way to another year of record EBIT results. Despite weak replacement tire demand throughout the fiscal year from a prolonged destocking cycle and.
In performance chemicals, we expect results to improve sequentially driven by volume growth in battery materials and inkjet, while the larger product lines. In this segment seem to have stabilized, albeit at a level well below recent history.
Given these factors, we expect adjusted earnings per share in the fourth quarter to be in the range of $1 40 to $1 55.
Which would bring our full year range between $5 13 to $5 28.
As Eric discussed, we expect the fourth quarter to be another strong cash flow quarter to support our capital allocation priorities.
Fiscal year 2023, certainly has developed differently than expected the rapid increase in interest rates has dampened demand across the housing sector and for consumer durable goods Europe has been in a technical recession in China's economy has not been the driver of global growth as was expected following their exit from strip.
Covid protocols.
Despite these headwinds we believe are creating for tomorrow strategy is the right one for Cabot with a focus on advantaged growth innovation and continuous improvement.
By pursuing this strategy, we believe we will grow transform and reshape the valuation potential of the company.
We continue to execute against this strategy, despite a challenging environment.
Have a very resilient structurally different business in reinforcement materials as evidenced by record results, despite lower year over year volumes to.
The performance chemical segment remains a mix of high growth high margin businesses with leading market positions and good industry structure that at the moment is dealing with a unique environment of weak end market demand in the China economy that has yet to rebound post COVID-19.
We believe that these product lines will recover in line with the underlying end markets.
Battery materials product line, while developing slower than we originally expected remains a compelling growth opportunity for Cabot and we believe we are well positioned to grow as the market expands outside of China.
Our cash flow and balance sheet remained very strong and support our balanced capital allocation priorities.
And finally, we are a recognized leader in sustainability and this strength underpins our purpose and are creating for tomorrow strategy.
I would like to close by again, recognizing the entire global Cabot team for their resilience and their commitment to execution as we navigate this challenging macroeconomic period.
Thank you very much for joining us today and I'll now turn the call back over for our Q&A session.
Thank you.
As a reminder to ask a question. Please press star one one on your phone and wait for your name to be announced to withdraw your question. Please press star one again.
Standby as we compile the Q&A roster.
One moment please for our first question.
Our first question will come from David Begleiter of Deutsche Bank. Your line is open.
Thank you good morning.
As Sean and replacement tires, how long a prior destock cycles less at four.
Yeah, Good morning, David.
Certainly.
The destock that we seem to be experiencing right now is is longer than I think.
History would say, we're now three all three of our fiscal quarters have volumes down.
Year over year, and our expectation on the Q4 consistent with the.
The outlook that Eric provided would say that that.
We'll probably be four quarters.
Where.
We're down year over year, so it certainly feels like.
More pronounced destock cycle than than history.
I think the result.
We listen to what the the big tire makers.
Say.
I think we should be coming to an end.
On this but I think it has been more difficult I think for for people to see this because we came out of Covid.
Bounce than they're worth a long period of transportation logistics disruptions.
And given given how many of the tires in the world.
Rely on Chinese exports I think there were a lot of tires.
On ships and in the in the supply chain that.
We're tied up and it really created a lot of distortion. So I think all of that has been getting worked off here.
This year, but certainly from our historical experience David This one.
One is is a bit longer but I think it's because of those distortions coming out of Covid and the.
On the supply chain disruptions that have now worked their way out and again as we as we.
As we look across our customer base.
It seems that.
Debt.
That should be coming to an end here and as that happens then.
We would expect.
Positive turn from a volume standpoint, and given the operating leverage in the business.
That can be quite material.
Good and just on your annual contract negotiations how are they progressing I know you had some a number of annual or two year contracts overall, how are they progressing how should we think about pricing for next year in that business.
Yes early to say at this point.
David but I would say the the annual contract cycle.
Is beginning now.
And we will follow I would say a more normal cadence, which is really a.
Our fall September through end of year cadence last year there was.
That was pulled forward a little bit.
I'd say this year's.
This year's cycle.
We will probably resemble a more traditional pace. So again discussions in the fall.
Is likely what will happen and we continue to believe that price increases are needed based on increased sustainability costs as well as the premium and <unk>.
Quality and service that we provide to customers and so while I can't comment because it's too early in the process.
Just as a reminder, we did closed several multiyear agreements last year with an incremental price increase in 2024, and our view is that.
Those price increases are the baseline for the rest of our 2024 contracts and should set the level of price increase is expected during the negotiations. So we will certainly be updating on our next call as we're deeper into the cycle and that would be typical.
Thank you.
Thank you.
One moment please for our next question.
Our next question will come from John Roberts of Credit Suisse. Your line is open.
Thank you how much has the energy co product credit declined for earnings with the lower oil prices that we've had until the recent bounce.
John .
Thank you.
Certainly last year energy prices, where we're higher than that.
Those have those have moderated and so.
I think in the full year numbers. This year, we're running about $5 million per quarter.
Lower energy center benefits so.
2023 versus 2022, so something on the order of $20 million on a full year basis 2023 versus 22 down.
And then are all carbon black producers, reducing production similarly or are you seeing any significant share shifts from some of the some of the suppliers continuing to run full out.
No we're seeing I think real stability there I think.
Sure.
Volume declines are consistent with.
What on average the major tire producers are experiencing of themselves.
So we're not seeing any.
Any any share shift here and that would not.
Be expected as agreements.
Annual agreements are multiyear agreements have.
Have certain volume targets attached to them.
So you typically don't see move.
<unk> inside of the contract periods I think also if you.
You look at this business you have a business with relatively I would say stable, but modest growth rates and so.
It is very important in terms of the key levers of success in running the business.
You want stability of volumes grow at the market rate.
Manage the pricing and product mix.
In a in a in a in a stable way and then continue to drive technology and operational efficiency.
In the plan so high OE, so we keep our assets and our uptime high.
And and then also drive the energy recovery that you you touched on those are those are really the drivers of success here.
And not.
Not not really.
Sure sure grab thats not thats not how we think about the <unk>.
Business.
Great. Thank you.
Thank you.
One moment please for our next question.
The next question will come from Josh Spector of UBS. Your line is open.
Yes, Hi, just had a couple of questions on the battery business. So I think Sean if we looked at a couple of quarters.
I thought that business could do north of $40 million in EBITDA I believe this year now you're talking low <unk> I heard you correctly can you go through that and maybe parse out how much of that is as volumes versus some of the pricing pressure here.
I'll stop there and I'll have a follow up there as well thanks.
Sure Good morning, Josh.
So certainly youre right at the beginning of the fiscal year, we had been seeing at that time really consistent sequential quarterly growth in the market and our expectation was that this trend would continue through the year and that that core assumption in combination with an <unk>.
<unk> ramp of volumes at new customers, particularly outside of China.
Is what informed our expectation for the year.
And then as as the year progressed in Q2.
A significant sequential decline in EV sales in China the market.
It was down pretty sharply we commented on that which which disrupted this trend of sequential growth that we had been seeing in and that was driven by by several factors certainly.
Covid related disruptions that were occurring at that time had a distorting effect on things as well as the fact that there was a very significant decline in key raw material prices, particularly lithium.
And that March quarter, and so it really drove a behavior of Destocking and then finally.
The Chinese government.
Had incentives for Evs in place in those expired at the end of December and so that that impacted buying behavior and so.
This impact in China from all of these things.
Definitely caused us to lower our outlook in Q2 now since that time.
<unk> seen a pickup in volumes in China, starting in April and this continued through our Q3.
As we commented on however, while volumes began this sequential.
Initial recovery.
Have seen price pressure in the EV auto OEM market has really intensified I think.
This was very visible as Tesla reduced prices there in.
It set off.
A bit of a price war.
Auto Evs.
In China as they were competing for for market share and this has created pricing pressure in the battery flowing back up to both batteries and the materials chain as we move into our fourth quarter. So I think this factor combined with <unk>.
Continued delay in the ramp of some of our western customers is impacting our view on the forecast and informs the outlook that we did.
We shared.
So I'd say I'd say, while the current environment in China is challenging.
It is concentrated in the lower end domestic Chinese vehicle market.
The market for the U S and Europe remained stable from a pricing standpoint in Chinese batteries that are.
Sold for export to Western Auto Oems that also remains remained stable so.
It's.
Really thinking through the segmentation of the market here. This is a real priority for us focusing our market segmentation on higher performing batteries.
And.
And then balancing.
Share in pricing and on the more more base and of our product line.
Really focusing on on cost reduction and then over time, what we see Josh is that the market is clearly bifurcated into a China market in our rest of world market.
And we expect the rest of world market to behave.
Consistent with the auto market norms, where there are very strict qualification requirements and management of change protocols et cetera.
And we also expect this market is going to continue to regionalize. So all of that creates I think momentum for growth outside of China and four.
More predictable and durable profit pools.
And then we expect inside of China.
That.
The market two is bifurcated, there with lower end vehicles sort of on one end.
There.
The Chinese government is promoting evs aggressively and.
The lower end of the market there are offerings.
In the 10 to $15000 per vehicle range, which is very very very cheap and then you've got on the higher end side.
More more traditional.
Vehicles that are.
A bit more premium and I think in this market. Our view is that the lower end will use more base conductive additives.
And pricing and margins here will will probably cycle with.
Demand and this will be probably pretty consistent with what we've experienced in China over the years across our other markets and then we expect the high end of the market will require higher performing conductive additives, which should command higher pricing and margins. So I think it's going to be critical that we manage.
These segments in a differentiated way.
And that'll be that'll be.
Really important for us as we manage through this.
Unexpected turbulence in China in the long term, we see the growth fundamentals here remaining intact and we see the growth expected outside of China U S and Europe over the next 10 years. It is expected by most forecasters to represent about 50% of the market.
And so I think the the requirements and therefore, the profit pools outside of China.
We will remain very attractive and.
And more durable and inside of China, it'll be about how we segment the market.
And choose our places to participate that oriented more towards higher value.
So that's that's a bit of what's what's going on in the market and how things have developed over the course of the year.
And what would evolve differently than what was originally expected and informed our initial outlook.
Thanks, John I appreciate that just two quick follow ups just one your exposure to China today in this business versus where you aim to be a couple of years from now can you give us some numbers there and then second just has anything changed on the supply side and carbon nanotubes is that an area, where youre seeing more pressure or is it realm.
<unk> broad across your portfolio.
Yes, so first I'll take them in the order.
Josh.
<unk> in terms of the China market today. It represents for the whole market about 70% of batteries are made in China. So the world is is definitely skewed to China at this point and our geographic makeup.
Similarly, skewed probably even a bit higher than that.
In terms of our our portfolio, what we would expect as we look out over the next 10 years is that U S and Europe will grow to represent about 50% of the battery market.
And we would certainly be targeting.
At least.
That.
Level of breakdown across our portfolio, but given our our position our global footprint, our breadth of technology the orientation of.
Of the market outside of China towards towards MCM, because they want longer longer range et cetera. Those are those are going to orient towards higher performing products is our view and so we would we would hope to win a disproportionate share, but that's how the market will break out in <unk>.
Wed expect that our percentage of our business wood wood at a minimum.
Evolve accordingly.
Now on the second question on the on the supply side the.
The market inside of China is certainly very dynamic.
And we have seen new.
New entrants that have.
Have been developing here over.
The recent period end and customers certainly given the the.
Pricing pressure in China, right now at the EV level.
Youre seeing that push all the way upstream in and customers are getting.
Getting more aggressive.
<unk>.
Pricing in about.
Trying to develop additional alternatives and so again, our focus is on segmentation because on the higher end of the market.
We see prices more stable because the performances is higher and certainly on batteries that are exported to global auto Oems same same thing so.
I think it's again in China is going to be about how we segment the market towards.
The higher value.
Product lines that will be our key area of focus.
Thanks, Sean.
Thank you.
One moment please for our next question.
Okay.
The next question will come from Jeff Zekauskas of Jpmorgan. Your line is open.
Thanks very much.
I know that it's early to talk about.
Carbon black price negotiations in Europe .
The United States for 2024.
But it's the general posture that the carbon black companies think that prices should be up and the customers think that prices should be down.
Hi, Jeff.
I think that's perhaps a reasonable.
A summary, if you look at.
At R.
Our business we have.
A percentage of our business that has multi year agreements with our second year with price increases I know some of our competitors that have commented publicly.
Have the same and so I think that.
The view is that those price increases are kind of the baseline for the rest of our 2024 contracts and should really set the level of price increases I would say number one number two the environmental costs.
Continue to rise in this business and those costs have to be recovered and so I think the fundamentals there.
Have not.
Have not really have not really changed so as we head into <unk>.
Negotiations here I would say.
On the supplier side the supply side capacity is picture remains has.
Structurally is.
We've commented on in the past so no no change there.
We are going to see restrictions or sanctions go in place around Russian product into Europe in 2024. So.
I think the supply.
The supply picture.
It remains very important for our customers and.
I think that.
That net getting supply reliability is going to be pretty critical for them.
Okay.
In China in the traditional China.
Carbon blacks tire markets.
Can you talk about the price raw material spreads.
Whether they're narrowing or expanding and can you talk about the effect of Russian imports of carbon black into China.
There are impacts.
Yes.
So in terms of our margin profile in China, Jeff, It's pretty stable right now so as as raws move around that market because it's more of a spot market tends to adjust very quickly.
And so I think the price raws recovery is is basically matched.
And the unit margins are.
Are holding pretty steady.
Though at a lower level than than where they were.
A couple of years ago, but they are holding their holding steady in terms of Russian product into.
Into China, maybe I'll, just sort of pull the lens back a bit so the Russian exports right now are down about 50%.
From into Europe from where they were they were pre <unk>.
Ukraine invasion.
And again there are sanctions.
On the books that will go into effect.
At the end of June 2024, so that number based on those sanctions then arguably has to pass to go to zero now what's happening with the product and where is it going.
We are seeing.
Some of the product go into markets like Turkey, which is a.
A pretty good size tire production base with no carbon black.
Production.
In countries. So some of it's flowing there some of it's flowing to the middle East some of it is flowing into China.
We're not seeing that flow have.
Any material impact on the competitive dynamics in China, because the market is just so big so a few hundred thousand tons flowing into.
A market that is.
I think somewhere in the order of probably seven or 8 million tons.
Is is not.
Not really changing the dynamic there I think in China the.
The market has its <unk>.
Competitive intensity in the Russian stuff isn't isn't really changing that but that's a quick overview of kind of what's happening with Russian exports.
And where we see them showing up.
And the expectation is that the exports into Europe , given the sanctions.
Go to go to go to zero by that by that date of June end of June .
Okay. Thank you for that and then lastly.
Can you talk about.
Your specialty black volumes, both in the second quarter and year to date that is what what kind of growth or contraction you are experiencing.
And how is the profitability of that business.
Yes.
So certainly across performance chemicals, we have seen weak.
Weak volumes and its really driven by.
Weakness in the end markets in specialty carbons that is definitely the case, where its been more pronounced in.
In performance chemicals is in our human lock sides business, but certainly specialty carbons has seen.
<unk> has seen weaker weaker volumes.
But.
I would say the carbons volumes are pretty similar to what we summarized for the overall segment down.
Round, 9%.
In in the in the quarter now.
While that's sort of headline volume you also have <unk>.
Mix factor here.
Where some of the higher end mix that pulls through much stronger margins has been has been weak while the auto sector is.
Beginning to recover in terms of production, we typically see a lag in that given the length of these value chains that we sell into so we've not yet seen that translate into our into our business and as a result, we're not we're not getting that mix uplift that we would.
We would normally get again as the lag works its way out.
From the auto build should flow through but certainly there is a mix impact on the business today.
In terms of profitability.
It is down.
In the business very similar to the overall declines in the segment I would say.
That's roughly how it's playing out.
Okay. Good thank you very much.
Sure.
Thank you.
And one moment please for our next question.
The next question will come from Chris cash Luke.
Loop capital your line is open.
Yes. Good morning, a lot of my questions have been asked but they do have a couple one I wanted to see.
Held back a little bit on the battery materials discussion and thanks for a lot of the characterization on details on that but.
So I get the bifurcation China versus.
Western OE producers.
Particularly.
I guess low price low value cars, and LSP batteries in China NMC.
For the longer range in western markets, but it's not intuitive to me that the role of the conductive carbon in these batteries is all that different.
Understanding is.
Regardless of the battery chemistry their inputs to just facilitate the flow of electrons from cathode anode and vice versa.
So I'm wondering what.
What is it about the China LSP battery construction Thats, that's led to this.
Kris and competitive intensity is it is it simply the mentality of these producers that you kind of alluded to this but it sounds like there.
Not adhering to.
Strict.
Keeping a high bar with the qualifications and Im curious if thats.
Just how pronounced that dynamic is in the overall battery value chain is it more focused on on carbon nanotubes or is it also applicable to.
The conductive carbons that are made in your traditional reactor footprint.
Yes so.
Chris a couple of things here so.
At a high level, what you have in China is a market that.
Battery market that is more oriented towards LSP.
Rather than NMC and so.
And outside of China, you have the orientation towards NMC because.
Range of matters more and so in China inside of China, It tends to be more ft, and while it is true that they both require conductive carbon additives in the volume loading is is not.
Materially different across those two you can have a very different.
Levels of performance. So some of the the low end of batteries in China RFP might have ranges in the 100 miles where these are going into evs that are sold into consumers that are probably more like tier three tier four cities in China.
And so it is it is a lower a.
Our lower performing battery.
And so a couple of things.
I think cap in there the the pricing intensity given that the cars are selling for such a low price.
Price is definitely higher end and given the performance requirements.
They'll they'll put more pressure on the inputs and.
And our view what we see is.
There they are more.
Aggressive.
Or less.
Less disappointed around around sort of qualification standards, because they're being sold as local domestic vehicles.
At at a very low price. These are not products that are being exported either the batteries or or the cars.
So I think that's that's a bifurcation that you're you're seeing how the market plays out at the low price end of the EV spectrum, you're going to see <unk> technology, and youre going to see.
The low end of <unk> technology.
P can stretch.
In terms of its range, but at the low end for these low priced cars.
Seeing much.
Lower performing LSP batteries. So that's that's the dynamic there in the sort of mid to higher end.
You still see an orientation in China towards LSP. It makes up I think somewhere maybe close to 70% of the market is LSP in China today.
But you have a higher performing.
And of the market, there, where you get more range and therefore, the requirement for higher conductive additives better performing conductive additives.
Higher purity.
And.
More.
Discerning customer base in terms of.
They or their willingness to switch and take quality risks and things like that so some of it is.
Behavior or the mentality as you as you put it but we see the market.
Kind of bifurcated between that low end and then.
Domestic the medium at higher end domestic and then on the export side, where Chinese producers are exporting batteries to global auto Oems.
We are seeing.
Real stability, there and we're seeing that obviously, the the management of change requirements for.
Western auto a global auto Oems.
Or are pretty strict and we know that from our other participation in the auto sector, but that's that's pretty strict that's why we see the.
The west developing differently then.
Then then in China.
Got it I appreciate that just as a follow up and I. Appreciate your comments about the market segmentation approach a little bit of a.
Pivot on the on the strategy addressing this growth opportunity, but the evolution of this market dynamic.
Once your.
Intent with respect to capital allocation to grow capacity as this market grows in other words are you going to focus only on.
Installing the capability to supply the western markets and walk from the large and growing domestic market in China or.
How are you approaching that yes.
So I wouldn't say.
Any fundamental shift but.
A bit of an adjustment I would say in terms of our approach so it'll be guided first by our choices around <unk>.
Segmentation and so certainly in the west in the U S and Europe .
We continue with our our intentions to build capacity there to support customers, but that'll be times with how the customers projects are advancing I would say in general.
While there are a lot of battery.
Giga factories under construction right now most of them are targeted to come on.
In the sort of 25 through 2028 period, and so we'll be looking to see.
Synchronize our capacity ads with that but I would say no change in the aiming point here because we believe those are going to be valuable.
And durable profit pools.
With respect to inside of China, again segmentation will be critical here.
And what we'll be doing is managing our capacity adds to <unk>.
To match that.
As you know last year, we brought on a significant tranche of specialty carbons capacity.
In China and with that market.
Slower to recover.
That is making more capacity to make high value.
Battery grades in China off our existing network, it's creating more and.
More capacity to do that so we can.
We can I think adequately serve that without significant.
Sure.
Increases in our near term capacity, so we're going to be managing that.
Very carefully in China tied to our segmentation approach.
And then outside of China, It's really no change in the aiming point, we just got to make sure we synchronize that I wouldn't call that a change but.
We're going to make sure we synchronize that with customers timing.
That's helpful. If I could just sneak in one last one about the fumed metal oxide business and under what scenarios would you be able to underwrite a recovery more pronounced recovery in that business. So it is it would depend on the semiconductor end market recovery is it going to be.
Piggybacking off of China, stimulants, and recovery, there or is there something that cap.
Cabot can do specifically to drive a recovery there. Thank you.
Yeah, So certainly the semiconductor I mean.
<unk>.
Silicone space, which really.
It drives the the largest part of the fumed silica business.
Has been very weak and if you look at end markets for silicones building and construction is.
Is the largest one and.
And that has been quite weak globally. So I think we would need to see.
Turn in in building and construction.
In order to.
Ill provide more more more stable volumes in that in that business because in this business volumes are are off gray.
Greater than 20% year over year end and it is the highest margin business in the performance chemicals portfolio. So it.
It is it is impacting us with those weaker volumes, but I would say housing recovery and building and construction.
Is one.
Silicones also go into the automotive sector and so as the auto builds improve.
Again with a little bit of a lag we should we should see some improvement there and then the semiconductors as you said electronics in general that Thats another important area.
And that certainly.
It looks like it's beginning to pick up a bit more now which is good.
But we need to see those end markets really improve Chris.
Chris to provide more normalized volume picture in terms of the things that we can do in terms of self help of course, we we continue to do in terms of.
How we segment the market and.
The products, we're selling the mix and how we manage our costs.
All of that is stuff that we can do but we need to see the end markets improve a bit here and there are some mixed signals in the U S. We're seeing maybe some early signs of of housing and construction beginning to turn.
Say thats the case, yet in Europe or China.
But.
We'll have to see how that evolves here in the coming coming couple of quarters.
Thank you.
Thank you.
And one moment please for our next question.
Our next question comes from the line of Laurence Alexander of Jefferies. Your line is open.
Good morning, So I guess first of all do you have any end markets by region, where customers are clearly telling you inventories are too low and.
And secondly can you give an update on how the.
<unk> <unk>.
Conductive carbons platform is evolving so should your operating leverage to.
<unk> and EV sales be different in 2400.
<unk> 25 than it was in 2023 can you just give us a sense for what the kind of.
Underlying.
Technology developments is looking like.
Sure. Thanks, Lauren so in terms of end markets and inventory.
Positioning.
It certainly seems like where we're at at the end or near the end of Destocking I mean, as we talk to our customers.
We're not seeing.
The inventory levels.
At at at normal safety stock. They are below that is what what customers are telling us and theyre basically.
Ordering.
To meet their current demand not.
Not not building stock in anticipation of.
Of growth and we do see that translate into order pattern behavior aware.
We might find customers order a couple of times a month instead of once a month, so they're truly reacting to their current demand and I think have a very cautious posture on inventory.
Where it can get more.
Murky I think is is downstream of them. How good is there visibility, especially in some of these longer value chains, but I would say the general.
Our sense is that inventory levels are low and below normalized levels of safety stock, but people were being cautious and looking for a turning point with with rates having ratcheted.
Consistently throughout 2023.
And question marks around the macroeconomic environment.
Customers have just been really really cautious and I would say, that's how I would characterize.
Things, so as a turning point happens.
Then I think our expectation is that customers would have to rebuild inventories to a more normal level to support demand, but we've not seen that yet, but that's a bit of characterization on the inventory side and my sense in in in hearing how other.
Players in the chemical chain are seeing things I think that's pretty consistent.
In terms of the conductive carbons.
Technology.
Evolution here, we have a range of conductive carbon additives technologies in our portfolio.
The.
The widest breadth of products.
Compared to any.
Any competitor from both conductive carbon furnace black types to carbon nanotubes to carbon nano structures now over time, what we see as the battery market evolves here.
Is that as the proportion of NMC batteries increases then the need for higher performing carbons.
And blends of things like conductive carbon blacks and Cmt's will become more important so no no real change there and we continue to.
Develop both of those product lines, because we think they will they'll offer differentiated performance, especially in these.
In these higher end batteries.
Certainly as as volumes continue to grow in this market there'll be some operating leverage benefits we've been investing.
Ahead on growth both in terms of capacity.
As well as SG&A in this business.
<unk>.
As as those growth investments are absorbed.
Sure.
Costs are absorbed with volumes there'll be some operating leverage that will certainly come.
Thank you.
Thank you.
And I see no further questions in the queue I would now like to turn the conference back to Sean Keohane for closing remarks.
Great well, thank you very much Chris and thank you all for joining the call. Today. We appreciate your continued support of Cabot and look forward to speaking with you next quarter. Thank.
Thank you very much.
This concludes today's conference call. Thank you all for participating you may now disconnect and have a pleasant day.
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