Eastman Chemical Q2 2022 Earnings Call Transcript

AlphaStreet
Provided by AlphaStreet
July 29, 2022
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Operator

Good day, everyone and welcome to the Second Quarter 2022 Eastman Chemical Conference Call. Today's conference is being recorded. This call is broadcast live on the Eastman's website, www.eastman.com.

We will now turn the call over to Mr. Greg Riddle, Eastman Chemical Company, Investor Relations. Please go ahead, sir.

Greg Riddle
Investor Relations at Eastman Chemical

Thank you, Tracy. Good morning, everyone and thanks for joining us. On the call with me today are Mark Costa, Board Chair and CEO; Willie McLain, Senior Vice President and CFO; and Jake LaRoe, Manager, Investor Relations.

Yesterday after market closed, we posted our second quarter 2022 financial results news release and SEC 8-K filing, our slides and the related prepared remarks in the Investors section of our website, www.eastman.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 second quarter 2022 financial results news release.

During this call, in the preceding slides and prepared remarks and in our filings with the Securities and Exchange Commission, including the Form 10-K filed for full year 2021 and the Form 10-Q to be filed for second quarter 2022.

Second, earnings referenced in this presentation exclude certain non-core and unusual items. Reconciliations 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 second quarter 2022 financial results news release.

As we posted the slides and accompanying prepared remarks on our website last night, we will now go straight into Q&A. Tracy, please let's start with our first question.

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Operator

Thank you, sir. [Operator Instructions] We will now take our first question from Aleksey Yefremov from KeyBanc. Please go ahead.

Aleksey Yefremov
Analyst at KeyBanc Capital Markets

Thank you. Good morning, everyone. Would you just cover the reduction in freight cost, expectation for [Technical Issues]. Does -- do you feel this is more of a timing issue or relatively more permanently set expectations?

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

Good morning, Alex. I'm sorry, I just want to understand the question, are you talking about how the raw materials are going to play out whether it's sort of separate or long term, is that correct?

Aleksey Yefremov
Analyst at KeyBanc Capital Markets

Yes, correct.

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

Yes, so the raw material situation The second question you talked about is customer project in the U.S. [Technical Issues]

If we achieve that milestone that's a key that we need to sort of move forward on that project. Even in uncertain economic environment, the customer is -- [Technical Issues]

Sort of come down in global -- [Technical Issues] If I continue to give you a viewing chance which the real issue from the driving point of view, we also don't take that long [Technical Issues] either. Despite [Technical Issues]

Aleksey Yefremov
Analyst at KeyBanc Capital Markets

Thanks, Mark. And the second, you talked about finding end deal was faithful to costumer. We are sort of our [Technical Issues] is this a large enough for you to kind of incur all this, that does sound like a little cord I mean can you provide any reference, hopefully, [Technical Issues] relative to that project.

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

Yes, yes. This is, Will, and also retaining costumer is very high -- [Technical Issues] in infrastructure around. Margin to billion investments are as such [Technical Issues] So, the contract signed, we're not [Technical Issues] And wether it si performing on core structure of what we've achieved. And then [Technical Issues]

We're making great progress with them, so we put all together we feel that if we achieve that milestone that's the key that we need to sort of move forward on that project and it's just a great testament that, even in uncertain economic environment all these customers are very committed to sustainability in the long term they know they need to deal with recycled plastic. Then you get waste out of the environment, they need to reduce that or Scope three carbon emissions and our project allows them to do both of those objectives at the same time and they know that mechanical recycling is not enough to serve the market and so what we have is molecular recycling as a perfect compliment or partnership with the mechanical guys to solve that challenge. So I feel really good about how it's going.

Aleksey Yefremov
Analyst at KeyBanc Capital Markets

Thanks a lot, Mark.

Operator

We will now take our next question from John Roberts from Credit Suisse. Please go ahead. Please go ahead --

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

John, we can't hear you.

John Roberts
analyst at Eastman Chemical

I'm sorry I was on mute. Mark, you still ramping up mixed waste plastic into the gasifier and how far do you think you can take that? What are the theoretical limits?

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

So John, yeah, we still are ramping up that project. And thank you for reminding everyone that it's not just methanolysis, which is incredibly exciting and has a huge amount of economic potential, as well as impact on improving the environment.

Our cellulosic opportunities are also quite strong in this marketplace, and that's where we go with this gas. So we have multiple options on how to ramp up the feed. And we - as we look at the demand curve in front of us for the next three years, we believe we can ramp it up to serve all that demand growth. We're not going to talk about the technical details of this, but we're very confident that there's no constraint in our ability to grow with the market.

And the market is really expanding and going really incredibly well. So you've got the Naia textile fibers that even in a down textile market today is actually - demand exceeding supply, and we're working on how to expand capacity, the value - the sustainable proposition of a biopolymer where the microfibers that might break off from the ocean by a degree is just very compelling. And then you add in recycle plastic and it's a trifecta win on the environmental with bio recycled in bio degradable.

We've got great progress going on the microbeads, now to the biodegradable additives for cosmetic applications that we told you about Innovation Day. And the Evento program is also making tremendous progress in the marketplace around how we can sort of replace polystyrene and food service and some other applications.

So we're really excited to grow - expectations are sort of honestly exceeding you know, what we imagine. So we're working hard on how we're going to debottleneck capacity to keep pace with it all, on the polymer side, as well as how we take in the waste plastic. So it's all going really well.

John Roberts
analyst at Eastman Chemical

And then did you finish the ethylene to propylene conversion project that you were working on? It sounded like that in the release, but I thought that was still yet to come.

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

No, John, it's just to come. We did the RGP project. As you know, a couple of years ago that allowed us to reduce a good portion of our ethylene production you know, switches to -- to propylene and through our crackers as we change the mix to use RGP instead of ethane.

So that's full tilt right now, you can do the math and see that ethylene prices are pretty much down to cash cost in the second quarter, as well as - as we go forward in the third. So we're pushing that as much as we possibly can.

But the ETP is an investment we need to make going forward. And it is a great investment. It's just a timing question of getting it done. But it would remove the entirety of our bulk ethylene exposure on the marketplace and switch it to propylene whenever we want to have the flexibility to go back and forth. So that means great we can sell it better. In times like this, we can completely eliminate any book ethylene, and that would take a lot of volatility out of the business.

John Roberts
analyst at Eastman Chemical

When is that actually get done then?

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

It takes about two years to get built, John. So it's not really going to have an impact until you look out in terms like 2024 or '25 timeframe.

John Roberts
analyst at Eastman Chemical

Okay, thank you.

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

And where we are today.

Operator

We will now take our next question from Josh Spector from UBS. Please go ahead.

Josh Spector
Analyst at UBS Group

Yeah, hi, thanks for taking my question. I just wanted to dig into some of the sequential outlook for you're forecasting it up 10% sequentially. Your full-year comment kind of impact, 4Q could be flattish sequentially. Typically, there is a pretty big step down in 4Q and then that's followed by a pretty big step-up into the first quarter next year. So, wondering if you could walk through that 4Q thought versus 1Q? What drives 4Q flattish and what should we expect 1Q up into next year off for that level? Thanks.

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

So in the back half of the year, as we look at the trend rates that we had in the first half of the year, obviously, first quarter was disrupted by about $100 million of earnings in AUM for the streamline events, we sort of have to add that back, if you will, just to look at an underlying quality of the quarter.

And so when you look at it that way, we had a very solid second quarter and the trends remained good. So when you look into the second quarter, we make good progress and starting to recover some of the spread compression that we faced last year with our pricing. And we had some limitations on the markets that we can serve.

So automotive is obviously down, which was not what we expected and then from 1Q to 2Q and logistics constraints on how much of the durables demand we can serve that was well in excess of the logistics in our production capacity in the second quarter, given the limited production we had in the first quarter.

So as you roll into the -- into the third quarter, you've got continued improvement in pricing and continue to capture in recovery of spreads, as you move into the back half of the year versus the first half of the year. That's a tailwind.

You've also got pretty stable markets. It's important to keep in mind that while there is some softness in durables, there's a lot of the market that's quite stable. So about 40% of the demand in advanced materials is very stable in medical, consumer packaging, cosmetics. And in advanced materials, P&C is actually stable. It's commercial demand that's actually holding up fairly well.

And then you've got automotive that's going to have some amount of recovery in the back half of the year versus the first half, obviously, a little bit less than we expected but still recovering. So you've got that as a sequential tailwind going into the second half of the year.

And then consumer durables, which is sort of the biggest exposure to what you're seeing from Walmart and Target and all those companies. Demand is coming off, but a good portion of that demand, frankly, we couldn't meet with our production logistics limitations. So it's not all impacting our outlook for the demand in the back half of the year.

So we're not expecting that much of a net hit of how demand drops relative to what we can produce, especially since we're trying to catch up with so many customers from the production limitations in the first quarter.

So, overall, the demand obviously is a little bit less than we expected. That's why we sort of reduced our outlook for AM in the back half of the year, but not that much. So all those are sort of the key trends, continue to improve spread, continue to improve volume mix on a trend basis versus sort of the limitations that we had in the second quarter.

Josh Spector
Analyst at UBS Group

Okay. I mean, that's helpful. I understood asking about '23 obviously a bit early, but I think if I consider that demand kind of stabilizes your 4Q levels maybe $170 million in EBIT are there one-time catch-up items in there that then remove that typical $30 million or $20 million step up into the early part of next year or is that a normalized base that we should be growing?

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

So if you look at the performance, we're going to have in the back half of the year and what we guided and annualize it, it's a pretty good earnings number that you would carry in the next year, you'd have continued volume mix growth. remember we have a lot of innovation, especially in durables. That's why your demand is holding up so well. Tritan is winning all over the place, especially with recycled content, especially as you go into next year, when the methanolysis plant starts up and that will really benefit the back half of the year in particular of accelerating growth in this or durables area as well as cosmetics.

We continue to cellulosic story that John just asked about a lot of that affect the growth that we're talking about that's the foodservice products on cellulosic or wins we just told you about and prepared remarks in the eyewear market, etc. All those are sort of building to grow faster than underlying markets on the sustainability trends in both polyester and cellulosics you've got continued automotive growth next year.

In that recovery phase you've got these markets are stable that will continue to grow like medical and to move packaging etc., cosmetics another market heavily levered to circular. So, demand looks really good. Yeah, I'm not going to pretend to guess at the net of the outcome relative to the economy next year.

No one knows whether it's going to be slow growth mild recession something worse. So we're not going to start giving any kind of guidance on a total basis, but we certainly will have a lot of vectors to grow. And then you've got continued spread recovery as I just talked about day to day prices are going to come off of these exceptional extreme highs due to all these supply outages and so you've got tailwinds there, probably tailwinds as well in PX and so, spread also tailwind for next year. So, there's a lot of different reasons that EM should have a good year and you're going to have an easy comp in the first quarter relative to this year.

Josh Spector
Analyst at UBS Group

Very helpful, thank you.

Operator

We will now take our next question from David Begleiter from Deutsche Bank. Please go ahead.

David Begleiter
Analyst at Deutsche Bank Aktiengesellschaft

Thank you, Mark, in CI you talked about structurally improved segment earnings quality given that we think the new normalized earnings level here is in the CI going forward.

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

Well, David, thanks for the question and we're still trying to work our way through the math on that you have to sort of look at the long-term energy cost structure implications of what's going on. Clearly right now what's going on the Ukraine war with the shift towards more green energy and the lack of progress on that front, in the short term that means that things like natural gas are even in more need around the world than anyone ever imagined.

You've got to shift in the cost structure on a global basis, where the Europeans and the Asians are going to be paying a lot more natural gas relative to the U.S. even though our prices are really high right now in the U.S., they are exceptionally high everywhere else and so that's advantage that's going to help us going into the future, but I'm not about ready to quantify what that means, but certainly better than what we were talking about in the Innovation Day in December, and when we built our guidance, it's important, remember that before even get to that topic, there's a lot of actions we have taken to structurally improve this business, yeah, 40% of revenue in this business is and really actually high quality, good margin, higher-margin businesses than the segment average on a normal basis so you've got functional amines, which is the biggest part of that 40% going into Ag and they have cost pass-through contracts with stable margins.

You've got a nice Specialty Plasticizer business in the benzoic acid area that has a nice stable margins good growth curves around sustainability and then you've got the acetyl business and for us it's focused on the cyclic anhydrides and some other derivatives that are pretty stable. And actually are tied to demand growth in food-feed pharma, which are all again stable attractive businesses and then the, of course, we've made the investments, we just talked about on RGP, we shut down our Singapore plant that was the biggest source of earnings volatility we had in the company when it came to olefins given the dynamics of the Asian market and then the future of ETP I mentioned.

So a lot of different things going on there that gives us confidence in the back half of this year and hold up a bit better than we expected. Three months ago and as we go into next year should also hold up better than we expect. But I'm not going to quantify anything about next year with all the macroeconomic uncertainty.

David Begleiter
Analyst at Deutsche Bank Aktiengesellschaft

Understood. And just lastly on your implied Q3 guidance, you talk about solid EPS growth year-over-year. I think solid really means is it up 5% is it up 10% year-over-year? Anything in that range.

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

I'll let Willie take that one.

William McLain
Senior Vice President and CFO at Eastman Chemical

David, I think as you look at what we've seen to date. If you look at year-over-year being roughly $2.45 last year we're $2.83 in Q2, if you can look at a quite approaching the middle of that range.

David Begleiter
Analyst at Deutsche Bank Aktiengesellschaft

Right. Thank you. Very helpful, thank you very much.

Operator

We may now take our next question from Jeff Zekauskas from J.P. Morgan. Please go ahead.

Jeff Zekauskas
Analyst at J. P. Morgan & Co.

Thanks very much. In general, do you think your domestic pricing of all kinds of products has benefited from the difficulty of imports coming into the United States, and do you think that if logistics are improved globally that might make pricing tougher for products in 2023?

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

So when I think about that, Jeff. I think that's mostly a question for CI than anything else and certainly logistics constraints out of Asia have limited some of those products ability to come into the U.S. and that's contributed to some of the market tightness that all chemical, here media companies around the globe, especially North American ones are benefiting from on the specialty side, I don't think that's really a factor, Jeff. We haven't really seen logistics brands of Asian competitors be a limiting factor whatsoever on the specialties. So, the specialties have enough value and margin for anyone that's not a limiting factor so it's really just a CI question.

Jeff Zekauskas
Analyst at J. P. Morgan & Co.

Thanks so much.

Operator

We will now take our next question comes Vincent Andrews from Morgan Stanley. Please go ahead.

Vincent Andrews
Analyst at Morgan Stanley

Thank you, and good morning, everyone. On the Kingsport facility that's going to start up in '23, you note that you have thousand sales opportunities, which is more than the capacity of the plant. I'm just wondering how are you thinking about allocating that volume from a customer perspective demand is indeed in excess of supply. Are there ways that you can leverage your existing relationships to improve contract structures or other things in Advanced Materials? Or how are you thinking about marketing the material?

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

So one, it's been tremendous to see such strong engagement across so many iconic brands interested in the recycle content and how that can play a role in their sustainability goals and their positioning relative composition in the marketplace. And as we said, we've got over 1,000 sales opportunities that's in excess of the capacity to play. So we are in that approach of figuring out how we align with the strategic customers that provide us along - the best long-term growth.

And we have relationships, Vincent, with a lot of companies that have been sort of loyal dedicated customers to us for a long time with our current products and now they want to do cycle content. So obviously, they get preferential treatment versus someone who's new. And so we're trying to balance all that out.

And when we look at some of the - and we look at the quality end markets that drive a lot of where we want to go. So markets like hydration which is in the trends of sustainability, reduce reuse and then recycle, right? So the trends moving towards hydration water bottles, for example, is a great market. It's going to grow incredibly well going in the future as people become more conscious about plastics single-use products.

When you look at these high-end brands like Williams Sonoma, and Cuisinart, and Ninja and all these other products where they are leaders in the marketplace and their winning share and growing in the market, you want to align with those winners.

So, same thing on cosmetics. We've got great relationships with all the top main luxury brands, LVMH, L'Oreal, Chanal, etc., that allow us to sort of help them truly be sustainability leaders and especially handpicked for future French project and not just our current project, those brands are very focused on their products being made in France, being global leaders in sustainability and highly engaged, not just in buying from Kingsport, buying our specialty products that we'll make in our French plant. So, it's aligning with the winners and the leaders is how we are approaching it.

Vincent Andrews
Analyst at Morgan Stanley

Great. Thanks very much.

Operator

Will now take our next question from Mike Tyson from Barclays. Please go ahead.

Mike Tyson
Analyst at Barclays

Great, thanks. Good morning, guys. First question just on fibers. One of your competitors in acetic told last night kind of called out what they say sort of untenable situation in the toll market today, needing a bit of an overhaul to increase the value proposition. Obviously, Eastman's previously made a bit of a pivot towards textile and non-wovens. But just curious how you're thinking about the filter market today or just the overall situation with your acetate assets?

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

Sure. So two market from a demand point of view, has been actually quite stable. The market is not actually declining quite as fast as we expected. A lot of it's benefited from things like the heat-not-burn cigarettes and also used tow. And so you've got traditional cigarettes decline in upper and growing so of that offset some of that market dynamics.

And as you noted, our textile business is doing incredibly well, right? So we put that in motion several years ago to say, to some degree, this market is going to decline. In the textile market is incredibly attractive where we've got a very compelling sustainability offer for the market. And what we can offer, as I mentioned earlier, and great customer engagement in a way to sort of replace any decline in tow and we're definitely at that stage where that's going on. So we feel good about where we are from a volume point of view.

From a market point of view, you've seen us increase prices in a pretty meaningful way for this segment because the raw material costs are higher. Pulp costs are higher, energy costs are higher, operating costs are higher. And so we need to improve our pricing and improve our margins back to a reasonable level because they currently are not at a reasonable level.

And so yes, we need to work with our customers to recover those costs. So we continue to invest and support this business and what they need to do. So we're looking for all those opportunities to partner and have those kind conversations with our customers to find a path that makes sense and recover those margins to keep supporting this business.

Mike Tyson
Analyst at Barclays

Great. Perfect. And then just quickly, can you just remind us on the Tennessee, methanolysis facility, if you do hit that mechanical completion target at the end of 1Q '23, just when should we expect to see commercial production rates and sort of see it running through your P&L then?

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

Yes. So it's going to take a period of time like it does in every plant to start it up. So we complete the end of first quarter or the second quarter is going to be a process of starting it up and you're going to see the benefit in the second half of next year. It's not going to be a huge benefit as you're ramping up when it comes to bottom line earnings because you're going to have all the costs showing up to the plant. But it will certainly start helping and then really make a difference in a pretty significant way in 2024.

Mike Tyson
Analyst at Barclays

Okay. Thank you.

Operator

We will now take our next question from Michael Sison from Wells Fargo. Please go ahead.

Michael Sison
Analyst at Wells Fargo Securities

Hey, guys. Nice quarter. In terms of ASP volume growth in the first half, it's pretty impressive. Do you see a similar level in the second half?

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

So, hey, Mike, it's good to hear from you. So we do see volume trends continuing, probably not as strong as the first half. So first half had just tremendous growth across the board for animal nutrition, especially fluids, care chemicals, even B&C in some of the restocking efforts that are going on. So growth was quite good. Obviously, automotive wasn't where we wanted it to be, as everyone knows.

When we look at the back half of the year, we still expect strong volume growth continuing in a lot of stable markets. And so we'll see that benefit in animal nutrition, especially flues, both the aviation recovery, as well as you transfer fluids for LNG, care chemicals continuing.

We also expect some recovery -- the automotive OEM side, maybe some softness on the auto refinish side. So I'm not quite sure how that's going to net out. B&C will certainly be a bit softer, and you can just see that comes to even architectural paint with our customers. And so we'll see that be a little bit softer.

So overall, the volume mix will definitely be better, spreads will be better, as we continue to recover our spreads relative to some of the compression that we faced last year where prices were chasing rods, but it was much less of an issue, you have to remember an A&P last year, right? So the pricing actions we took were much swifter given the contractual contracts we had there to sort of keep up with the raws. So we have a delay but it's not nearly the same scale as Advanced Materials.

So all that's going along, but then that's going to be offset by several factors to mitigate how much we're up year-over-year. You've got an FX headwind, which is pretty meaningful in ASP, you've got higher growth spend and we have a higher shutdown schedule in the back this year versus last year. So all that sort of nets out some of that. So that's why you're going to see some decline.

And you need to remember, there's just a natural seasonal sequential decline in ASP when you go from first half to second half with ag markets and B&C market seems like that just less busy in the back half of the year versus the first half. So a great strong start to the year, but not as much on a year-over-year basis in the back half for those combined factors.

Michael Sison
Analyst at Wells Fargo Securities

Got it. And in terms of the outlook for AM, I think you outlined a pretty good portion of why in the prepared remarks. But when you think about the segments, is the shortfall similar between Tritan and interlayers? and how do we sort of get that back? I mean, is that earnings power that is still there, that's just come back maybe in '23 if everything -- if the headwinds kind of subside?

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

Yeah. So just to step back for a second around the segment from an end market point of view before I get to product view. When you think about the demand portfolio across AM, we'd say about 40% of revenue is stable. It's medical, consumable packaging, cosmetics, P&C, right? That's going to continue to be stable, continue to have some growth.

You've got segments like medical that are still restocking to get to a safe supply level. And then you've got the auto, which has some upside versus last year or the first half of this year, how that's about 30% of the revenue in the segment. And then you got consumer durables, which is about 25% that obviously has some risk, as I discussed.

So from an end market point of view, a good portion of this is pretty stable or actually improving. And then that gets offset by sort of this durables question in particular, and how that backlog of demand sort of reduces relative to our production capability. And we think probably is a bit below that in our sort of revised outlook. Then you've got this innovation that drives growth across the segment.

So when you think about the end markets, especially plastics is on track to have a really good year, both in the first half of the year once we got passed the first quarter, and they're certainly going to continue to have a good year on the demand side on a net basis in the back half of the year, and they have spread recovery in the back half of the year relative to last year, that's quite meaningful.

So, SP is on track to having a really good year. Performance Films is also doing incredibly well. It's amazing to see how the kept earnings sort of stable to last year in such a difficult market. And so they've got a lot of programs allowing them to win a great set of new channel programs, to grow their dealers and auto dealers, tremendous ingenuity that they've demonstrated in China, which is a big market there with no COVID, the heroic axis of figuring out how to completely redo our logistics system out of Shanghai, which was shut down to another one of our locations that wasn't you know, where there was sleeping in the place and making sure we kept our customers supported. So just a tremendous business, and that - and we see that continuing into the back half of the year.

Interlayers is a business that has a challenge. And I think I already covered it. Demand will get a little bit better in the back half of the year, obviously. But the spread challenge is pretty significant, and so the one part of the portfolio.

We don't think this continues at all into next year. As I mentioned earlier, where will, I think, improve for that business, but certainly an issue there. So you get all those great things going, but it's important to remember, we got gross spend and we got global energy costs. They're going on, especially in Europe that impacts all of the business that's true probably for every company. And so that's a headwind that gets netted into the math too.

Michael Sison
Analyst at Wells Fargo Securities

Right. Thank you.

Operator

Will now take our next question from Kevin McCarthy from Vertical Research Partners. Please go ahead.

Kevin McCarthy
Analyst at Vertical Research Partners

Yes, good morning. Mark, with regard to your Advanced Materials segment, I think there was some verbiage in your prepared remarks last night, whereby you indicated you now see less improvement in global auto production versus the prior expectation in April.

What is the current outlook for global bills that you're kind of building, no pun intended in outlook for the back half. Some of the companies that pant cars, you're talking about 80 million-plus global builds. Is that consistent with your view? Or are you starting to see anything more cautionary there?

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

No, I think that's consistent with our view. Certainly, our customers drive our demand. So as they're talking about their view on the market, it's important to pay attention to that.

But no, I think it's going to get better sequentially from where we were in the first half of the year, but certainly not as much as we expected, I'd say. But I think that number is fine.

Kevin McCarthy
Analyst at Vertical Research Partners

Okay. Secondly, I appreciate any updated thoughts on paraxylene procurement and whether or not we should anticipate any relief there in coming months. It looks like maybe is starting to soften a little in Europe. I'm not sure how you view the flow-through for the U.S. market that you have?

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

So PX, obviously, in June, it's really spiked up and into parts of July as well. But it's already come off quite a bit. If you look at where it was versus where it is now. From an exposure point of view, we produce and consume the PX here, in the U.S. But our exposure and how we pay for it, we've diversified quite a bit away from U.S. PX, and so that mitigates a little bit of that volatility, which is more extreme here.

But we did see a spike in the last two months without a doubt. That's flowing through our COGS. And our pricing model isn't -- and there is continues pricing model in our specialties. So there's a lump there of higher PX costs occurred relative to our pricing strategy that we had in place with the increases that we were able to achieve.

And so there will be a little bit of that sort of flowing through, they'll have some impact on the third quarter. I don't think it's a significant impact, Kevin, but there's a bit of that.

But when you look at it on a total basis, whether it's the first half or the second half for the year, we're making really good progress in improving our spreads in this business relative to last year. It may not be quite as much as we intended, but it's still quite significant improvement relative to where we were to get our margins back to where they should be.

So we continue to feel great about investing in this business. And - and so it's a business where the team has done a great job in managing price and having good discipline on how to do it.

Kevin McCarthy
Analyst at Vertical Research Partners

That's helpful. Thank you, Mark.

Operator

We will now take our next question from Mark Mitch from Jerome Research Please go ahead.

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

That's actually Frank, but we'll take it.

Frank Costa
Analyst at Jerome Research

Nice results.

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

Hey, Frank. How are you doing?

Frank Costa
Analyst at Jerome Research

Going fine. Frank Costa or Mark Mitch, I don't know. In the release, you obviously mentioned the 75% asset base in the U.S. And obviously, I also mentioned logistics having an impact on your business. How do you look at the impact that you've seen so far? And what's your expectations in terms of getting to a more normalized logistics that you don't have to call that out anymore having an impact on your business? What's going on in that area?

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

I'll let Willie take that.

William McLain
Senior Vice President and CFO at Eastman Chemical

Yeah, Frank, to your point, I think Mark described as we look at our asset position, we look at that as a position of stream as we serve the global markets with our specialty products. Obviously, earlier in the year, with our operational challenges, we're not achieving the year-over-year reductions in logistics costs that we had expected, and that's been compounded by the continued inflation and continued high demand in the first half of the year.

So as we think about the markets that we serve, actually some level of softening will actually call it, improve the supply chains and allow us to better serve and then achieve the volumes in the back half of the year. But it is done - continued inflation on that front, and we've had to continue to use modes of transportation and logistics that aren't completely optimized, and we look to get back to more optimized business operations in the back half of the year.

Frank Costa
Analyst at Jerome Research

Okay. Back half year. And Willie sticking with you, congrats on executing the $750 million ASR, the guidance is to get to $1 billion plus buybacks for the year. So not a lot left. How do we think about the pace of buybacks for the balance of this year?

William McLain
Senior Vice President and CFO at Eastman Chemical

Yeah. Frank, I think what you can do is we'll continue to be disciplined and you can basically spread that evenly across the last half of the year. And I guess people remain committed to greater than a $1 billion, and I appreciate that.

Frank Costa
Analyst at Jerome Research

Thanks.

Operator

We will now take our next question from Duffy Fischer from Goldman Sachs. Please go ahead.

Duffy Fischer
Analyst at The Goldman Sachs Group

Yeah. Good morning. Maybe a four-parter just around the PVOH thing. So one, did that disproportionately hit you where it might be causing market share loss? Two, the price that you're using to offset that, is that structural? Or are you using surcharges? And then third would be you obviously have some acetyls products yourselves. Are you seeing some benefit in other geographies on the acetyls that you sell that might be offsetting that? And then just the last one is how do you see the acetyls chain normalizing kind of from now through 2023, maybe? Thank you.

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

Sure, Duffy. There's a lot of questions embedded in that one question. So good to hear from you. So on the competitive side, the VAM situation is shared by all of us. There were some unique aspects and how that price spiked up for our European asset, as I explained, where we had to buy some spot material that our competitors may not have bought as much. And so that's why we had some spread compression there, as there was limitations on how we can move pricing relative to our contracts and kind of dynamics. So I don't think we have a significant share loss issue that - instead, we just had spread compression that we're going through in the second and third quarter.

In regards to how we're managing pricing, I think that we've used a combination of contract terms that allows the pricing and some surcharges to try release some of the extremity of what we're facing right now. It's important to keep in mind that from a long-term point of view in this business, there's just tremendous growth in front of us. There's the auto recovery. But beyond that, the EVs, as we told you, about three and half times more value in them than a combustion engine car, the way those cars are designed and the way they're using glass in a different way. So there's a tremendous amount of volume upside in big upside, right?

So as we sell more and more advanced complicated windows, which is why is are so attractive. Those are very differentiated products, and we are launching the most innovative products in the market, both on HUD on solar and very complicated integrated functionality that also includes solar rejection to take air conditioning load off the car in an EV.

So we're really excited about the innovation portfolio that's got a tremendous amount of engagement at the auto OEM level to drive this business forward. We just needed to get past is sort of -- in the supply issues that were so extensive. So that's -- the business we feel great about.

And when it comes to the broader acetyl chain, there's someone coming up in a couple of hours, you can ask that question to on the broader acetyl chain. What I'd say is, we're not in VAM and PVOH. So obviously, we're not seeing the posing benefit in Chemical Intermediates.

The overall acetyl chain is holding up really well, but we're very small in acetic acid, so I can't comment on that any meaningful way. Silicon hydrate business, which is where we're the largest player in the world and that business has always been a little bit more stable. It doesn't have fly up as much in market tightness, but it also doesn't go down as much.

So we're feeling like we've got a good sort of stability in that acetyl business, both in sort of what it was last year, what it is this year and what it will be next year. So it's not going through as much supply/demand dynamics.

Duffy Fischer
Analyst at The Goldman Sachs Group

Terrific. Thank you

Operator

We will now take our next question from P.J. Juvekar from Citi. Please go ahead.

P.J. Juvekar
Analyst at Smith Barney Citigroup

Hey. Good morning, Mark.

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

Good morning.

P.J. Juvekar
Analyst at Smith Barney Citigroup

Good morning. In your prepared comments, you talked about slowing consumer durables and construction-related end markets. Can you give us some color on durables and appliances, home-related stuff in construction, residential, commercial, because downstream customers like Sherwin have already warned and seeing a slowdown? Can you characterize your slowdown? And how do you see that playing out?

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

Sure. So just to step back for a second, and then I'll come to the durable question. When we look at the overall portfolio, durables is an important part of the portfolio, but it's not a huge part of the portfolio. And as you think about Eastman and its overall exposure from this sort of recession question, we've dramatically improved our portfolio, you can go all the way back to 10 years ago and how much you know, $3 billion of divest businesses that were commodity and $3.5 billion of specialties added and all the innovation that we've been talking about for the last eight years and how we've improved the portfolio or divesting $1 billion of revenue in ASP that was you know, businesses that are not performing well. And so that gets us now to an end market portfolio that's quite improved.

So when you look stable markets. And we think about 45% of our revenue is in what we call stable as like medical, personal care, consumables, animal nutrition, water treatment, etc. Then you have about 20% in transportation and energy, which actually has offside going into this year and next. And then you get to B&C and consumer durables where we have sort of this sort of market demand sensitivity and risk and about half of that is durables, right? So we're talking about 15% of the total corporate revenue.

And that is a place where it's predominantly two places where we go into consumer durables, mostly specialty plastics. That's our Tritan that would be going into a Cuisinart or a Ninja blender or any of those sort of typical appliances that you would think about, as well as electronics, where we have some of our cellulosic's.

And so its high-value business, but it's also a place where we have tremendous innovation, creating our own growth, especially as we go into next year with all the new content, the recycled content that we're adding.

So you got to sort of - for sure, we're seeing demand come off in those markets, as you can hear, Walmart, Target, etc., destocking, but already hit that. The demand was well in excess of our capabilities. So some of that's actually not a lost volume in the forecast. It's just the backlogs going away, if you will. But there will be some moderation in that business.

And then there's some of it in the coatings business where we have you know, coatings to go into all those different types of products as well, and we'll see some softness in that business. And so that's where we see some sensitivity. B&C also has some risk to it.

I think it's another important thing to keep in mind about what happens in the back half of this year isn't just about primary demand. You've got or innovation, how you offset it, but there's also this question around how much destocking is going to occur.

And we don't think that there is going to be the same kind of bovid you would normally have going into a recession because supply chain constraints have really limited how much inventory could be built through the chain getting to the retailer, especially in markets like auto where clearly, they have no inventory at retail at the dealer level, and B&C also had its own challenges. And as I said, you've got markets rebuilding inventory like medical and aviation, as well as having upside growth and then you're back to this durable question.

So when we put it all together, there's certainly some demand risk and uncertainty. We're trying to factor that into our outlook. And we're really just trying to focus on what we control, continue to drive the innovation, keep driving the pricing on specialty, but be conscious about maintaining a good competitive position while you do that. And that will certainly improve spread to last year and give us a tailwind for next year and manage our costs as always and stay focused on the secure platforms and how we return cash to shareholders.

P.J. Juvekar
Analyst at Smith Barney Citigroup

Great. Thank you for that color. And then I have a quick question on cash flow in the first half was down significantly. Looking at some of your competitors that reported last night or even earlier in the week, many of them had flat to up operating cash flow.

Can you talk about your weaker free cash flow or operating cash flow? And is it maybe due to some seasonality like ag and you have a big ag end market exposure, maybe that comes back in the second half. Can you just - either you or Willie can go through that?

William McLain
Senior Vice President and CFO at Eastman Chemical

P.J., I'm happy to go through that. Obviously, as we think about the situation that we're in with the highest inflation in 40 years, and actually, that gained momentum. So as we looked at the beginning of the year versus where we are now, the raw materials and energy that we are seeing is about $0.5 billion higher. And obviously, that $0.5 billion translates here in the near term into an impact on working capital. So you're seeing about $100 million on a year-over-year basis, negative impact of higher working capital consumption through the first 6 months.

Additionally, the payout and the variable comp from last year, you can see that the cash flow is about $140 million. We're taking actions on our cash conversion cycle, whether it's inventory, managing our receivable programs, as well as looking at and continuing to look at our terms.

As we look into the back half and traditionally at Eastman, we have been more back half loaded on operating cash flow from a seasonality standpoint. And you can look at over the last five to six years when we generated the robust operating cash flow of $1.5 billion or $1.6 billion. Typically, that has about $1.1 billion to $1.2 billion of operating cash in the back half. So we have headwinds in this environment, and they acknowledge those, but we're still focused on delivering that approximately $1.5 billion even in the face of that.

P.J. Juvekar
Analyst at Smith Barney Citigroup

Great. Thank you very much.

Operator

We will now take our next question from Matthew DeYoe from Bank of America. Please go ahead.

Matthew DeYoe
Analyst at Bank of America Securities

Good morning, everyone. Do you have any patents or competitive advantages beyond just like the first mover advantage that would protect you from an entrant in textiles over time? Thinking maybe of a competitor until?

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

So we don't have a lot of specific patents on the textile side. We have a significant market position advantage where we are - in the vast majority of the market when it comes to textile filament, which is different technology than making to tow fiber. And so - and there's a pretty high capital intensity with that business.

So the position we have is pretty solid in developing and producing that product, but we don't have any patents on it. You can in the staple side of things where you can use the tow assets that's a more competitive market. But again, there's a big advantage we have in this sort of market relationships that we currently have.

William McLain
Senior Vice President and CFO at Eastman Chemical

And Mark, I may add there, the other highlight that I would add is, we produced textiles at our Kingsport, Tennessee site, which is highly integrated. And we have the lowest cost position from producing flake at this site in the world. So as you think about the integration and the power of acetyl stream and cellulosics differentiate us versus our competitors.

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

I mean, one of the great things about this business is the size of the market relative to our capacity or even now who wants to join in is just far greater than what we can make. So we view it as a great business for us. And if there's some amount of competition, there's plenty of room.

Matthew DeYoe
Analyst at Bank of America Securities

Understood. And this one might be a little long, so I apologize. But just looking at Animal Nutrition and Crop Protection, right? It did something like $330 million to $350 million in sales in '15 and '16 and then went all the way up to the mid-500s. And as of the end of last year, I guess, we were back in the mid-330 level.

Is this business COVID sensitive and why if it is? And then it seems like it's doing pretty well right now. So is that mid-500 in revenue number kind of the right target in the medium term again?

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

So what I can tell you about the Animal Nutrition business is it is growing really well. It's very stable. And we benefited obviously a bit of from more food consumption, I guess, you could argue through COVID that you had more home consumption, less restaurants, so those sort of net each other out. So it's just - from a market point of view, it's pretty steady.

Now prices go up and down, it would impact some of the revenue story just based on the market dynamics that we've been going through in many products and the profitability of this business has materially improved. The key that we're doing in this business is focusing on how we value up the business, right? So we have one of the broadest organic. Our asset portfolios to replace antibiotics and nutrition, which is driving our growth.

But historically, we've mostly just sold them as individual assets, organic assets. And as we have been moving forward creating more formulated solutions that combine the assets and other elements of product performance together, use top of the value two to four times as much as what we get currently today.

And this 3F acquisition we did last year also brought in a lot of capability to sort of not just grow their business, but really value our portfolio and the synergies on that have been fantastic. So all that is really driven a lot of improvement in the performance of this business. So it's pretty steady. I'll let Willie to try and respond to the numbers that you're referring.

William McLain
Senior Vice President and CFO at Eastman Chemical

Well, what I would say, Matt, is yes, sorry, is as I look at the last couple of years, its been around $300 million. And then there's a pretty good jump up here in 2022, and that is related to the 3F acquisition in addition to overall growth, as Mark just referenced. So not seeing the big spikes that you're talking about in a year and then coming back, it's more been spec steady, at least over the last several years.

Matthew DeYoe
Analyst at Bank of America Securities

Thanks.

William McLain
Senior Vice President and CFO at Eastman Chemical

Let's make the -- sorry, Matt. Let's make the next question the last one, please.

Operator

Will now take our last question from Laurence Alexander from Jefferies. Please go ahead.

Dan Rizzo
Analyst at Jefferies Group

Hi, guys It's Dan Rizzo on for Laurence. Thank you for squeezing me in. I was just thinking about energy curtailment in Europe, and I don't know if I missed this, but I was just wondering if you're thinking about how that might affect you guys towards the winter, late this year and early next year.

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

So like everyone, we're working hard on making sure we've got supply positions in place to manage any sort of risk on the curtailment side and are doing everything we can on that front.

Our exposure in Europe has been reduced pretty significantly. So the largest plant we had in Europe were in the adhesives and tires business, which we have recently divested. So the two businesses that really have exposure to this in a meaningful way is our Amines plant in Belgium and our Interlayers plant in Belgium. Interlayers is more electricity-driven than natural gas driven and what it's sort of exposed to.

But that cost exposure is there. I mean the energy prices are already fairly high embedded in outlook and forecasting. But from a curtailment point of view, we're doing everything we can to minimize that risk.

Dan Rizzo
Analyst at Jefferies Group

And what about your customers? I mean, have they said anything?

Mark J. Costa
Chairman and Chief Executive Officer at Eastman Chemical

I think every customer around Europe is doing the same thing. There's a lot of uncertainty. I don't think anyone really knows what's going to happen, right? The governments across Europe are working hard on trying to come up with a plan. They realize it shutting down industrial facilities that don't shut down very well or come back up very well, its not a great idea because it creates a lot of economic and job risk and safety risk in some cases.

And so I think they were trying to be very thoughtful about how they're going to manage this problem going into the winter and then anyone's guess on what food and will do between now and winter. So we're all working to manage that issue together.

Dan Rizzo
Analyst at Jefferies Group

All right. Thank you very much.

Greg Riddle
Investor Relations at Eastman Chemical

Thanks again, everyone, for joining us today. We appreciate your interest in Eastman. And I hope that you have a great day.

Operator

[Operator Closing Remarks]

Corporate Executives
  • Greg Riddle
    Investor Relations
  • Mark J. Costa
    Chairman and Chief Executive Officer
  • William McLain
    Senior Vice President and CFO
Analysts

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