Ladies and gentlemen, welcome to the Arkema third quarter 2019 results conference call. I will now hand over to Marie-José Donsion, CFO. Madam, please go ahead.
Thank you. Good morning, and welcome to the Q3 2019 results conference call. I'm here together with Béatrice Zilm, the investor relation team. As usual, in addition to the press release, we have posted on our website the slides which detail the third quarter performance. I propose to start with the macroeconomic context, which remains clearly challenging. Geopolitical tensions are weighing on global demand. Our customers who operate on a low visibility environment are being cautious in their inventory management as well as in their investments. Of course, this has an impact on our business. In such a context, Arkema delivers a resilient set of financial indicators demonstrating two things, I believe. First, the strength of the business portfolio, and second, the benefits of our transformation strategy.
If I start with the first item, speaking of the strength of Arkema's portfolio, this third quarter results show different trends between specialties and intermediates. Since the beginning of the year, we have seen the increasingly strong performance of specialties, and this trend accelerated in our Q3 thanks to the impact of price increases, to the continuous work on product mix, and a more favorable raw materials environment. Bostik is a good example of that, continuing on a strong momentum, recording EBITDA growth of 20% in the quarter and reaching an EBITDA margin of over 13%. Bear in mind, the performance in specialties is achieved in a downbeat volumes environment in technical polymers as certain end markets such as transportation, consumer electronics, and oil and gas are still seeing lower demand year-on-year.
Meanwhile, the intermediate businesses have fluorogases facing a significant decline, suffering from the illegal HFC imports into Europe, while MMA, PMMA, and acrylics have delivered a solid performance. On the second point, which is the impact of our long-term transformation strategy, we have ArrMaz delivering a solid performance in line with our expectations in quarter 3. In addition, we finalized the acquisitions of Prochimir and Adhesives and Lambson in Performance Additives. We successfully started the 50% expansion of our high-performance polyamide 12 powders capacity in Mont site in France, and we have announced the 50% capacity expansion of our high-performance Kynar PVDF for the electric vehicle battery application at our Changshu plant in China.
Finally, on the 14th of October, we announced the project to divest our non-core functional polyolefins business, which is an intermediate activity and part of our PMMA business line, for an enterprise value of €335 million, roughly at 10 times EBITDA. It was important for Arkema and our employees to find the right partner, and SK Global Chemical is an excellent strategic fit, as they will be able to leverage their existing assets to grow the business over long term. Those actions, all in all, contribute to our long-term ambition for specialties to make up more than 80% of our sales by 2023.
Just to give you an idea, if we include the pro forma contributions of ArrMaz, Prochimir, and Lambson and take into account the proposed divestment of functional polyolefins, we end up with specialties making up for 74% of group sales in the first nine months of 2019. I now propose to take a closer look at some of our financial figures for Q3 2019. I'll start with sales that are up 2.3% compared to last year at EUR 2.2 billion. This includes volumes rising 0.7%. We have growth of acrylic monomers in Asia and U.S. that was particularly dynamic, notably thanks to the start-up of the new acrylic acid reactor in Texas. Volumes in Industrial Specialties are up 2.8% and thanks to strong performance in tire chemicals in particular.
Meanwhile, we have High Performance Materials that recorded a 4.1% volume decline impacted by the general economic context with weaker demand in certain end markets that are overshadowing the good momentum in high growth niche markets such as the batteries or 3D printing for technical polymers. The price effect is a negative of 4.4% with very contrasting factors at play. On one hand, the High Performance Materials division benefited from a 6% increase thanks to a positive product mix and our strong pricing actions, especially at Bostik. Whilst on the other hand, Coating Solutions were impacted by lower propylene prices and fluorogases by the very tough market conditions in Europe. The integration of ArrMaz on 1st of July is the main driver behind the 3.9% perimeter effect. Finally, we have a positive 2% currency effect, mainly reflecting a stronger US dollar versus euro.
EBITDA at €385 million is 2.9% up on last year's level, which is a very strong performance in the current context. The EBITDA margin at 17.4% remains resilient at a high level. Looking at results by division, we have High Performance Materials EBITDA that rose 12% to €182 million. Together with the contribution of ArrMaz, Bostik was the key driver for EBITDA growth at a remarkably strong 20%, as I mentioned. Our mid-and long-term ambition for this business remains, of course, as strong as ever. As for Advanced Materials, they resisted well in spite of the weakness seen in some of its end markets. EBITDA of the Industrial Specialties division is lower relative to last year at €252 million, marked by very different trends by business line. Fluorogases results were heavily impacted by lower prices, linked, as mentioned earlier, to illegal HFC imports in Europe.
Waxes MMA/PMMA resisted well, thanks to the quality of its innovation and the lower raw material costs. I think it's fair to say also, Arkema's performance remains solid in the continuity of the first half. All in all, the division EBITDA margin remains close to last year's high levels indeed. Coating Solutions EBITDA is up around 8% to €70 million, with a 80 basis points increase in EBITDA margin to 13.1%, thanks to improving unit margins in downstream activities mainly. Just to mention on the impact of Tropical Storm Imelda on the Clear Lake facilities that in the end was limited to a few million dollars. Depreciation and amortization reached over €135 million, up EUR 26 million year-over-year, as a result of a number of phenomena: IFRS 16, of course, the setup of several production units, the integration of ArrMaz, and the negative exchange rate impact.
Recurring operating income amounted to €250 million, and REBIT margin was at 11.3%. Non-recurring items total €33 million and include PPA amortization, some restructuring expenses, asset write-offs, and acquisition costs of ArrMaz, mainly. Financial results stands at €29 million, including an interest rate impact coming from the partial swap of our net debt into US dollars. Year to date, the tax rate, including exceptional items, is at around 20% of the recurring operating income. Consequently, quarter three's adjusted net income amounts to €166 million, which corresponds to roughly €2.2 per share. Moving on to cash flow and net debt. Free cash flow is once again very good at €218 million, mainly reflecting the group's solid operational performance and a decrease in working capital linked to the business seasonality. At 16.4%, the working capital ratio on annualized sales is comparable to last year's level.
Total capital expenditure amounts to EUR 148 million in the quarter. We can confirm our assumption of around EUR 610 million for the full year. Including both our 5.5 recurring CapEx as well as the exceptional CapEx projects. Net debt reached EUR 1.77 billion at the end of September. This includes close to EUR 600 million cash outflow linked to the payment of ArrMaz acquisition and that of the remaining stake in Sunke we bought from our partner Jurong, as well as EUR 13 million for share buybacks. Our balance sheet is very solid as the net debt represents 1.2 times the last 12-month EBITDA. To conclude my remarks, a quick word on the outlook. Our assumption is that the macroeconomic environment is going to remain challenging, with ongoing cautious customer behavior.
We will, however, continue to focus on our internal momentum and on the execution of our long-term strategy, and we therefore confirm our ambition to achieve this year an EBITDA comparable with the 2018 record level. What does it mean for quarter four? We actually expect to deliver an EBITDA for quarter four broadly in line with last year's Q4 level. This takes into account a strong decline in fluorogases, given the high base of comparison we had last year, and the illegal HFC imports in Europe that are continuing to weigh significantly on prices. Specialty businesses should, however, continue to record solid growth, boosted notably by Bostik's positive dynamic, the contribution of acquisitions and improving unit margins in Performance Coatings. The contribution of specialties versus intermediates should be more favorable relative to last year, and this is a really positive point for Arkema.
It demonstrates we are on the right track implementing our transformation strategy, and step by step, improving the company's resilience. This concludes my comments. I thank you for your attention, and I'm now happy to answer your questions.
Ladies and gentlemen, if you wish to ask a question, please press 01 on your telephone keypad. The first question comes from Martin Roediger from Kepler Cheuvreux. Sir, please go ahead.
Hello, Marie-José. Hello, Pierre. I have a few questions. First is on Bostik. I see this 20% EBITDA increase, and of course, it's partly supported by a low comparison base. What was the primary reason for that increase? Was that price hikes, or was it lower raw material costs year-over-year? In that context, can you quantify the mixed effect on the 200 basis points margin improvement? I remember that you have given up some business because that was low profitable, and therefore, that was also certainly supportive for your profitability. Secondly, on the tax rate, rather low again in Q3. What is your full year tax rate? Is that 20%? Should we expect that also go forward after 2019? Final question is on acrylic acid. You mentioned solid performance in Q3. Where do we stand right now in terms of profitability?
Is it closer to mid-cycle conditions or to low-cycle conditions? Thanks.
Hi, Martin. I'll take them in order. Regarding Bostik, we had this conversation actually for some time now. What I see in Bostik is obviously the strong effect, in terms of margin recovery versus last year, of the price actions that were conducted earlier in the year. Clearly, as we published in the first quarter or even the first half, you already could see in fact, let's say, progressively a 100 basis points recovery of the margin, a 150 basis points recovery in the margin in the first half. In fact, if you remember well, last year it was a continued erosion of the profitability of Bostik, since we were facing this lag in transferring the raw material price increase to the end customer. This year, I would say these price actions clearly have paid out.
It's clearly definitely pricing as well as mix, because as you could see, we had some pruning. It's fair to say, regarding some of the applications we have in the portfolio of R&D's business, which was weighing on the volumes that we had in the first half. You can see in fact, the situation in the second half is actually much more under control, and volumes impact at Bostik are actually just slightly negative. The fact that we have a raw material context, which has changed in 2019 and is clearly more benefiting to the business is obvious, because as you know, we are slow when raw materials go up. We are also slow when raw materials go down.
It's fair to say that, despite volumes not being extremely buoyant, we resist extremely well in terms of our pricing actions that we conducted earlier in the year, and clearly they're holding up very well. Definitely this continues to pay as we progress in the year, and as in fact, the gap compared to the margin of last year increases further. I definitely expect the margin level that we have reached now, which is over 13%, to be a resilient one. Not to mention, to continue to improve further. In terms of tax rates, we have actually a guidance which I think is around 20%-21% effective tax rate for the group. This is a mix of geographies, as you know. We have actually a quite good situation in France, since we have accumulated tax losses that we can apply, obviously, to some of our profits.
This has an impact on the average tax rate of the company. I definitely confirm we are in line with the guidance, and I don't expect a significant change of that guidance as we go into next year. Concerning acrylic acid, I'd say we are still in this mid-cycle plus in U.S., mid-cycle minus in Europe, and low-cycle level in Asia. I'd say we start seeing some pressure. It's on the margins of the upstream. That, of course, clearly benefits to the downstream. Right now, clearly this Coating Solutions segment is actually performing really well. There is obviously a tension in the market and therefore we are obviously monitoring this into Q4. At this point, I am not seeing a change in trend. We are finishing now October, so no major change in trend.
Thank you.
Thank you, Martin.
The next question comes from Alexandra Touton from Morgan Stanley. Madam, please go ahead.
Hi. Good morning. Thank you for taking my question. It was just on fluorogases and the illegal imports into Europe. It obviously seems to be impacting prices quite significantly. If can I just confirm you're talking about a sequential decline as well into Q4? Also, what is it going to take in terms of regulation enforcement for this market to improve?
Regarding fluorogases, you are correct. In fact, if you remember the performance of this business line last year, we had an exceptional contribution, which was kind of out of the season, because normally the high season for fluorogases tends to be Q2, to some extent, a bit of Q3. In fact, last year we had an exceptionally good, high volume contribution on fluorogases in Q4. This year, definitely, if I continue on the trend we've seen since the start of the year and into Q3, I therefore expect a decrease of the fluorogases impact on the performance of the group, yes. Correct, it's kind of sequential. In terms of actions from the EU, I'd say it's still at an early stage. I think there is now an awareness in the public of the situation.
We went through a phase of denial first of the situation. I think all the actors of the market have been pretty vocal on the phenomena. Now basically it's for Europe to actually put some discipline at its borders. No, I do not anticipate right now a recovery or any change in the situation short term.
Okay. Thank you.
The next question comes from Alex Stewart from Barclays. Sir, please go ahead.
Hello, good morning. Could you talk a little bit about the volumes in Thiochemicals, where they're coming from, whether that's improved and a bit of context on that? Then in the same breath perhaps update us on your new Thiochemicals capacity in Asia, how the construction is going, when you're expecting it to sell first volumes, that kind of thing would be great. Thank you.
Okay. Thank you, Alex. This business is really enjoying a good momentum. The main drivers for this activity, I'd say it's twofolds. We have roughly 50% of the business is geared toward the methionine application. In that context, we actually supply our partners CJ in Asia and our partner Novus in the U.S. We are actually a good partner for non-integrated methionine players. We've seen actually a good level of demand in this market. I would say as usual, it's a demand that grows typically 5%, 6% a year. This is basically confirmed this year, definitely. The second point is desulfurization regulations evolution in the world, and we actually deliver a product that helps desulfurize the oil. As these regulations become more stringent, so we also actually have enjoyed an increase in demand on that area, too.
Classically, oil and gas, in terms of end market for Thiochemicals, is more kind of 1%-2% growth year-on-year. In fact, this trend has a bit benefited from the evolution of the regulations and therefore has also contributed to additional volumes for Thiochemicals. I think it's a good momentum for us to come up with this additional capacity in Malaysia. As you know, we are actually doubling the capacity of our plants there. The CapEx is actually progressing well. It's almost complete. We actually target mechanical completion by end of this year and the start of production early 2020. At this point, I still confirm the schedule.
Very kind. Thank you. Could I just follow up on that? The third quarter volume in Industrial Specialties was 3% positive. Biochemicals is about a quarter of the division, it implies that it was probably a high single-digit growth in biochemicals volumes. Was that evenly split between the desulfurization and the mercaptans and the methionine, or was it more heavily weighted towards the desulfurization? Any sort of sense of where the growth comes from would be really useful.
No, I'd say methionine is still the highest contributor in terms of growth for this business, definitely. We have also an application, which is gas odorization, which has also performed extremely well in this business line. The entire portfolio of products has been in a high demand level across the business.
That's great. Thank you so much.
The next question comes from Mubasher Chaudhry from Citi. Please go ahead.
Thank you. Hi, Marie-José. Just two quick questions. What's the cash inflow expected from the polyolefin deal? Just trying to figure out the net debt impact there. On the fluorogases, do you still think you can be between the previous guidance of 2017 and 2018 on sales, or do you think it'll be edging towards the lower end of 2017? That'd be helpful.
Thank you, Mubasher. On the polyolefins disposal, as you know, we've given a total amount of the transaction. Actually, I've confessed kind of multiple in my speech just before. It was actually a pretty amortized asset. You will see, in fact, in our publication end of the year, we will have in our balance sheet the amount of asset held for sale that will be actually extremely visible. In total, I'd say, yes, it's a significant gain on the transaction with, let's say, an average tax amount of EUR 50 million. Probably assuming something, let's say, not far from EUR 200 million contribution on cash is not totally crazy.
Thank you. On the fluorogases?
Regarding fluorogases, I think we had, in fact, mentioned we were in the trend of 2017 contribution. I would now say we are probably below that level, if I look at this year. Clearly, we are on the baseline, which is now more modest than what we had at the time in 2017. Also, probably more resilient from that point on.
Perfect. Thank you.
Thank you.
The next question comes from Laurent Favre from Exane BNP Paribas. Please go ahead.
Hi, good morning, ladies. Laurent Favre. Two questions, please. The first one, trying to reconcile your comments on the Q4 guidance of flat EBITDA and the guidance for the full year. Am I right to assume that functional polyolefins will be in discontinued operations, and therefore we're losing that EBITDA on a year-on-year basis? The second question on HPM. Based on what you said on adhesives at 20%, it seems that Advanced Materials was not down. I'm wondering why. Is it that ArrMaz is also growing EBITDA year-on-year, or are there some exceptional factors that are helping Advanced Materials' EBITDA on a year-on-year basis? Thank you.
Thank you, Laurent. Regarding the polyolefins disposal, in fact, the only phenomena impacting our accounts for year-end are this reclassification in the balance sheet of asset held for sale. There will be no reclassification in the P&L. After reviewing with our auditor, basically it's not a business line in full, it's not a segment in full, and therefore there is no change basically in the contribution of the polyolefins in the P&L of this year and of next year till the time we dispose of it. No impact coming from this announcement on the P&L side. Regarding the adhesives progression and the Advanced Materials progression in terms of margin, as we mentioned, in fact, Advanced Materials, despite they have this tough situation on the volume side on some of their end markets, they still enjoy some positives on some other markets.
The mix is actually holding well. Therefore, the margin levels and the pricing levels are also holding well in the quarter and let's say since the start of the year. Right now, the contribution of Advanced Materials remains extremely good and extremely resilient. I also confirm ArrMaz performance is very sound. In fact, it's a significant increase compared to their performance last year, quarter-on-quarter. It's fully in line with, even a slightly better, in fact, than the business plan we had on them. Clearly the momentum at ArrMaz is robust.
Okay. Thank you.
Thank you.
The next question comes from Geoff Haire from UBS. Sir, please go ahead.
Good morning. Just had two quick questions. First of all, just I wonder if you'd comment on the organic growth of Bostik. When I look at your peers, it would appear that organic growth is negative for them. Is that the case for Bostik? Maybe you could split out price and volume. Just going back to biochemicals, do you just supply Novus and CJ on the methionine side, or are there other players you supply as well? Because I'm conscious that there is no volume growth for Novus and CJ, at least that's been announced. I'm just wondering then where a lot of the new capacity in the Asia will go.
Regarding the organic growth at Bostik, I'd say, putting together the volume evolution and the price impact, it's probably a break even or slightly positive let's say. Looking into biochemicals, I confirm on the methionine, the two customers we have are the ones you have mentioned. I have good volumes selling to them, so this is what I can say at this point.
Could I just come back on that then? If you're doubling the capacity of the Asian biochemicals and CJ and Novus haven't announced any new capacity in methionine, where is the additional capacity going? Is that going into desulfurization of oil or other end markets?
No, actually, right now we have doubled the capacity at the request of CJ, and therefore this new capacity is mainly going to CJ, who has actually already completed their expansion at the site.
Okay.
They're waiting for us to start basically, delivering them. Right now, we have to try to anticipate this trend. We have transferred some of the material from Europe to Asia as well. Yes, it's fully devoted to this end market and to this partner.
Okay. Thank you.
The next question comes from Martin Evans from HSBC. Sir, please go ahead.
Yeah. Thanks. Just looking at this third quarter below the EBITDA line, there's a lot of negative indicators. Obviously, REBIT was down, the margin was down, net income was down, EPS was down for the quarter, although I admit it was against a strong quarter last year. Given your comments on the sort of year-end outlook with customers managing their balance sheets, the fluorochem situation and what we're hearing generally, I'm just struggling a little bit now to see why or how you'll be able to grow next year, versus certainly the current consensus, despite the acquisition contributions coming in. These, as I say, below the EBITDA line, the indicators are looking quite negative. Thanks.
I'm a bit confused actually by your comment. As we mentioned, actually, when we have this EBITDA, which is comparable to last year, you perfectly know it actually includes the IFRS 16 impact. It includes the acquisition. It includes some positive Forex effect as well. I don't think it takes anybody by surprise. In terms of, let's say the other lines, as I said, tax is extremely in line with the guidance that we've given at 20% effective tax rate. In terms of financial expenses, we've had this refinancing of the hybrid bond that we did in the first half, in light of the positive financial markets securing actually, $400 million with a gain of a 2% rate compared to our initial hybrid line. Everything is the consequence of the actions that you conduct.
Regarding next year, as you know, it's kind of early to already comment on 2020. At this point, the macroeconomics that probably everyone assumes in the markets are not too different from the ones we see in the current year. In such a context, what you are seeing is actually a very good resilience of the performance of the group. Now, we will have the full effect of the acquisitions that we have done, like, I would say any other company in our sector or let's say in the market. We can remove all the positives and see everything in negative. All in all, definitely, I think it's a very solid performance in such adverse conditions.
Thanks. Just a second quick follow-up. On your definition of specialty, because you have used it a lot through the call and more recently as well. Do you have a, whether it be a margin or a return on invested capital, do you have a target definition of specialty returns? If, as you now say, 70%-80% of the portfolio is specialty versus commodity, how do you see that definition?
Basically, the specialty characteristics that we define is when you have actually a leading position in a market with limited number of players in specific products or applications. Definitely a solid contribution. Not necessarily only on EBITDA, but definitely on EBIT level. As you know, Bostik and Advanced Materials have very different EBITDA profiles, but they also have very different capital expenditure intensity in them. When you look at the net contribution, they are actually both not too different and therefore fulfill these characteristics of a specialty contribution in our portfolio. In terms of return on average capital employed, basically we were last year at 16%. Of course, when you have this growth strategy, you start first having a CapEx and then the contribution of those assets only come up, let's say, by the time you finish the construction and even you finish the ramp-up of the asset.
This has a natural dilutive effect on the return on capital employed that you will see going forward. The minimum we fixed is that we expect Arkema to continue delivering over 10% return on capital employed, and the businesses that we have in the portfolio will support that.
Okay. Thanks very much.
Thank you.
The next question comes from Chetan Udeshi from J.P. Morgan. Please go ahead.
Yeah. Chetan probably, I don't know if he disappeared.
He left the Q&A session.
Okay.
For the moment, we have no further question. Ladies and gentlemen, I would like to remind you that if you wish to ask a question, please press zero one on your telephone keypad. We have a question from Chetan Udeshi from J.P. Morgan.
Hello, can you hear me?
Please go ahead.
Can you hear me now?
Yes.
Yeah. Sorry, I don't know what happened because I was on the call, but the question I had was, can you remind us of the new projects which start up in 2020, and how much they could contribute in the current environment? If I look at your HPM volumes, they are still down 4% or 5%. I'm just wondering whether you will be able to ramp up all the 2020 projects as planned at this point, given the current macro backdrop. The second question would be, on Industrial Specialties, do you have a sense on whether fluorogases probably has bottomed now? Do you think we could have some additional headwind next year, just given the exit run rate on pricing could be lower than the average for this year as a whole? Thank you.
Thank you, Chetan. New projects for 2020, I think I've mentioned a few actually, initially. Of course, the exceptional projects starting next year is the biochemical capacity in Malaysia. We will have polyamide 12, let's say 25% increase in capacity in China. We have the start of our Japanese operation in the adhesives for industrial adhesives in Japan. Top of my head, this is what I would say. You will have the full year effect, let's say, of some of the contributions that we had this year, of course, since the acquisitions were mainly done, let's say, towards the end of the year. You would have the full year of ArrMaz, the full year of Sunke. Obviously, Prochimir and Lambson. You have the reactor of Clear Lake that started in the summer this year, so obviously you enjoy a full year volume next year.
Same for Sartomer capacity in Nansha, China. Again, it's a combination of things that most of them have actually started or will start pretty early in 2020. Regarding Industrial Specialties, the fluorogases, I mean, we've mentioned the performance this year and the contribution that is now, let's say, at a level which is below the 2017 level. Again, I'm not expecting anything major in terms of change in trend. Right now I'm assuming something not too dissimilar to this year. Thank you.
The next question comes from Matthew Yates from Bank of America. Sir, please go ahead.
Hey. Good morning. Thank you for taking the question. I wanted to ask about the dividend. I guess we're getting to the time of year where the board begin to think about that. Given in this call, you've emphasized how the portfolio has changed to become now north of 70% specialty, and you've shown the balance sheet of just over one turn of trading leverage. Are you thinking about a more fundamental review of the dividend policy, or do you still see quite a rich deal pipeline to deploy the capital into?
We've actually not fully completed, as you know, our ambition in terms of M&A growth. We've done some operations this year. Actually, both sides, buying and selling. We obviously still need to close some of those transactions. Definitely, I would still see a kind of bolt-on volumes of acquisitions continuing to feed the external growth in our portfolio. At this point, what we said is that, clearly, we are in a trend where we progressively grow the dividend payment. As you know, the payout ratio is still pretty modest. We will continue probably doing that as we go into next year. Of course, this is subject to upcoming discussions at the board.
Understood. Many thanks.
Thank you, Matthew.
We have no other question for the moment. Ladies and gentlemen, I would like to remind you that if you wish to ask a question, please press zero one on your telephone keypad. We don't have any further question, Madame Donsion.
Okay. I'll probably conclude then this call. Thank you very much for attending. As you've seen, I think it's a good set of numbers for this quarter in a challenging environment. I think, again, it reflects the robustness of the portfolio and the trend of transformation of the portfolio paying out in terms of the resilience of the results. Again, looking forward to see you in the coming conferences or, let's say, in the coming meetings we'll have together. Thank you very much. Have a good day.
Ladies and gentlemen, this conclude today's conference call. Thank you all for your participation.