Welcome to the Solvay Q1 2023 earnings call for analysts and investors. Solvay team, the floor is yours.
Hello, everyone, and welcome to Solvay's first quarter 2023 earnings call. I am Jodi Allen, head of investor relations, and I'm joined by our CEO, Ilham Kadri, and our CFO, Karim Hajjar. Today's call is being recorded and will be accessible for replay on the investor relations section of our website. I would like to remind you that the presentation includes forward-looking statements that are subject to risks and uncertainties. You may refer to the slides related today's broadcast, which are available on our website. With that, I'll turn the call over to Ilham.
Thank you, Jodi, good afternoon, everyone. I'll begin with an overview of our first quarter 2023 results on slide 3. When we spoke to you in February, we shared some insights on our early view of the first quarter, including our expectation that volumes would decline in a weak macro demand environment as this talking effect from Q4 would linger into the first half of the year. We also said that pricing would offset the volume decline, and we were confident in our team's ability to sustain profitability and margins. This is exactly what happened. I'm pleased to report that our businesses again did a great job in a challenging inflationary environment, delivering EUR 421 million of price, more than offsetting EUR 127 million of variable costs.
The sustained pricing power was group-wide, meaning all three business segments delivered pricing that compensated for both variable and fixed cost inflation. Let me give you some color on the volumes, which declined -12%. The weak demand was evident across a number of our end markets, as expected, including in EV batteries, where customers continued destocking. This impacted specialty polymers. The agro market was another area where customer destocking occurred, impacting Novecare. In construction, we saw reduced demand across several businesses serving this market, including soda ash and also in coatings. In consumer re-related industries, which impacted Novecare's home and personal care markets and aroma, food and fragrances markets. We had already planned for the expected normalization of the coatings business, which significantly impacted the volumes. On a regional level, sales growth in Europe was offset by declines in the U.S. and in Asia Pacific.
China sales were impacted by the destocking of battery customers, while our consumer-facing markets were impacted by soft demand from China. The 14% selling price increase enabled us to fully overcome the volume decline and deliver 2% organic sales growth. The stock pricing momentum and our continued focus on cost discipline drove organic EBITDA growth of 22% in quarter one, higher than our initial expectations. This translated into EBITDA margin expansion of 320 basis points, reaching a new record of 26.5%. Keep in mind, this is in comparison to quarter one last year, where our pricing initiatives were only beginning to take traction. Looking back over the last 12 months, our EBITDA margin averaged 24.8%. Moving to cash, I'm pleased with our continued track record of positive free cash flow generation for the 16th consecutive quarter.
This has been one of my key priorities, as you know, and areas of focus since taking the helm at Solvay over four years ago. You may recall that we committed to delivering free cash flow conversion above 30%, and we have consistently delivered on that metric, and we expect to maintain that discipline even in a higher investment cycle. I am pleased to report that our free cash flow amounted to EUR 125 million this quarter. You will notice that this is despite the significant increase in working capital. That increase reflects the choices we made to invest in inventories to better serve our customers. Karim will give you more details on that later. Now, earlier this year, we shared our plan to invest in our future growth, and we indicated a higher capital spend this year.
In the first quarter, our CapEx reached EUR 212 million, 40% higher than in quarter one last year. The growth project this year include specialty polymers investment to address the future needs in a variety of markets. This includes the expansion of our sulfone technologies in the United States of America to support our healthcare customers growth. It also includes our investment in PVDF in France to support future growth in EV batteries. We're investing in a new generation of green solvent in our Melle, France in France, which aligns with our ambition to bring more sustainable solutions to the agriculture market. We also announced a new bio-circular, highly dispersible silica process at our Livorno, Italy site, utilizing bio-based sodium silicate derived from rice husk ash. As you know, we are investing in our natural soda ash expansion in Green River, Wyoming.
Aside from our investment in capacity, we also continue to bring new innovations to the market. I'm pleased with the Novecare team, who launched a new naturally derived guar-based solution called Polycare for the beauty care industry. Specialty Polymers introduced a new high performance polymer to address the high heat and electrical insulation requirements in EV batteries. I also like to highlight some other recent announcements. In March, our 2030 climate targets were approved by SBTI, Science Based Targets initiative. This validation reaffirms Solvay's targets to reduce scope one, two, and three emissions, as set out in our Solvay One Planet sustainability roadmap, reflects our ongoing commitments to raise the bar in tackling climate change. We also streamlined our portfolio with the sale of our 50% stake in RusVinyl and received EUR 432 million in cash proceeds at the end of March.
I am also pleased to share our latest customer highlights and new partnerships. Our Aero team was recently recognized by Northrop Grumman and won a prestigious Quality Excellence Award in March. We've been partners for over 40 years, this demonstrates the team's ongoing commitment to quality and service excellence. Just last week, we signed a license agreement with GHCAC in China, which will enable them to build and safely operate a hydrogen peroxide unit designed to support another propylene oxide production facility. Finally, I'm really excited about our new strategic collaboration with Ginkgo Bioworks that we announced in April. They are a recognized leader in synthetic biology. Through this partnership, we acquired a lab in Cambridge, Massachusetts, which will establish a growth base in one of the most important biotech hubs in the world.
The alliance will focus on new sustainable biopolymers and specialties, which could address a breadth of markets from home and personal care to agriculture and food. It's only the start of the year, and I'm so proud. We have many achievements to be proud of. Now I'll give the floor to Karim, who will review the segment's results and financials highlights. Karim?
Thanks, Ilham. Good morning. Good afternoon, everybody. As usual, I'm gonna present figures on an organic basis, meaning a constant scope and constant currency, unless I state otherwise. I'm gonna start with the materials segment, where sales increased 16% to EUR 1 billion. The driving force behind this growth was the increase in prices of 17%, this much more than offset the modest reduction in volumes for the segment of -2%. Sales in specialty polymers improved 15%, driven by higher prices as customers continue to value what we bring, our lightweighting solutions, because these are mission critical and also help to reduce CO2 emissions. Volumes are slightly down, mainly because of reduced demand in EV batteries as customers continue to reduce their high inventory levels. That impacted the demand for our PVDF.
It's important to note that our PVDF suspension technology offers a differentiated value proposition, specifically for the high-end battery applications like NMC, and this supports margins even in the current deflationary environment. Elsewhere, sales grew most notably in the electronics market, where our polymers are used in semiconductors, and also grew in our life solutions sector, where our polymers are used in pharmaceutical packaging and hemodialysis. Turning to composite materials, sales were up 17%, and there we saw higher volumes and higher prices. We witnessed a continued demand recovery in civil aerospace, driven by increases in the build rate in single-aisle aircraft, as well as growth in space and defense programs, the volumes for high performance automotive were slightly down.
Although inefficiencies that are plaguing the aerospace supply chains are really persisting and they will continue to put limitations on production and orders, we're really pleased to see that overall, the recovery in the aero market is clearly underway. Thanks to the volume performance and thanks to the pricing gains in the segment, Materials EBITDA increased 35% with an EBITDA margin of 35.4%, marking a 600 basis point improvement against Q1 2022. Turning to chemicals on slide seven, segment sales for the quarter increased 2% and they reached EUR 1.1 billion. This is due to our well-placed pricing measures that delivered 17% increase, more than offsetting for the reduced demand, which impacted segment volumes by 15%. Starting with soda ash, sales growth amounted to 19% and was driven mainly by higher prices.
Demand remains strong for soda ash used in container glass, in photovoltaics, and in lithium processing, as well as for bicarb, which is used in pharma. This partially offset modest and temporary demand weakness in the construction and detergent sectors, and it reflects the fact that we continue to prioritize pricing over volumes in select cases of new business opportunities, particularly in the Siebel market. This performance further illustrates the resilience that we've seen over the past years. Indeed, as we highlighted in our webinar of the 27th of February recently, and it's great to see those results continue. Peroxide sales were down 6% in the quarter due to lower volumes, and these offset pricing gains compared to Q1 2022.
In particular, demand for HPPO used in auto and in building and construction industry softened, whereas demand for peroxide that is used in food and in disinfection industries remained stable. Sales in silica increased 6% for the quarter, driven by pricing actions that were able to more than compensate for softer demand in the tire market. The fact that we work hard on developing innovative, sustainable solutions that our key customers appreciate adds to the resilience of that business as well. We were really pleased, in fact, to see that one of our key customers, Bridgestone, launched in January its Turanza 6 tire, which delivers best-in-class safety and fuel efficiency performance. You know what? We're really proud of the fact that Solvay Silica is a part of this exciting new product launch. Well done, Bridgestone.
Sales in Coatis were down 29% versus the strong comparable of Q1 2022. You may recall that this business delivered strong performance in exceptionally supportive market conditions that prevailed in the past two years, we fully expected this to normalize with lower priced exports from competitors from China and India. Clearly, it has an impact on market prices. No surprise there. Wrapping up chemicals, segment EBITDA rose 19% versus the previous year's quarter, driven by sustained pricing in our soda ash and derivatives business as well as silica. That supported an EBITDA margin of 27%, which is an improvement of 3.4 percentage point when you take into account the divestment of RusVinyl. Turning now to the Solutions segment.
First quarter net sales in the segment were down 9%, reflecting a 16% reduction in volumes, partially offset by higher pricing of 8%. Starting with Novecare, sales decreased 14% against Q1 last year due to continued softness in consumer market demand. That's a dynamic that we started to see in Q4 last year. Sales to the coatings market were impacted by low building activity. Home and personal care was also impacted by continued weak consumer trends, particularly in China. In agro, demand was weak, driven by higher inventories in the value chain and by delays in the planting season in certain regions, sorry. In general, pricing was positive in the quarter, that reflected a continued improvement in mix and our decisions to prioritize profitability based on maintaining a pricing over volume strategy.
Special Chem sales increased 4%, mainly reflecting higher prices. Volumes in auto and in industrial applications were stable, whereas demand for electronic chemicals was softer than in Q1 last year. Sales in technology solutions in Q1 increased 15%, with higher prices and higher volumes driven by strong demand in copper mining and in phosphorus derivatives. Demand for copper is expected to stay strong, helped by recovery of Chinese economic growth. Aroma Performance sales decreased 31% in the quarter, driven by lower demand in vanillin, which is used in flavors and fragrances markets, and inhibitors used in monomers.
While the food and beverage market is expected to remain resilient, the fragrance market faced strong price-led pressure from Chinese competitors. This is another example where our business chose to preserve pricing over volumes, chose to preserve and protect value, whilst also initiating further actions, both to reinforce the competitiveness of our business and to invest in the industrial scale-up of natural vanillin, which is important because that will respond to an important growth trend that we're seeing as well. Oil and gas solutions sales fell 18% compared to the same quarter last year, mainly due to a sharp decline in natural gas prices that result in a decrease in drilling activity. Taken overall, EBITDA in the first quarter for the solutions segment declined 9% year-on-year due to lower volumes across the segment, whereas EBITDA margin remained flat at 21.1%.
This actually is quite noteworthy when you compare that, 21% margin to the 17% and 18% we were talking about a few short years ago. The EBITDA contribution from corporate and business services activities in Q1 improved by EUR 25 million compared to Q1 last year, as we reported the benefits of the stabilization of our energy activity, which included a net favorable impact of around EUR 11 million. On slide number 9, you will see that EBITDA increased 22% to EUR 839 million, mainly due to sustained strong pricing. You'll also notice that fixed cost increased EUR 24 million. Sorry, that the fixed cost increase of EUR 24 million was below the levels of prior quarters, and that results both from continued structural cost reductions and lower spend on group-wide investments such as in digitalization and in cybersecurity.
EBITDA margin improved by 430 basis points to a record 26.5%. Moving on to slide 10. We continue to make progress towards our strategic goal of EUR 500 million in total savings, delivering an additional EUR 17 million in the quarter. Our structural cost savings now amount to EUR 484 million since 2020, that's about 97% of our end of 2024 target. We also took an EUR 80 million restructuring cost provision as we take further actions to cut costs. We're not gonna stop looking for more opportunities, frankly, particularly as we look forward and we look to anticipate and contain any future dyssynergies associated with our Power of Two projects. Of course, we'll give you more details on that later on in the year.
Our free cash flow in the quarter was EUR 125 million. As Ilham mentioned, this reflects our strong profits, our growth investments in CapEx, and our investments in working capital, as well as the benefits related to the successful resolution of a litigation. Insofar as working capital is concerned, our receivables remain very tight, with average DSO, days sales outstanding, it's a KPI, of 43 days, and overdues at a record of 1.5%. You will also remember that we ended 2022 with a low inventory balance. We invested in building inventories this quarter because we remain focused on being well-placed to supply our customers throughout the year. Payables are lower, mainly due to lower energy and raw material prices.
We are adapting to the demand environment, we expect working capital intensity to reduce over the next quarters because frankly, we are resolute on driving cash generation. Now, a few words on our debt, on our net debt. The underlying net financial debt was further reduced in the quarter by EUR 339 million to EUR 3 and a quarter billion, reflecting the cash outflow from the dividends, the positive free cash flow from operations, and of course, as Ilham mentioned, the EUR 432 million in proceeds from the successful divestment of our interest in RusVinyl. All in all, our balance sheet is stronger today than it's been for a decade or more.
These improvements have also enabled us to achieve a historic return on capital of 16.7%, more than double the 8.1% that we reported at the end of 2019. If anything, this truly reinforces and demonstrates our ability to create two champions by the end of the year. With that, I'm gonna hand you back to Ilam to discuss the outlook and the closing remarks.
Thank you, Karim. Let me provide some insights now into our upgraded full year guidance. We have again demonstrated this quarter our ability to maintain our hard-won pricing gains more than overcoming inflationary pressures. Looking into quarter two, our April order books indicate continued weak demand. At this time, we have limited visibility into May and June, and we therefore do not bank on any recovery in volumes in the second quarter. It is also important to note that we have a tougher comparable quarter as our pricing actions began to take effect in quarter two last year on the top of solid volume growth. We therefore expect quarter two EBITDA to be sequentially lower than quarter one.
We remain confident in our ability to maintain strong margins, and we have upgraded our full year guidance range to reflect our current forecast. We are raising full year 2023 EBITDA guidance on an organic basis to a range of +2% growth to a decline of -5%. This is a significant improvement from our previous guidance of a decline of -3% to -9%. As you can expect, this assumes that there will be no significant change in the prevailing macro environment. Indeed, this range reflects different trajectories between now and the end of the year. At the lower end, we foresee a scenario of volume stable at current levels and some modest growth margin erosion in select product lines.
At the higher end, we anticipate profit growth based on modest volume recovery in the second half of the year and an expectation that we will sustain leading margins across much of the portfolio. On cash as a result of our upgraded profit expectations and improved performance, we are raising our full year free cash flow guidance from EUR 750 million to around EUR 900 million. We still intend to increase our capital investments relative to last year as we remain resolute in our determination to ensure that we sow the seeds for future growth. To conclude, I remain confident in the capabilities of our people. They continue to demonstrate quarter after quarter, year after year, an ability to deliver and overcome significant challenges.
We are a stronger company today, and our balance sheet keeps us well positioned to progress on our separation journey, which will unlock value for our customers, shareholders, and our employees. With that, Karim and I are happy to take your questions.
Thank you, Ilham. We will now move to the Q&A session. I ask that you kindly limit yourself to one question per person so that everyone has an opportunity to participate. We will be managing the queue directly today. If you wish to ask a question, please dial star one one on your telephone keypad and you will enter the queue. Once again, dial star one one to ask a question. Our first question today comes from Wim Hoste from KBC. Wim, please go ahead.
Good afternoon. Thank you for the opportunity to ask my question. I wanted to dive a little bit deeper into the PVDF market dynamics. Can you maybe indicate, yeah, how far the destocking has gone at customer level and also what that destocking trend has maybe caused to pricing dynamics in the market? I know you have a different technology than the mainstream and you're in the higher end. Can you maybe also elaborate on the pricing dynamics for your products and the market overall in PVDF? Thank you.
Thank you. Thank you, Wim. Indeed, you know, as Karim and I, we told you that there has been a destocking which will continue probably through quarter two as well, in general in batteries in automotive. As you've seen, frankly, and I will come back to batteries, our business is not only PVDF battery, right? I mean, you've seen specialty polymer really doing well, including in other applications in also under the hood, right? We're in business of lightweighting, electrification, but please do not forget lightweighting. On PVDF, Wim, there has been a destocking on EV batteries, and you've seen it in many other publications. We expect it again to continue in over quarter two this year.
On the differences, and I think we've tried to do some education on emulsions versus suspension. Karim alluded to that. There are two type of PVDF technologies for EV batteries, suspension, emulsion. No one material is inherently better or worse than the other, but, you know, we produce both. The reality is that suspension-grade PVDF, in which Solvay is the world leader, has set of properties that make it better suited for nickel-rich, high-energy density cathode, like in lithium-ion batteries, and specifically with NMC, which is the high-end batteries in the market, right? The suspension is the reference binder material in the production of those NMC material. There is basically no emulsion PVDF used in NMC today. I know, you know, people are still trying to get there, but this is mainly suspension.
The emulsion PVDF is commercial products available worldwide with Chinese competition. We expect that to be more commoditized in the midterm, and with very little, again, and no significant penetration in the high end in NMC. What has happened, I think for us, obviously there is a raw material cost decrease. For us, we just kept our margin, you know, constant and even as compared to the end of last year. Without giving you that much number and sensitive competitive information, our Q1 PVDF batteries margins have been, you know, stable compared to the end of last year. I think that's the message. That's how we ask our team to fight for value pricing on PVDF. We are more resilient than, you know, the other technologies.
Definitely we like our, you know, the investments we are doing in Europe and in the US in the suspension, because the barriers to entry For imports, for example, from China, like in the United States of America, are pretty high, the tariffs are high, more than 30%. All of this makes our strategy very sound for future growth CapEx. Back to you.
Thank you very much. That was very clear.
Thank you, Wim. We now have a question from Martin Roediger from Kepler Cheuvreux. Please go ahead, Martin.
Thank you. My question is on chart 8.
One.
The scope effect was plus EUR 7 million on sales, but minus-
We can hear you. Can you repeat, please? Sorry, Martin.
Okay. Okay, sorry for that problem.
Yeah.
A question is about chart number nine.
Chart number 9.
Where you show that the scope effect was plus EUR 7 million on sales, but minus EUR 36 million for earnings for EBITDA. Can you explain that gap?
Yeah.
Sure. That's mainly inaudible which you recall was equity accounted.
Okay.
Hope that helps.
That's clear.
It's the simplest answer I can give you. Thanks, Martin. Thank you, Martin. The next question comes from Andreas Heine from Stifel. Andreas?
Wasn't that strong as it comes to volume. While you do not predict Q2 to be better, not to be better, it probably will also not be worse. Where do you expect then the quo-on-quo falling earnings to come from? It has to be margin, and it's probably not broad-based. What are your assumptions that you've come up with, these Q2 guidance?
Sorry, Andreas, can you repeat your question?
Yeah.
We didn't hear the beginning of it. Sorry.
Okay. It's on the sequential earnings trend, where you said that earnings in the second quarter are probably lower than Q1. Looking what the explanation for that is, it's probably not volume. Volume is not getting better from Q1 to Q2, what you said, but Q1 was already pretty low and probably Q2 is not worse in volume. It probably has to do with margins then, and that is not across your portfolios. Maybe one or the other thing might be weaker than the general trends. Could you outline where you think that the Q-on-Q earnings decline might come from?
Yeah. Thank you, Martin. Well, listen, I think our quarter two and, you know, we have April in bed internally, but a month is not a quarter. Definitely you could see it across all other peers and our customers who have published. Our quarter two order book volumes remain low, therefore we expect demand to remain soft. We do not see yet any improvements, right, in consumer construction or batteries, by the way, I just mentioned that there will be still some destocking. Some markets could soften further like semiconductors. Therefore, we see quarter two, right, sequentially lower than quarter one. And that's what we see today, right.
We give you the low and the high of the guidance, right? Betting on H2, either there is some recovery of the volumes or not, right? Knowing that there is a seasonality marking between H1 and H2 in general. Our quarter two, to give you some ideas, it can be anywhere between 5%-10% below quarter one, to give you some precision.
Okay. Thanks, very helpful.
You're welcome.
Next question will come from Alex Stewart from Barclays.
Hello. Thank you for letting me ask a question. Well done on the results. You raised guidance three times last year, and you've raised guidance once already this year. The price increases that you've been doing, if they were indeed part of your overall strategy, then why have you had to raise guidance so many times? To my untrained eye, that would suggest the results were coming in better than you'd expected rather than as you'd expected. I'm really interested to hear your view on that, if possible. Thanks.
Yeah. Who's asking the question?
Alex Stewart.
Alex. Hi, Alex. Well, I think, you know, frankly, it's a good question, by the way. Remember, Alex, back in the fall 2021, we told you that we are gonna start, you know, working on our value pricing. Quarter four, 2021, right? The fall 2021. We started, you know, not knowing what 2022 will look like, and we have trained more than 1,000 of our salespeople on value pricing, right? We renegotiated and we opened thousands of contracts to look at our formula pricing. That's why, you know, last year, when inflation picked up, you know, as a consequence, specifically in Europe, with the crisis in Ukraine, you know, we were ready. We were ready to do a good job, right? Frankly, you know, nobody has a crystal ball.
Some are probably sharper than others in usual times. When visibility is reduced and uncertainty is higher, you know, what I do normally is, you know, my wisdom is not, waste good crisis. We are in our master code pricing, part of our portfolio and probably 50/50, one is linked to supply demand, right? When supply is tight and, you know, you know what it takes, right? When inflation is there, we are baking formula pricing, right, linked to raw material or energy. Soda ash is one of the good examples we told you, doing just that, right? Silica is another one. The other part is value pricing.
In value pricing, we have been testing our portfolio, where pricing is gonna be sticky, frankly, we are learning. I'm, you know, last year I've been learning a lot personally on the portfolio and its stickiness on where we have a differentiated value at the product level. We've been improving the portfolio. You've seen it in solutions, for example, where we have been making calls, pricing versus volume, we let go some of the low quality products we just didn't take, right? Seaborne in soda ash, for example. I think that's, you know, by testing the market, but better understanding our competitive edge. In quarter four we told you that we are gonna, you know, continue defending our value pricing, our margins.
You know, as you've seen, the EBITDA margins last 12 months has been at 24.8%. Without, probably RusVinyl and the team, the IR desk can give you those data, we did it actually. We removed RusVinyl since I joined the company, and we've been gaining one percentage point, right, every year in margin. Right? Those are leading specificity margins. That's what we've been doing, right? If we can get the same level of record margin of last year, this year, I will be more than happy, right? We will go and outperform the market in term of volume, right? That's I think what we gain this year, while continuously testing our value pricing, and some of it should be sticky, and will stay with our portfolio.
Another way, if, when you and Karim were chatting at the beginning of last year, were you expecting Solvay to deliver EUR 3.2 billion-EUR 3.3 billion of EBITDA? Or was that above your expectations, let's say this time a year ago?
Well, I mean, our team surprised us, Martin. I mean, you remember the EUR 3 billion was even a big event in this company because, you know, since 10 years we were looking at that. Sorry, we were looking at that. No, obviously we didn't have a crystal ball earlier this year. The pricing was new in this company. In quarter four, we trained the muscle. I remind you when we, you know, started in March, and we started our real campaign in pricing, we had few contracts negotiated, but the team really outperformed and surprised us. I think what is important, the end of last year, we started really going forward with value pricing against supply-demand and formula pricing. Make sense, Alex?
Thank you very much.
Just to remind you, we had a war that had started, we had inflation that had never been so foreseen, so all of that added a great degree of uncertainty. We're really pleased with what the team delivered in that context, no?
Thank you, Alex. Our next question comes from, Geoff Haire from, UBS. Geoff?
Hello, is that for Geoff Haire?
Yeah. Mm-hmm.
Sorry, I didn't hear my name. Sorry. Thank you very much for being able to ask a question. I just wanted to come back to the guidance and the comments you made about margin erosion in certain product areas. If you look at the low end and high end of the guidance, are the areas that you expect to see margin erosion the same as those that you'd expect to see margin recovery in at the high end? Could you give us some examples of where that margin erosion or recovery might come and which businesses?
Yeah. Well, I mean, again, the demand dynamics are still uncertain, right, in this world. They will continue. Now, as we told you and you know with the pricing comp will obviously be more challenging as quarter two last year was particularly very strong in this respect. Now in our guidance, we don't expect much of the improvements in the macro environment. Volume are still under pressure due to the sub-demand across many markets, as we mentioned. That's specifically quarter two. Net pricing remains positive, but again, against a very strong comparable quarter versus last year. That's why, you know, I even gave you some color on quarter two EBITDA, you know, sequentially lower than quarter one. H2 levels will depend on the level of volume recovery, as we told you.
We have very little visibility now. Finally, do not forget our usual seasonality. H2 is usually lower than H1, with quarter four being the lowest quarter of the year. You know, that's the main thing you need to, you know, to keep in mind, frankly, we'll see how quarter two develops, obviously we will come back to you. On the business unit level or business level, we expect materials and chemicals to continue to do better in this environment, right? Although in some areas, hot area like batteries, they will, this talking will continue. Solution will recover more gradually. Again, we are taking, you know, our destiny in our hands, we are really choosing to let go some volumes if they have low profitability.
I remind you that this company had a problem on return on capital employed. In 2019, just four years ago, it was 8%, and we have an issue of profitability of our assets. We don't want to go back to fill the pot, right, with low profitability products. We will keep that in mind, and that's how, you know, we are looking at the portfolio. Make sense?
Yep.
Thank you, Geoff. Our next question come from Chetan Udeshi from JPMorgan. Chetan, please go ahead.
Yeah. Hi, thanks. You know, my first question was, I'm bit curious why did you feel the need to invest in inventory in this sort of environment where, you know, maybe like you said, volume visibility is quite low. Like, what drove that, you know, inventory increase in Q1? Like, did the demand end up worse than what you guys were expecting through Q1? I was just surprised. Second question was, if I look at the guidance raise on EBITDA, it's roughly, I think EUR 100 million to EUR 140 million EBITDA guidance range, so increase. The free cash flow is going from EUR 1,750- EUR 900, EUR 150 delta, out of which EUR 90 is from the payment from the previous owner of one of your assets.
Where is the remaining EBITDA increase going in terms of free cash flow contribution? Why are we not seeing bigger increase? Thank you.
Great question. I'll take the working capital, Karim, maybe the free cash flow later.
Sure. Mm-hmm.
Well, frankly, the working capital was the million dollar question when we started the year. I'll remind you, Chetan, that at the beginning of the year, we started with very low working capital percentage of sale in quarter four. That's number one. Nobody knew, and I remember even with you guys and others, some peers stated Q1 is gonna be a disaster and others, we don't know. We had our own guess, but frankly we don't have a crystal ball. The answer to your question is simple. It's customers, customers.
We, our customers and we have now, through 2020, by the way, this is one of the positive things of COVID, we have a central order book where we go back bottom up, you know, from customers, understand their needs, because at the end of the day, I wanna be ready, whatever happens, to supply customers' needs. The working capital, indeed, quarter one, we have a higher, it's approximately EUR 300 million-EUR 450 million above historical level, an increase about 10% of net working capital, Chetan. When you take into account the effects of price and cost inflation, frankly, such increase could have been expected or is expected. We've done it by choice because we entered the year again with low inventory and, you know, we didn't know how the markets will evolve.
We had several you know, contradictory, you know, opinions on the development. You need also to look at inventories and payable. In inventories, from low level, we decided to invest to meet customer demand and markets like Aero to address the ongoing recovery. We have strong markets in mining where our technologies are needed, as you know, to support the copper extraction. The agro season arrived. We expect this to be temporary, right? We will go back to normal levels later in the year. The second is the payable, and there they are lower than usual, primarily because of further sequential reduction of variable costs, energy and raw material, and you will see the impact in the coming quarters. Also because we buy less raw material as we intend to decrease our inventories.
Yeah, I mean, despite the increase, we are doing much better than many of our peers who published at least. We are approximately 17%. I asked the team actually to give me some median of the peers that are at 30% plus. Yeah, and frankly, I don't regret that decision or that call with our presidents, business presidents, because some of our materials performance, some markets, the volume increased and we were at the rendezvous. I think those are business calls, and I don't frankly regret it. I think it was the right thing to do, and we have still three quarters to fix the working capital as percentage of sales. Karim?
Indeed. Another question, Chetan, on the, why is the free cash... I'm gonna reframe the question. Why is free cash upgrade relatively modest in the context of, I think you said a EUR 150 million profit guidance improvement? I think there are three components. One, you rightly pointed out we have a EUR 92 million, let's say unplanned in our initial guidance of the year, litigation settlement. That leaves you with a EUR 60 million improvement because you said around EUR 750-EUR 900. Two other factors are, one, the effect of a higher guidance in profits, less working capital, less tax effects. I'll come back to that. For the avoidance of doubt, we are at this stage not planning to change our CapEx investments compared to what we said earlier in the year.
Why does EUR 150 million-ish of cash of higher profits increase the profits by cash by EUR 60? It's really to do with working capital and taxes. We're looking here at cash conversion on the incremental profit around 40%, which is stronger on average, as you'll note. Also, it's important to note the phasing of that increase. If it's very backended, let's say towards Q4, much more challenging to crystallize into cash before the end of the year. That's part of the judgment we apply as well in looking at it. Any extra profits we generate will be crystallizing to cash, and we'll do what we can to make sure it happens this year.
Understood. Thank you.
Thank you.
Thank you.
Thank you, Chetan. The next question comes from Jaideep Pandya from On Field Investment Research.
Thanks. Apologies for this, just could you give us some color on the debt structure or the two companies when they are going to, you know, come into the separation and also just an update on the timeline, considering a lot of volatility in interest rate markets these days, how confident are you that it will not There is no risk of a significant increase in interest burden for both the entities? The second question, sorry to ask this, here to Ilham. I mean, you've done a phenomenal job in price versus raw materials, really almost EUR 1.3 billion now, if I look back to, you know, early 2022 through Q1 this year. In your experience in the industry, I mean, have you ever seen something like this?
Cause it is fascinating for us from the outside in for Solvay to report these kind of results. We're obviously all scratching our heads in terms of sustainability of this. You know, just some color, some confidence as to, you know, if you can retain most of this EUR 1.2 billion-EUR 1.3 billion, that would really help us understand the new Solvay better. Thanks a lot, and well done again on the results.
Thank you. Karim?
Jaideep, let me just first of all start to address your question. I won't be able to answer everything at this point in time. I'll start by reminding you that we said a few weeks ago that we'll be giving insights on the capital structures in the June, July timeframe. I'm gonna ask you to please be a little patient. We wanna finish our work. We wanna do it really well to what should the capital structures be. I'm gonna come back to a bit about that in a moment. The good news is our leverage is lower than it's been. Our cash is really strong. We've said consistently we're gonna create two strong companies with strong balance sheets. I'm gonna say we're spoiled for choice. We have very, very strong Solvay SA balance sheets as we head into this.
Once we finalize our own assessment of the capital structures, we will finalize our plan on the liability management. What do we do with the bonds? How do we incentivize, motivate, discuss debt investors to see the strength of the balance sheet of both companies? That's the plan. In doing that, you talk about high interest rates, et cetera. Let me just say this, we have more than adequate liquidity reserves. You can expect us to adhere to normal market practice in these situations. Honestly, we think that people will see the strength of those balance sheets, and they will see the logic of responding to the opportunities that we've put before them.
I'm not gonna go into more than that at this stage, beyond the fact that we have a lot less debt at a net of EUR 3.25 billion than we've had for years. For the rest, Jaideep, I'll ask you because what we do there will actually directly be linked to what we'll share with you in June, July on the capital structures of both companies.
Yeah. On the pricing, thanks for the words. It's phenomenal job actually on more metrics, by the way, than pricing. I mean, this company looks very different and smells different than back in 2019. I remind all that we've been in through this transformation, financial transformation and non-financial, by the way, and I'm so frankly proud on the debt reduction. The 1 times today just put us in a very solid position to have choices we didn't have just few years ago. The underlying EBITDA margin, I mean, I told you without RusVinyl now, which we exited fully, and we are glad about this, we have improved our EBITDA margin, which was already best-in-class specialty margins, one percentage point every year till last year.
The free cash flow, and you know it, we were very much of a lagger in our peers group, and we promised you 30%, you know, at least to be in that league one. We all performed and we became a free cash flow machine. Return on capital employed. If there is one thing I'm very, very proud of with the employee engagement, by the way, which is close to my heart, is the ROCE. I mean, 8% we're dating with the cost of capital, and we doubled it. This is not an easy one, by the way, because you need to prune the portfolio, you need to choose your products, and you need to choose the customers as well. Here on pricing, I think we moved from, you know, selling probably product to selling value.
That's a big mindset shift in the company. It's not easy. In my career, right, I've seen it in my previous companies. You need training, you need to know how to sell the value, and you need to understand which value you create with your customers and share the value created. I'll give you an example. When I replace a piece of metal under the hood application in any automotive customer, it's not about the euro per kilo of the polymer I am giving away, right? It's not that. It's about the value I create by replacing metal at lower weights, therefore consuming less fuel, emitting less CO2 at a lower total cost of ownership. Now we agree with our customers what's the value created, and then we share the value created. That's it.
I think, the net pricing, call it pricing power, whatever, means pricing net of the variable cost and fixed cost. Our salespeople are rewarded. We have even CEO awards in the company by now on those, you know, net pricing, which before was even on the volume side. I think all of this is important. On the second thing, I know you are scratching all your head, and I think time will tell us, right? We'll tell you, and frankly we have been telling you now for more than one quarter. A few quarters. That's fourth 4th quarter in a row. Half of our business of our portfolio supply demand related. This is, you know, in a tight supply situation, let's say an area, you can, you know, push your prices, et cetera.
you know where we have tight supply. More importantly is that we reviewed our formula prices, right? We reviewed the components of it. Energy, raw material. We put surcharges, you know, and you've seen it last year. There if energy or raw material is up and down, we give back to our customers because we want to protect our margins, right? Around half of the portfolio is more specialty. There we are, we are experimenting. We've been experimenting, now we are reinforcing, you know, areas where we sell a strong value proposition based on customized innovative solution designed to meet the customer needs. I think that's important. Now, that's new in the company and obviously I'm calling on our teams to continue fighting for that. It's about being obsessed by the value we create to our customers.
Again, not leaving it all on the table, it's about sharing the value creation.
Thank you, Jaideep.
Can I just ask a follow-up? Oh, sorry, go ahead. Thank you.
At this stage, we will take two more question. Matthew Yates from Bank of America is the first one. Matthew?
Hey. Afternoon, everyone. Might actually be a follow-up on the last question. Specifically on the materials division, if I look at your Q1 sales, they were a touch below Q4, yet your EBITDA went up by EUR 60 million sequentially, or about 20%. Just why would profitability be so much better Q on Q if the top line hasn't really changed? Do I infer from this that you've already started to see a drop in your raw material inputs that haven't been passed through in pricing? Obviously 35% margins is pretty phenomenal. Is there a risk here, and that's embedded in your Q2 guide, that there are some products perhaps with formulation clauses in that kick in with a lag, or you need to give back some pricing in Q2?
just really wanna understand, you know, why Q1 was so good relative to.
Mm-hmm.
To Q4.
Yeah.
The sustainability of that into the coming quarters.
Yeah. It's a good question. I think the volumes and, you know, I talked about the destocking, right, on the PVDF side. And we're more resilient than others because, again, our specialty polymer portfolio, generally is not only automotive by the way, is only one sector. In automotive is not only batteries. I think the diversification, which, you know, investors do like in the specialty polymers is really a good thing. We had many markets with materials delivering volume growth, with only batteries down. In specialty polymer we have a new fab equipment, supported growth for our polymers used in electronics. We also delivered volume growth, for example, in healthcare applications such as pharma packaging. I remind you, we are in pharma packaging. We're in hemodialysis.
We are one of the few leaders in hemodialysis in the world, and that have been picking up nicely. I like this business since COVID time. Something important to note is while polymer demand for EV batteries was low due to destocking, again, the polymers also non-batteries grew in the quarter, and under the hood application. Of course composites volume growth. I mean, I think we mentioned it in our prepared remarks. It's linked to the ongoing recovery in civil aero, and we are not back at the 2019 levels, by the way. The pricing level versus last year, the business has demonstrated its ability to maintain a higher pricing, which was the main driver of the growth. That's value pricing. I'm not gonna repeat, you know, my favorite case, and story of replacing metal under the hood.
Customers, they come to us when they have many ends, right? They need the chemical resistance, abrasion resistance, et cetera. As many ends needed, they come to us. That makes us very differentiated. Even by the way, when you look at our batteries products, right, in this destocking, we kept the margins, right? The percentage stays, EBITDA margins for those products or gross margins for those products became stable. Over time, we will continue value pricing our solution, while in some application we will give back pricing when raw materials are favorable, right?
By the way, we did it somewhat in batteries because 142b, for example, as a raw material prices for those who are, you know, they know the level two or three of the formula of batteries and PVDF, we gave away, but we protected our margins, right? We sustained, you know, margins even when the batteries volume and destocking is happening. Longer term, you know, we have specialty margins here. That's what we are talking about. We will look for more profitable volumes because, you know, in giving lightweight and electrifications, you know, we will continue penetrating with those technologies, like in composites, whatever the market does. It's value pricing, right? Not value based on cost plus, right?
I think that's what you can expect from us in the specialties and in specialty polymers, specifically. Back to you.
Thank you, Matthew. Our last question will be from Sebastian Bray at Berenberg. Sebastian, go ahead.
Hello. Good afternoon. Thank you for taking my question. It's on the segmental, sub-segmental profit contributors to the material segment. It builds on the questions asked earlier. Between Q4 of 2022 and Q1 of 2023, was there a significant change in the profitability in absolute terms of the composites business? In other words, are what we are seeing in terms of EBITDA improvement is largely due to specialty polymers or the mix between the two is more even. Thank you.
Yes. Thanks for the question. Well, I mean, we don't give obviously guidance and sensitive information at granular level, right, between specialty polymers and composites. As you know, when I joined in 2019, I already told you at that time that, you know, I didn't like the composites material margins, right? We're gonna do, you know, turnaround and really fix the profitability. That's why. 2020 helped us. It was tough. It didn't go without sweat, tears and pain because we had to shut down few assets which had the lowest return on capital employed in composites material, I remind you, which helped us actually to move products in other places, in existing manufacturing sites and which helped us to fill the existing capacity and do better job there.
As we recover, you know, as the aero is recovering, you will see, you know, improved margins here and there, but it's across the board. I think Specialty Polymer, again, did a great job. I think the value pricing there was one of my, you know, dreams at the beginning. I told you it's a crown jewel. I knew that we need to train, we need to understand better, you know, our value pricing. There is no particular outlier. I'm very pleased, you know, again, with the whole material segment, Specialty Polymer delivering strong results outside batteries and even in batteries, they kept their margins. I cannot, you know, ask for more. This shows the strength of our diversified and unique portfolio of polymers that customers, they value.
That's, you know, the sincere story, and we'll continue testing. You cannot imagine how much work is going behind the curtain in this company. Each business is actually delayering, like Pandora's box. We are opening one after the other and understand where we differentiate, where we are not, where we are leaving value behind us, where we don't value enough our products. No one has the strength and the depth of our specialty polymer portfolio. I truly believe it. We are gonna continue different margin. Through innovation, we'll do better work on value pricing. Back to you.
Thank you for taking my question.
Thank you.
Well, I think we've reached the end of our call, so I want to thank everyone for your participation today and remind you that the investor relations team is available if you have any further questions. Thank you so much, and have a great day.
Ladies and gentlemen, this concludes today's conference call. Thank you all for your participation. You may now disconnect.