Earnings Transcript for TSE - Q4 Fiscal Year 2022

Operator: Good morning, ladies and gentlemen, and welcome to the Trinseo Fourth Quarter 2022 Financial Results Conference Call. We welcome the Trinseo management team, Frank Bozich, President and CEO; and David Stasse, Executive Vice President and CFO; and Andy Myers, Director of Investor Relations. Today's conference call will include brief remarks by the management team followed by a question-and-answer session. The company distributed its press release along with its presentation slides at close of market Wednesday, February 8. These documents are posted on the company's Investor Relations website and furnished on a Form 8-K filled with the Securities and Exchange Commission. [Operator Instructions] And I will now hand the call over to Andy Myers.

Andy Myers: Thanks, Abby, and good morning, everyone. At this time, all participants are in a listen-only mode. After our brief remarks instruction will follow to participants for question and answer session. Our disclosure rules and cautionary note on forward-looking statements are noted on Slide 2. During this presentation, we may make certain forward-looking statements, including issuing guidance and describing our future expectations. We must caution you that actual results could differ materially from what is discussed, described or implied in these statements. Factors that could cause actual results to differ include, but are not limited to, risk factors set forth in Item 1A of our annual report on Form 10-K or in our other filings made with the Securities and Exchange Commission. The company undertakes no obligation to update or revise its forward-looking statements. Today's presentation includes certain non-GAAP measurements. A reconciliation of these measurements to corresponding GAAP measures is provided in our earnings release and in the appendix of our investor presentation. A replay of the conference call and transcript will be archived on the company's Investor Relations website shortly following the call. The replay will be available until February 9, 2024. Now I'd like to turn the call over to Frank Bozich.

Frank Bozich: Thanks, Andy, and welcome to our year-end 2022 call. I'm proud of what we accomplished over the course of 2022 while being faced with significant macroeconomic headwinds, which are well documented at this point. Operating in this challenging environment did lead to earnings and cash generation that were below our expectations, especially following our record profitability in 2021. But we focused our efforts throughout the past year on initiatives that will improve our strategic position when demand recovers. These can be broken down into 3 categories

David Stasse: Thank you, Frank. Our fourth quarter adjusted EBITDA was below our previously announced guidance due to $19 million of negative net timing impacts caused by falling raw material prices as well as $15 million of unfavorable impact from nat gas hedges. I'd like to spend a minute explaining our philosophy related to the use of natural gas hedging to manage our cost risk and how it has changed over the last 9 months. Volumetrically, about 60% of the gas we purchase is in Europe. In 2022, this represented over 90% of our cash spent on natural gas. We formed a view in mid-2022 that record gas prices in Europe would have to fall because of the high levels of storage and declining industrial demand. As such, we hedged our natural gas only out a few months. We've since seen European natural gas prices fall over 80% and North American gas prices by over 60% and we've been layering in 2023 and some 2024 hedges on the way down. Because we don't qualify for hedge accounting treatment for all of our hedges, we will have some mark-to-market volatility in the P&L going forward, but I wouldn't expect it to be the same magnitude as Q4. During the quarter, we reported a noncash $297 million goodwill impairment charge related to the PMMA and tech services acquisitions. The impairment charge resulted from our annual goodwill impairment analysis and was deemed necessary given the challenging macroeconomic environment, particularly for building and construction, as well as a prolonged drop in our market capitalization. We view these businesses as integral components of our evolution as a specialty materials provider and remain excited about the growth opportunities they will provide in the future. Fourth quarter free cash flow of negative $20 million was below our expectation, caused mainly by lower earnings and the $34 million payment to the European Commission to settle the 2018 styrene purchasing investigation. An accrual for this was booked earlier in the year and with this cash payment, we consider this matter closed. We ended the year with $717 million of available liquidity, including $212 million of cash on the balance sheet. As it relates to capital structure, our nearest term maturity is a $660 million term loan that matures in September 2024. The financing markets have improved considerably to start the year and refinancing this loan is a priority for us. Our strong liquidity position and our view that the bottom of this earnings cycle is behind us, gives us great confidence in our ability to weather this economic downturn. Now I'll turn the call back over to Frank, who will talk about our expectations for 2023 and the first quarter.

Frank Bozich: Thanks, Dave. Looking back at 2022, it was a year of 2 halves, with the second half earnings substantially lower than the first half. This decrease was essentially from lower demand, which led to both reduced sales volume as well as margins. While raw materials and energy prices were elevated in the first half of last year, these costs were passed through in our pricing. However, higher interest rates and energy prices as well as COVID lockdowns in China, eroded consumer spending in all 3 regions, resulting in lower sales volumes and margins. So we view an increase in demand as the number one catalyst for earnings improvement. For the full year 2023, we are guiding to a net income of $3 million to $33 million and an adjusted EBITDA of $375 million to $425 million. We expect demand levels to improve as the year progresses with first quarter sales volumes slightly higher than fourth quarter from seasonality. We view this as the trough level demand. For the remainder of the year, we see volumes about 10% higher than this trough level, which equates to about $30 million of the EBITDA per quarter. To give you some added perspective, a 10% volume increase would represent a recovery of about half the volume drop from the first half to the second half of [Audio Gap] should come from a few areas

Operator: [Operator Instructions] We will take our first question from Matthew Blair with TPH. Your line is open.

Matthew Blair: Frank and Dave, I thought the commentary on the recycled products was pretty interesting. I think you said it was 1% of your volumes, but 3% of your margins. Could you talk about how you price these recycled products? Is it like a fixed contract, like a fixed spread on your end? And then as we think about this price premium that you're getting, how much of that comes from like regulatory factors? And how much of that is just like a voluntary premium that these brands pay to improve their ESG scores.

Frank Bozich: So thanks for the question, great question. Most of the premium we're getting is basically being driven by self-imposed goals that most of our end customers are setting on themselves rounding related to CO2 intensity reduction. So -- and we're basically -- in the current environment relative to the availability of these materials, there's an unlimited demand. So we see this as -- and a big opportunity for us and is we're trying to accelerate the availability of the key feedstocks that allow us to supply more into the market every quarter. So there are some regulatory drivers that will come. I think there are some various packaging taxes that will be imposed in Europe and that I think that's reflected in the pricing that we're getting. But again, most of it is self-imposed, and it's a negotiated price rather than a formulaic price that we have with the customers.

Matthew Blair: And then, Frank, you called out weakness in Q4 in areas like construction, durables and electronics. Could you talk about how each of those markets are faring today versus the Q4 level?

Frank Bozich: Yes. So what we're seeing is the level in Q1 that would be consistent with that level but obviously, with the normal Q1 seasonality. So far, we haven't -- we aren't seeing a significant demand increase in those underlying markets other than seasonality. .

Operator: We will take our next question from Frank Mitsch with Fermium Research. Your line is open.

Frank Mitsch: Given your headquarters location, I feel like you need to say go Eagles. So we'll see on Sunday. David, I have a random question for you that's in the footnotes at the bottom of Slide 16, talking about your 2026 revolver suggesting that it's going to end at $102 million at the end of the first quarter. Can you talk a little bit about that? And what should we -- what should -- what are you meaning to imply there?

David Stasse: Well, yes. So the revolver, it has and always has a -- there's a covenant attached to it that measures a certain leverage ratio. And if that leverage ratio goes above a certain threshold, which were not at the end of the year, but we will likely will be at the end of the first quarter, the availability under the revolver shrinks to 30% of the revolver. So a $375 million revolver. We have a small amount of letters of credit drawn against that, which is just normal business. So all of that is available to us today. At the end of the first quarter, I expect on an LTM basis, our leverage ratio will go beyond what's stipulated in the covenants, at which point only 30% or 112 -- well, $102 million will have available to us under the revolver, okay? So that's how that works, the mechanics of that, given the guidance that we laid out here today and what we expect to have happen in the business, we expect that leverage ratio to go below the threshold and have available -- the full availability under the revolver by the end of the year. But look, to be clear, Frank, I'm a I don't see that affecting us operationally. As we said, we ended the year with $212 million of cash. We have $150 million effectively in ABL and asset-backed receivables line available to us. there's no covenants attached to that, and that's a fully committed facility. And then beyond that, we would still have $102 million available under the revolver. So we highlighted that and put that in here because we think it's instructive for investors, but I don't foresee the need for us to need that liquidity.

Frank Mitsch: That's an excellent synopsis sincerely appreciate that. And Frank, coming back to the Engineered Materials business. Some of the expectation is to see an improvement post Chinese New Year. I'm curious, you did mention that your order book is somewhat encouraging. Can you add a little more color with respect to the Engineered Materials business and what you're seeing there and expectations there?

Frank Bozich: Sure. I think that clearly, we -- one of the big benefits that we're going to have is not having the hedge headwind that we had in Q4 and Q1. And -- so I would expect that to be an improvement over where we were in the quarter. We'll have some normal seasonality. But as it relates to that arbitrage window and sort of the destocking I think there's going to be overhang through Q1 is what we would anticipate. And then we get back to more of a normalized over the course of 2023, we'll get back to levels like we were in the first half of 2022, which is about a $35 million per quarter run rate in the business. There was -- now for us to get back to where we should be with the business, we need to see a structural market improvement in automotive and in building and construction, particularly around the Asian imports that sales of building and construction products in Asia that used to be exported into Europe. So we see that as a longer-term improvement. But our expectation is we get back to the first half 2022 levels during the -- in the second half of 2023.

Operator: We will take our next question from David Begleiter with Deutsche Bank. Your line is open.

David Begleiter: Frank and Dave. Frank. Just on European natural gas prices, given the reduction we've seen, any change in your thought process on European asset restructuring? .

Frank Bozich: Any -- well, first of all, no, I don't believe that any of the actions that we've taken, I would have any reason to second guess those given the reduction, I think that's consistent both strategically and in the near-term financials. So -- and in fact, we're going to see a benefit from both of those restructuring plans early in 2023. The -- just give you this color. Bolin was -- our Boehlen styrene monomer plant was only predict contributed a positive EBITDA contribution in 2 quarters during the last 3 years. So again, this is the right decision long term and we'll see the near-term benefit from it. Obviously, with improvement, we see other we'll see our other assets be more competitive versus like I described in the script versus this temporary arbitrage window, which we see largely closing at this point.

David Begleiter: No, very helpful. And just to have a view on the global styrene cycle the next couple of years in terms of new capacity margins and how that might trend?

David Stasse: Dave, this is Dave. I'll take that. I would say -- first of all, I'll start off with AMS. AMS continues to be a very steady performer despite the kind of trough level conditions it's low-cost Gulf Coast producer. So I mean, I see them as being relatively immune. We would see the building cycle, we would see 23 million as probably the trough, maybe 24 -- 23, 24 at the latest pending of the trough or ending of the capacity is probably 2023. And then mid-single-digit additions coming online globally in 2023, and that's all in China, obviously, and then starting to recover from there. So I would say probably some recovery in global styrene margins and operating rates in 24, 25. Now look, the thing I would say is with the closure of Boehlen, I mean, we kind of -- we've substantially reduced our exposure to styrene. We're now just producing at the 1 site in Trinity in the Netherlands. That is just supplying our internal downstream needs within Europe. So closing that site, I think, kind of reduces the profit exposure to the styrene cycle.

Operator: [Operator Instructions] We will take our next question from Michael Leithead with Barclays. Your line is open.

Michael Leithead: First question, can you just talk -- give a little bit more color about your expectations for first quarter EBITDA growth sequentially? And then second, if I heard correctly, it sounds like you're really not assuming much if at all, economic recovery in your full year guidance. So I mean, they just optically seems like a pretty steep ramp from the back half of '22. So can you just help square that for us?

David Stasse: Yes. Let me -- I think the best way to think about the -- to bridge Q4 to Q1 is basically, Q4, excluding raw material timing was about $25 million of EBITDA. It also included $15 million of hedge headwind. And then we'll -- and then additionally, we'll benefit from about $15 million in the quarter from the run rate savings from the restructuring activities that we had. And then we'll have about a normal benefit from some of the year-end effect or seasonality plus lower cost in Europe, and that gets us -- I mean we have a high degree of confidence in though those factors added to the Q4 run rate in Q1. And then as we described if we recover -- we think there's a 10% volume increase from this level from a number of factors, Asia recovery, also the end of this arbitrage pressure that we saw in Europe and North America -- and so a 10% recovery in volume from those levels at $30 million per quarter of adjusted EBITDA. So we don't see that as a very aggressive assumption, really contemplates not a lot of underlying improvement beyond that. So there's upside if we see that.

Michael Leithead: Great. And then second, I just wanted to ask briefly on the styrene separation. I mean Dave just talked about a pretty choppy styrene outlook until '24 '25. And obviously, a lot has changed since you started the sale process 1.5 years ago. So can you maybe just talk about how your approach is at all as kind of changed? Is there a different kind of suitable valuation or structure for separation, just again, broadly how you're approaching it today versus maybe when we started this off.

Frank Bozich: Well, I think, one, we've improved the business with the actions that we've taken, as Dave outlined with Boehlen. I think also that as we've gone through this cycle. It's demonstrated the resilience of this business, our polystyrene business. So I think that those are all very, very helpful. And the other thing I would point out is this year, we're making -- taking the first steps to establish our own recycled polystyrene assets in Europe with our with a project that, frankly, we see as being the best-in-class in the industry. So I think those things will position the asset to be more attractive than it was when we initially marketed it. And when the capital markets improve and we see well coupled with those improvements in the business, we'll make a decision on when to restart that process. But I guess, when -- the bottom line is I see it as more attractive and a better positioned asset to sell when the capital markets improved based on those actions.

Operator: And we will take our next question from Laurence Alexander with Jefferies. Your line is open.

Dan Rizzo: It's Dan Rizzo on for Laurence. I just have one. I was just wondering if the macro environment, particularly in North America, were to deteriorate significantly, do you still see a bridge where you can hit the low end of your 2023 outlook? .

David Stasse: Yes. It's Dave. I'll answer that. The answer is yes. I mean, we have a pretty small footprint in North America, in fact, a large footprint is of our JV, which is America Styrenics, which I see as I mentioned earlier, if you look historically, a pretty stable -- quite a stable EBITDA generator. So beyond that, our footprint in North America is actually quite small. So our exposure to North America, I'd say, is we've got 2 Latex plants in ABS and compounding business that primarily serves automotive in North America, but those are relatively small. So I think the answer is yes. We do see a path still to hitting the low end of the guidance in that scenario. I think in terms of earnings exposure, I think we have far more exposure both direct and indirect to recovery in China than we do to what happens in North America, not only because of demand in China and in greater Asia, but also because of the overwash that currently exists from stuff produced in Asia not getting soaked up in China. So that's how I'd answer that question, Matt.

Operator: We'll take our next question from Angela Catie with Morgan Stanley. Your line is open.

Stefan Diaz : This is actually Stefan Diaz sitting in for Angel. So I guess a quick question here. You postponed your legacy ERP upgrade in 2023. Is this something that you expect would come back in 2024? Or how should we think maybe, I think, generally, regarding CapEx or general investments.

Frank Bozich: Well, yes, we frankly, we don't have to do this conversion, we're under no time pressure to do that conversion in 2024. And so as conditions improve and we fully fund our other priorities, we'll make a decision on that. Obviously, we want to do it and there's operational benefits and cost savings from doing that implementation. But right now, that significant spend is not a priority in this environment. But again, I wouldn't put us on the clock for any specific timing to do it, we're under no pressure, too.

Dan Rizzo: And then in your EM segment, could you give a little bit of color on where your operating rates are and where do you see them progressing throughout 2023?

Frank Bozich: Yes, that's a great question. So I would say, for us in the low 70% operating rates is where the -- our PMMA assets are running the asset utilization on MMA is quite different by region. And clearly in Europe, during the second half of last year, there was significant capacity that was idled. So operating rates in Europe have been extremely low in the second half of last year and volumes moved from, as we pointed out, from Asia into the region. So I would say we would expect some of those assets to restart in 2023, but some of them are marginal assets on the cost curve anyway, and it's possible they don't restart at all. So I guess that's how I would characterize it.

Operator: We will take our next question from Hassan Ahmed with Alembic Global Investors. Your line is open.

Hassan Ahmed: Dave, I just wanted to revisit a couple of the questions that were asked earlier on the full year guidance, $375 million to $425 million in EBITDA. I mean from the sounds of it, it seems you guys are being pretty conservative with the 10% volume gains, it seems you're factoring into this guidance. I mean you had some interesting charts in the presentation, which looked at where volumes are right now, what a snapback could look like. So now looking at those historic trends, if things do actually snap back and if the restocking is actually fairly rapid, what could those volumes look like? So that's one part of it. And again, going back to this sort of full year guidance, I also want to get a sense of what European nat gas prices you're factoring in as well.

David Stasse: Yes. I'll take the last question first, Hassan. I mean we -- generally, when we do forecast, we forecast based on what the current forward curve for natural gas is. So we're kind of in the -- in Europe, we're kind of in the high 50s or 60 right now. So that's what we're -- that's what's baked into the guidance that we're giving right now.

Frank Bozich: So if we got -- so I guess if you -- going to the first part of your question, if you -- if we saw a recovery back to the first half '22 levels that would be an additional $30 million of EBITDA per quarter incremental to what we've already guided. Now and I'll remind you, in the first half of 2022, there was also some volume pressure in the underlying markets because of the chip shortage and chip constraints in automotive as well as some pressure on Chinese production that was essentially sales that would go into Europe. So again, I think we would expect that a real snapback would get us back to the half one 2022 levels, but there's still market improvement while above that, that's possible if we see markets normalize completely.

Hassan Ahmed: And sort of moving gears a bit. Look, it's -- seems like 23 still sort of a trough as year or coming out of a trough. And then we go into '24 and '25 and you guys have obviously some chunky debt maturities. So I'm just trying to sort of think through how you guys are thinking about share buybacks. I mean I would imagine they're off the table for a while.

Frank Bozich: Yes, that's not a priority in this environment right now.

Operator: We will take our next question from Eric Petrie with Citi. Your line is open.

Eric Petrie: How much of Engineered Materials is more commoditized the sheet and MMA versus resins and compounds?

Frank Bozich: So if you look at the volume mix about slightly over 50% of the volume that we've historically had in the business is formulated formulated specialty materials. And as I mentioned on the call, the margins and volume of those materials actually held up quite well. Then you have less formulated or nonformulated materials or more standard grade materials like standard grade resins and/or the PMMA sheet business. And that's where we saw most of the volume pressure when the prices between the regions dislocated so dramatically in the second half. So I would say 50% to 60% is formulated and compounded in specialty applications and 40% of it is more standard grade materials.

Eric Petrie: And then I think the prior rule of thumb for your Europe's styrene assets was a $50 ton styrene monomer change equal $35 million of earnings. It sounds like Terneuzen is a little more profitable. So how does that change? And then how much styrene monomer are you going to be buying with the closure of Boehlen?

Frank Bozich: So let me take the second half of that question. So we're somewhere about a third of our purchases will be merchant market. Purchases now with the closure of Boehlen. And then with Terneuzen operating, we can make the other two-thirds of our needs.

David Stasse: Yes. I'll take, Eric, the second half of that question. I think the rule of thumb, you're right, the old rule of thumb was a $50 change in margin would be about $35 million, that is now about $20 million.

Operator: And ladies and gentlemen, that is all the time we have for questions today, and this will conclude today's conference call. We thank you for your participation, and you may now disconnect.