Good morning, ladies and gentlemen, and thank you for standing by. Welcome to today's Q2 2019 earnings conference call. At this time, all participants are in a listen only mode. There will be a presentation followed by question and answer session. At which time, if you wish to ask a question, you will need to press star one on your telephone and wait for your name to be announced. I must advise you that this conference is being recorded today, Thursday, 1st of August 2019. I would now like to hand the conference over to the speaker today, Tim Lange. Please go ahead.
Thank you very much, and good morning from the Evonik team. It's our Q2 earnings conference call, and with me is our CFO, Ute Wolf. I will hand over directly to you, Ute, for the short presentation.
Thank you, Tim. A warm welcome also from me, and thank you for joining us today. Evonik continues to deliver despite a further weakening market environment. Before providing you with further insight on our financial performance, I would like to comment on our strategic delivery and in particular, the divestment of our MMA business. Last night, we have completed and successfully closed the deal. We will finally deconsolidate the business with our Q3 financial statements. In anticipation of the deal, we already report MMA as discontinued operations since January 1st. The net proceeds are a function of the purchase price, minus pension provisions, transactional taxes, and carve-out taxes. The latter result from the reverse carve-out of assets which were part of the divested MMA legal entity, but now remain with Evonik.
The fair value step-up for these assets leads to one-time tax obligations of around EUR 260 million, payable in the second half of 2019. At the same time, the fair value step-up results in higher depreciation and a further tax relief of up to EUR 20 million per year for the next 15 years. Both effects balance out over the long run. The divestment proceeds will reduce our leverage from the current elevated level of 3.4 back to our comfort level of around 2.8 times. This definitely helps in the currently further weakening macro environment. Main areas of concern remain auto and coating related businesses, as well as China. While we are not entirely immune to such economic changes, again, we have proven our resilience and delivered on our promises. Earnings increased sequentially on group level as a whole, as well as in all three chemical segments individually.
Based on that, we confirm our guidance for the full year and continue to expect at least stable earnings. The first half performance was based on a more well-balanced portfolio, combined with the consistent execution of our self-help measures. As mentioned before, some industry-linked businesses, especially in Resource Efficiency, were impacted by the current macro development. This is mirrored in negative volume developments on segment level in the first half. Consequently, parts of silica, oil additives, and the coating businesses experienced slower demand from the auto and coatings industry. These developments were, however, counterbalanced by our more resilient and defensive businesses in Nutrition & Care, as well as our pricing power in Resource Efficiency. In the first half of 2019, we consistently pursued our SG&A efficiency program, which delivered additional EUR 30 million of savings.
Furthermore, as a reaction to the challenging environment, we cut our CapEx budget for 2019 by EUR 60 million. While we successfully cut costs and increased efficiency, we continue to advance our future growth drivers. Our innovation pipeline is well-filled. By 2025, we will generate EUR 1 billion in revenues from our innovation growth fields with above average margin potential. Already in 2018, we generated EUR 250 million in sales from our innovation growth fields. For the future, we anticipate revenues from innovation to grow continuously by 25% per year, mostly in resilient markets with lower dependency on macro cycles. Our latest innovation success story is the Veramaris joint venture. We concluded constructions at our plant in Blair, Nebraska ahead of schedule and on budget. Currently, the new facility is ramping up with tangible earnings contribution expected already for next year.
After this short excursion into our most recent development and innovation, I would like to steer your attention to our Q2 figures. While sales volume declined slightly, pricing was robust and even up in Resource Efficiency, which underlines the strong added value that our specialty products provide to our customers. Adjusted EBITDA reached EUR 566 million, with all segments showing sequential growth. In the current market environment, it is worth mentioning that we continue to accomplish a margin of above 17%. With this robust development in the first half, as well as more favorable phasing in the absence of one-time effects in the second half, we confirm our outlook for the adjusted EBITDA and the free cash flow.
With respect to the latter, we are well on track to deliver significantly higher cash flow on a full year basis. For the first six months, free cash flow is up by EUR 50 million. If you consider the lower earnings and the significantly higher bonus payments, we clearly improved our cash conversion. The bonus payments alone are EUR 90 million higher in the first half than last year, or even EUR 130 million in Q2. We managed to compensate this effect in 2019. Based on the bonus accruals we are currently building, we can already say that the bonus cash out in 2020 will be clearly lower than this year. So far in 2019, our measures to strictly manage net working capital clearly bear fruit.
We were able to reduce cash out for our net working capital by EUR 190 million in the first half compared to last year, in an environment of lower demand and customer destocking. Also, the CTA reimbursement and the very strict CapEx management supported our free cash flow. Both for costs and cash out, we are currently questioning every spending and will continue to do so. This will give further support to earnings and cash flow in the second half. Now let's take a look on the segment development, starting with Resource Efficiency. The segment held up well despite the weaker market environment in the second quarter. Achieving sequential earnings growth in this segment was tight, but again, we were able to deliver on our promises. Lower demand from auto and coatings-related end markets had an impact on parts for silica, oil additives, and coatings, which resulted in lower volumes.
Overall, strong pricing continued and guaranteed a continuously high margin of above 23%. Businesses like crosslinkers and high-performance polymers continued their resilient performance. Also, hydrogen peroxide continued to be a solid and stable earnings contributor, which helped to limit the year-on-year earnings decline to only 4% in the first half. With easier comparables in the second half and EUR 30 million license fees from our hydrogen peroxide business, the segment is on track to deliver the projected slightly higher earnings on a full year basis. Nutrition & Care continued its resilient performance in most businesses and delivered sequentially higher earnings as well. On segment level, strong methionine volumes were neutralized by the planned shift from bulk to specialty products in Care Solutions, as well as lower lysine volumes. The latter resulted from the shift of low-margin lysine production assets in the U.S. to high-margin Veramaris business.
Earnings-wise, Care Solutions experienced another very good quarter, and Health Care delivered the expected sequential pickup in earnings, which will further accelerate in the second half. Continued strong volumes in methionine were counterbalanced by the negative price effect of around EUR 40 million year-on-year and the ramp-up cost for the new Singapore plant of another EUR 50 million in Q2. For the second half, the absence of ramp-up costs, the acceleration of earnings in Health Care, and softer methionine comparables provide comfort to limit the year-over-year earnings decline in line with our full-year guidance, slightly lower. Performance Materials delivered noticeably higher earnings compared to Q1, as the raw material constraints in our C4 businesses were solved by the end of the first quarter. Operationally, good seasonal gasoline demand and refinery shutdowns led to higher MTBE margins.
In contrast to this, weaker global demand for petrochemical derivatives like butadiene, ENAs, and butene-1 put pressure on the respective product spreads. For the start into the second half, spreads continue to be weaker, but comparables are clearly softer, especially in Q4, which was affected by low water levels in the River Rhine in 2018. Finally, we come to the outlook for 2019. Generally, for the second half of the year, we expect the weaker macro environment that we experienced in Q2 to persist. Consequently, we do not anticipate improvements, but also no further macro weakening as a foundation of our outlook. One-time effects which burdened Nutrition & Care and Performance Materials in the first six months by a total of €50 million will not reoccur in the second half. Additionally, earnings in Health Care will increase sharply in the second half, and the comparables are getting softer.
Regarding the closing of PeroxyChem, we are still awaiting approval from the U.S. FTC. We are in the last phase of the process and expect a decision on the deal within the next weeks. PeroxyChem is not accounted for in our outlook, as most of you already have it in the models from Q3 onwards, you may rather want to move the earnings contribution to Q4. Our free cash flow guidance remains unchanged. As already visible in the first half, we will continue our strict CapEx discipline and further closely manage our net working capital. To conclude, despite the lower earnings level in the first half, the higher bonus payments and cash taxes, we are on track to significantly increase the free cash flow generation and cash conversion in 2019. That closes our brief presentation.
Thank you very much for your attention so far. Now we are happy to discuss your questions.
Thank you. First question comes from the line of Guenther Heckmann. Please ask your question.
Hi, good morning, Ute. Good morning, Tim. On the free cash flow guidance, can you just confirm that this is excluding the carved-out tax payments for the Methacrylate Verbund, and how that guidance would look like if you were to include that cash out that you expect in the second half for this year? On the outlook, secondly, on the full year outlook and the H2 outlook, can you just talk us through what you bake in for your assumptions, particularly around autos and around China? Anything else you'd like to flag what the sensitivities are? Thank you.
Yeah. Good morning, Guenther. Thank you very much for your questions. The carve-out taxes are clearly related to the transaction, so they are really not an operating cash flow from our point of view. That's why we have given our free cash flow guidance irrespective of that, and we have reiterated our free cash flow guidance also irrespective of that number. We have given you the number, so I think you can make up the calculation, how it would like if you took it in or not. Very clearly, from our point of view, the operating business is really improved. The operating cash conversion improves. The carve-out taxes are clearly caused by the transactions and from our point of view, should not be mixed with the operating cash generation. For the second half outlook, as we said, we do not see improvement or further deterioration for that outlook.
What we've seen is, of course, some slowdown in the auto and coatings businesses. If you look at our volume development, I think you can see how that really is mirrored in our figures. This is more or less what we have seen now and what we see for the next couple of months.
Maybe I can just follow up with an unrelated question. In baby care, you mentioned an improvement from a low rate. Can you just help us quantify, A, how big the improvement is? Secondly, if that's self-help or if the market conditions have improved.
Yeah. We see some earnings improvement, which is really a very low double-digit number. No, it's on low levels still. If you compare quarter on quarter or against the previous year, it is an improvement. The savings and the portfolio measures we undertook, they now become more and more visible. Again, there is no big support from the market. It's more restructuring and self-help on our side.
Thank you, Ute.
Next question comes from the line of Thomas.
Wrigglesworth. Please ask your question.
Yes. Good morning. I have three questions, please. Firstly, on CapEx, the reduction by EUR 50 million. Is this something we should view as sustainable? Going forward, run rate of EUR 600 million, is this something which looks fair for the next years? That was the first question. The second question on your outlook on Nutrition. What do you bake in for methionine, if I may ask? Do you still expect a negative base effect on pricing in H2? Is it already running out? If you could quantify based on current run rates, would be great. Thirdly, on Resource Efficiency. I understand what you're saying regarding the royalty payments and that they are just not evenly spread this year. If I put this into my model, I would still require some other improvement to get to your guidance of slightly better than last year.
Could you give us a hint, what do you have in there in terms of other drivers leading you to this guidance? Thank you.
Thomas. Thank you very much for your questions. I start with the CapEx. This level is, of course, in the range of our sustainable CapEx level. From that point of view, I think it is also sustainable. Of course, CapEx spending corresponds to a certain extent with the overall macroeconomic environment. If we were in a very strong cycle, maybe CapEx would tend to be somewhat higher than in a more sideward or weaker cycle. That's why our cut is also, not only, but also related to the somewhat weaker macro environment. The other part is, of course, as well, that we need more CapEx discipline and need to bring CapEx to somewhat lower levels by being more efficient and more effective. That's an ongoing process. For methionine, we have continued to see a very strong market growth in this year.
The volume growth is very satisfactory. Overall, we see a good and strong global demand. The African swine fever helped a little bit, especially in China. On the other side, the new capacities are in the process of ramping up, and that is still impacting the prices and the competitive pressure we see. We will still see some slight sequential decline we have seen in Q2, and that might persist also in Q3, but we're really talking about a couple of cent here to put that into the right perspective. We have initiated our efficiency program already some quarters ago. We will secure our cost leadership. We will operate on good and efficient cost levels. For the second half, in our case, of course, we will have no further ramp-up costs for our methionine plant in Singapore, that helps in the sequential assessment quarter to quarter.
For Resource Efficiency, we do not expect the market environment to change, so no further worsening, but also no support. If you look at seasonality, Q3 is also a strong quarter in RE, so there is also from the seasonality some support if you look at this. Also, if you look at Q4, we would see a rather stronger quarter here for Resource Efficiency. The license fee will more or less be split over the two quarters. This is what we see in individual effects in Resource Efficiency. Your question with regard to the royalty payments, we have adjusted our approach in hydrogen peroxide so that giving licenses, HPPO licenses, is part of our strategy. That might occur, maybe not every year, but every second year.
It's for us also a very CapEx-light approach to really make the bare fruit of our technology without investing a couple of hundred million EUR. From that point of view, that is something which we will occur here and there, maybe not every year.
Just perfectly clear. Thank you.
Next question comes from the line of Sebastian Bray. Please ask your question.
Thank you for taking my questions. I would have two, please. The first is on the polyamide 12 plant. Can I just ask for an idea of timing for when this starts to make an impact on Evonik's P&L? Is it that the plant enters operation at the very start of 2022 and ramps quite quickly? That's the first question. The second question is on the methionine market. How far away are competitors now from having fully ramped their volumes, given that volume development in the market as a whole seems quite strong? What exactly is the time period over which we could expect Evonik to fill its own plant? Thank you.
Yeah. Good morning, Sebastian. PA12, I think from today's point of view, would start to contribute by the middle of 2022. It's still a little bit away. Sometimes we have also managed to be ahead of schedule, but I think from this day, of today, that's the fairest assumption you can take. Methionine, we see that the volume demand is strong, so the competitors have already started to introduce their capacities over the last couple of quarters. We are flexible with our asset park, where we really can see how in the global environment, what is really the best mix. We are prepared to do that step by step. Normally, a new plant ramps up, or until it is fully utilized, that takes three to four years. That's the more general view to that.
Again, we are prepared to have a very flexible and market-adequate approach to that.
Just as a follow-up to that, do you think we are currently at trough utilization levels in methionine, i.e. utilization will improve if nothing bad happens on the demand side in 2020?
As the demand is growing very robustly, so from that point of view, the market growth into the capacities, I think there is no change to that view on the market. There are not many new projects announced. I think what had been announced is more or less built, is ramped up now. This is what we see for the next two years.
Thank you.
Your next question comes from the line of Geoff Haire. Please ask your question.
Oh, hello. Sorry. I may have missed this, but could you just confirm, if you can, how much the license fee for the hydrogen peroxide license is? How much you're getting for that? My second question is slightly more detailed. When you had the Innovation Day in September last year in London, the question was asked about what the margin contribution would be to the group of those products. At that time, it was said that there would be no margin contribution because it would be replacing other products that were falling away. I just wonder if you could help us understand what's changed since September last year, where you're now saying that there will be margin contribution.
Yeah. Hello, Geoff. On the first question, EUR 30 million, that's the license fee we are expecting. For the second question, I'm not 100% sure whether I got it right. Of course, if you have new products, there is always some replacement of aging products. Again, they tend to have, in most cases, they have higher margins, so there is a margin improvement by the innovation pipeline overall.
When the question was asked about that in September last year, the comment was that it would have no impact on margins. I'm just trying to understand where the change has come, but maybe I can discuss this in more detail later.
I do not exactly know what kind of discussion you are referring to. As I said, there is a portion where aging products are replaced.
Yep.
There is a portion where new products come in. If you take, for instance, our Veramaris joint venture, where we rededicate a lysine plant with relatively low margins with another product which has clearly higher margins. Maybe that is one example which helps.
Okay, thank you.
Your next question comes from the line of Laura Lopez. Please ask your question.
Hi, good morning. First on nutrition. During your presentation, you already mentioned it, but can you maybe go a little bit into detail what was driving the weakness on the volume side on nutrition, despite methionine being so strong in the quarter? My second question will be, problems in the Rhine cannot really be completely excluded. There's still a risk, let's say midterm or in the second half of 2019. My question would be, have you prepared your supply chain for this? If something happens, will we see a less pronounced impact, compared to what happened last year? The third one is on Health Care. Your peers in this market have a very good visibility on this business, as normally contracts are longer. I know you're facing now going away from one of your biggest contracts, but how is your visibility next year?
Next year you expect a flat development, can we expect that business picking up again next year? Can you maybe remind us more or less the size of that business at the moment? Thanks.
Good morning, Laura. On the volumes in Nutrition & Care, as I said, methionine volumes were good. We had a switch from bulk to specialty products in Care Solutions. That is part of our Care Solutions strategy. We have now a more favorable product mix. For instance, within the Cosmetic Solutions, that is what you see in the earnings development. Of course, that left a trace in our volumes development. The second influencing factor was really taking volumes out of the low-margin lysine business to prepare the new facility for the Veramaris joint venture. The Rhine water levels, of course, we are closely monitoring that. So far, they are not critical, so there are currently no logistic restrictions. Of course, after last year's experience, we started very early to consider additional measures to secure our transportation and, of course, minimize our risk.
We have already ordered other ships, for instance, flatter vessels or with reduced loads. We have alternative supply routes for our raw materials and intermediate products worked out. We have expanded railway capacities, additional rail tanks, and so on and so forth. We are really prepared as well as we can, should there be a situation like this. Again, the situation so far is not critical, and we are much better prepared than we were last year. Health Care, the visibility is good as you describe it. That's why we can really count very much on the second half pickup. We said from the beginning of the year that Health Care will be back end loaded this year, so this is exactly what we are seeing.
For next year, of course, they also have their pipeline very well filled, so it could be like a 10% growth for next year. The size of the business is larger than EUR 500 million in sales. To give you some data here.
Thank you so much. Very clear.
Thank you. Your next question comes from the line of Chetan Udeshi. Please ask your question.
Yeah. Hi, thanks. Few from my side. Firstly, just to confirm, Ute, did I hear you mention that methionine, you expect further price decline sequentially, or you are talking about just the run rate for Q2, probably the exit rate being down versus the start of the quarter and that probably has some impact small in Q3? The second question was the transfer of pension assets as part of the MMA deal. Does that change anything on the ongoing cash flow for Evonik in terms of pension contribution at all? The last question I had was on the comment around targeted specialty chemicals acquisition as a use for the proceeds. Maybe can you throw some light whether that means it's more bolt-on in nature, or are you guys willing to consider even more bigger transactions if one was to come? Thank you.
Good morning, Chetan. methionine, as I said, we have seen a couple of cent price deterioration in Q2. I think it's a fair assumption that also in Q3 prices can decline still a little bit. The transfer of the pension assets with the sale of our methacrylate business, of course, is linked to a EUR 20 million service cost we will not have. Again, this is already accounted as discontinued, you don't see it in our numbers in this year. M&A, we expressed several times that we are looking more for bolt-on kind of deals. Again, we are not under pressure to do something. We have already some ideas where we reinvest the proceeds, we can really take a cold, latter view here to step by step reinvest the money.
Thank you.
Your next question comes from the line of Mubasher Chaudhry. Please ask your question.
Hi. Most of my questions have been answered, but just one quick one on the CapEx, the reduction. Is that coming from any particular business line, or is that coming across the board? That's it. Thank you.
That is across the board.
Okay, perfect.
Next question comes from the line of Alexandra Tiu. Please ask your question.
Hi. Morning, guys. I've just got three, hopefully, very quick questions. Firstly, on cost savings, I see that you're already running at EUR 30 million. Is there any chance that there could be upside to the EUR 50 million you expect this year? The second question is just on some of the business lines that haven't really been contributing much to EBITDA so far, like baby care and bio amino acids. I see that you've mentioned some self-help measures that can help with margins in baby care. What's your expectations going forward into the second half? Is there some further self-help that you can do here, or can you expect any improvement in the industry? Finally, the third question was just on CapEx. Obviously, you've lowered your guidance for this year. What do you see as the normalized level of CapEx with the current business?
Yeah. Good morning, Alexandra. Thank you for your questions. Cost savings, given the weaker macro environment, we have already initiated further contingency measures here for the second half in all our business and functions. We have a very high level of cost awareness for everybody, more or less on a daily basis. It is difficult to put a precise number behind that, but for sure, this will be a double-digit EUR million number, to really make sure that we achieve our outlook on the given assumptions. baby care, they have been running their program now for two years, so they are really executing that. Maybe here and there is an extra effort. Again, the cost savings and the contingencies have to be spread over the whole company to be really meaningful and influential for this year.
Normalized CapEx, we see around EUR 850 million for the group as it is after the sale of the methacrylate business.
Thanks very much.
There are no further questions. Please continue.
Thank you very much, ladies and gentlemen. That concludes our call. Have a nice day and talk to you next time. Goodbye.
That does conclude our conference for today. Thank you for participating. You may all disconnect.