Earnings Call: Q2 2021

Aug 5, 2021

Dear ladies and gentlemen, welcome to today's Q2 2021 earnings conference call of Evonik Industries AG. At a customer's request, this conference will be recorded. As a reminder, all participants will be in a listen-only mode. After the presentation, there will be an opportunity to ask questions. If any participant has difficulties during the conference, please press * followed by 0 on your telephone for operator assistance. May I now hand you over to Tim Lange, Head of Investor Relations. Please go ahead. Good morning, welcome everybody. This is the Evonik Q2 call. As always, with me today, our CEO, Christian Kullmann, and our CFO, Ute Wolf. With that, shortly and briefly, I directly hand over to Christian for the presentation. Thanks, Sebastian. Welcome also from my side. Thanks a lot for joining our earnings conference call this morning. I really hope you're all in pretty good health. Obviously, the pandemic is far from over. There is more reason to be optimistic today than a few months ago. Many countries around the world are making good progress with their vaccination programs. We, at Evonik, are making our contribution as we deliver the first volumes of lipids to BioNTech in the second quarter. We were able to vaccinate more than 16,000 colleagues and their families at our Evonik facilities, thereby safeguarding their health and safety. The vaccine marks a big step back to a more normal life. Hopefully, it will enable more personal interaction and even business travel as soon as possible. Personally, I'm looking forward to seeing many of my Evonik colleagues around the world, our valued customers, and last but not least, you in person again. During our Q1 earnings call, we presented a strong start into the year and a slightly more positive outlook for 2021. Back then, I described our outlook as conservative. Ladies and gentlemen, this conservatism has now definitely turned into optimism. The strong trends seen across our businesses in the first month of 2021 continued, resulting in an even stronger second quarter. This positive dynamic will continue into the second half of this year. This positive dynamic will continue into the second half of the year. Because of this kind of optimism, it is worthwhile to repeat it. Let's get started with the highlights of the second quarter. As in the first quarter, we saw strong growth, not only compared to the 2020 pandemic year, but also against the more realistic ambition level of 2019. Adjusted EBITDA came in 15% above the second quarter of 2019. Our three growth divisions again stood out and delivered an even higher growth rate, 18%. With this, we were outperforming our European peer group the second year in a row. Last year, in terms of earnings resilience. This year, in terms of structural specialty growth. In our discussions with investors over the last month, rising raw material prices were a recurring topic. For us at Evonik, tight global supply chains, highly utilized capacities, and rising raw material costs limited the upside in some of our businesses. Ladies and gentlemen, nevertheless, we delivered on our promises in the second quarter, and we are really and truly optimistic for the second half as well. This optimism, this kind of strong optimism, is rooted in the great efforts of our procurement team taking actions to mitigate the supply challenges, but also in the natural hedge in our portfolio. While the steep raw material price increases had a negative impact on the profitability in some divisions, Performance Materials benefits from higher oil and naphtha prices. This kind of benefit will continue into the second half, just like we will continue to push through own price increases here. In other words, the full benefit of this will pay off in 2022. Our strong performance is definitely not a result of a commodity-driven cyclical recovery. It is a result of our strategy, of our strategic agenda over the last few years. In respect of our portfolio transformation towards more resilient businesses, our accelerated innovation efforts, and our push towards products with a high sustainability benefit for our customers. These structural growth drivers, pretty well intact. That holds true for all of our 3 growth divisions. Nutrition and Care led the way this quarter, but also the 2 other growth divisions benefit from the innovations and structural growth drivers. Despite higher raw material prices and some temporary negative effects, all 3 growth divisions are above the pre-crisis level. As you could see at our 3 growth divisions, talking about our 3 division spotlights over the last month, growth divisions are making constant strategic progress towards higher profitability and returns. I would just like to highlight the recent examples from Nutrition and Care. In the growth field of active ingredients, we acquired Infinitec Activos. With that, Nutrition & Care enriches its portfolio with additional cosmetic delivery systems and several natural-based active ingredients. In the growth field of drug delivery systems, we signed a research collaboration with Stanford University. Jointly and beyond our lipid platform, we'll develop a new polymer-based drug delivery platform for mRNA and gene therapy. Both of these two examples are attractive, shining proof points of how the division transforms itself into an even stronger system solutions provider. With that, I hand over to Ute for more details about our performance we have shown in the second quarter of this year. Thank you, Christian, and welcome from me as well. Let me start with page 10. In terms of free cash flow, Q1 was the best first quarter ever, and for Q2, we can report the same. This proves our structural improvements also on the free cash flow side. For the first 6 months of the year, the free cash flow of EUR 430 million is double the already strong level of last year. While in Q1, we still benefited from a net working capital inflow and lower tax prepayments, these 2 factors normalized in the second quarter as expected. The increase in inventories and receivables clearly reflects the strong business performance, as well as the rise in raw material prices. Our strong operational performance more than compensated these 2 factors. We are on a good track for another year of 40% cash conversion. With that, we will expand our history of absolute free cash flow growth for the fourth year in a row. This translates into an impressive CAGR of more than 15% since 2017. Let's now have a brief look at our operational performance by division. Specialty Additives has seen unchanged strong demand across virtually all industries and regions. Additives for coatings and PU foams performed particularly well. Crosslinkers continued on good levels as well. In terms of profitability, we experienced the expected normalization from the extraordinary high Q1 level. Nevertheless, EBITDA margin stayed on a group-leading level of above 26%. In Q2, the division started to feel the impact of rising raw material costs. While we see our own price increases coming through more and more, the nature of the Specialty Additives business model is value-based pricing, so there are no broad-based pass-on clauses or regular price negotiation based on raw material impacts. We will adjust prices further and we will see the positive impact from these measures in the next quarters. The full effect will even pay off next year, hence supporting the 2022 earnings and profitability levels. Nutrition & Care delivered a clear step-up in earnings, both compared to the prior years as well as quarter-on-quarter. The strong performance was broad-based. Beyond the well-flagged higher prices in animal nutrition, the first contribution from lipid sales to BioNTech and strong demand for active cosmetic ingredients were the drivers for the higher earnings level. Again, we expect these structural growth drivers to continue into the second half and into the next year. More shorter term, we expect another satisfactory quarter for the division ahead, again confirming their newly achieved 20-plus margin level. Smart Materials continued its performance from Q1 with unchanged positive demand across all business. The division faced temporary higher costs, like for the ramp-up of our new PA12 plant, an unplanned outage in the existing PA12 chain, and for managing a tight logistic situation and higher raw material prices. These were compensated by the prevailing recovery in automotive and the high demand for eco solutions like Active Oxygen Specialties and gas separation membranes. While raw material price pressure is less pronounced here with a higher share of inorganic raw materials, the division has also started pricing initiatives which will become visible from Q3 onwards. Performance Materials has lacked the general cyclical recovery for quite some time. They are finally returning from trough levels to a more normalized earnings level. Higher volumes for all main products in the C4 business and higher spreads are driving the recovery. The natural hedge in our portfolio against higher raw material price is working. Most of our C4 products have naphtha-based price formulas. Our value creation for these products is X times naphtha. They suffered from a low oil price and now benefit from the higher level. Into Q3, we expect markets to remain tight, while expected lower raw material availability and own plant maintenance turnarounds will play a role as well. With that, back to Christian for the outlook. Thanks a lot, Ute. Ladies and gentlemen, let's have a deep dive into our full year's outlook. Listening to Ute, you could have reckoned that Evonik is in good swing, and that is what will remain for the rest of the year and will become even better in 2022. On the back of the positive first half of this year and the continued positive dynamic, we are confident. We're confident for the second half of the year as well. That is why we upgrade our outlook. We now expect adjusted EBITDA to come in between EUR 2.3 billion and EUR 2.4 billion. We do expect a pretty unchanged and positive operational performance in the third and fourth quarter. The third quarter, you will see some effects from maintenance shutdowns, mainly in Specialty Additives and Performance Materials, and see in the fourth quarter the usual year-end seasonality of give or take around 20% below the average of the first to the third quarter. All in all, and to sum it up, from today's perspective, all signs are clearly pointing to the upper part of the new range. As I know that you are already today, in the middle of the year, looking beyond 2021, let me try to give you our long-term perspective as well. Over the last years, we've put a lot of work in optimizing our portfolio and strengthened our innovation and sustainability activities. As a result of this, we have proven our portfolio resilience in the crisis, and we are now set for sustained structural growth in 2021 and definitely beyond. The upper part of this year's guidance marks a 5% EBITDA CAGR since 2017. By the way, these have not been the easiest years. We will continue on this structural growth path in the next years as well, obviously, always assuming no global economic downturns. To put it more bluntly, with none of our businesses at a cyclical peak, with healthy structural growth trends as well as shorter-term growth drivers, we are confident for another year of attractive structural growth in 2022. For free cash flow, we continue to guide for a cash conversion of the high prior year level of around 40%. Since we today upgrade the EBITDA outlook for 2021, this translates into higher absolute cash flow for 2021 as well, coming very close to EUR 1 billion of free cash flow. By the way, at the current share price level, this is a free cash flow yield of 7%. That, ladies and gentlemen, we thank you so far for your interest and your time listening to us, and we are now happy to take your questions. Now we will begin a question and answer session. One moment, please, for the first question. The first question is by Andreas Heine of Stifel. Your line is open now, sir. Thanks for having the opportunity to ask three questions of mine. The first is in Nutrition & Care. There was quite a strong increase in sales sequentially in healthcare. Is that something seasonal or project driven, or can we extrapolate this into the second half, maybe driven by the biotech deliveries? That's the first question. The second is, do you have any number or guidance what you can say how big the impact was on the two industrial divisions, and if it comes to supply constraints, raw material increases, logistic costs, and higher bonuses? All these negatives combined, have you anything you can say here? Lastly on Baby Care. Baby Care is a value chain based on acrylics. How is it to pass on through higher prices for this business? Has that seen quite a drop in earnings in the 2nd quarter, which was then obviously significantly more than offset by the C4 value chain? Anything you could share on this would be helpful as well. Thanks. These were my 3 questions. Good morning, Andreas. Thank you very much for the questions. Nutrition & Care, the Care sales is Care Solutions and healthcare together. We also have a very strong structural trend in Care Solutions now, as we really worked on the product portfolio, integrated some of the acquisitions. Overall, of course, Nutrition & Care will continue the earnings resilience and in the second half, and that will, of course, be supported by sequentially stable methionine prices, and also further accelerating contribution from our lipid business. The second half will be the main weight of that. As I said, a strong demand for our active cosmetic ingredients and of course, also the structural work that this business line has undertaken in the last years. With regard to the supply constraints, I think we have some influence here. I think in the divisions, it's maybe high single-digit, low double-digit amount, if you take logistics, because some things can be passed on according to the terms and conditions as we deliver. The bonus level across the board is a double-digit influence as, of course, we are now really on the very positive side of our scenarios for the outlook for the year. I think that are maybe the main influences here. For Baby Care, they have a 2-3 month pass on of propylene price increases, that will also now come in the next quarter. Yeah, Andreas, good to hear. Let me try to provide you with some color about our lipid businesses. As you know, we've started our new lipid capacities in the second quarter, a few weeks ago. This is because we have built this up in rapid time, right from scratch. In other words, the first shipments, and we have done in the first half of the year, but the much more larger volumes you will see in the third and in the fourth quarter, and here you will see a definite very positive impact coming from this. You might remember that we have already updated you and your colleagues on our M&A sales contribution for this year. We have lifted this up from double to triple digit. One thing is for sure, having said this, that we will see higher sales and higher sales contribution in the next year. Reason for this is as simple as possible, that will be the first year where we will see 12 months of sales contribution coming from the very attractive lipid business field, lipid nanoparticle business field of Evonik. There's more to say. Our growth in Nutrition & Care is definitely not relying and focusing on one product, one customer, or one project. Nutrition & Care will have, in this year, EUR 200 million higher earnings compared not to 2020, instead of to 2019. This is now coming back to the perspectives broad-based. Here I think about our drug delivery systems. Here I think about the pretty attractive and progressively accelerating positions in our active cosmetics ingredients. Here I do think about methionine and sustainable nutrition too. This kind of broad-based growth, yes, I dare calling it broad-based growth. We do also expect for our mRNA activities. Why is it? We are a fully integrated solution provider, and we are the one who cover the whole value chain, from the acceptance to manufacturing. That translate into the perspective, and that means into the potential that we are able to serve the whole mRNA market beyond, ladies and gentlemen, beyond the current vaccination boom. Right now, we are involved in double-digit number of mRNA projects. This means that we will deliver a constant, sustained, and sustainable growth. We'll demonstrate and we will deliver on in the incoming years. That was about our mRNA position, and then you've asked something about Baby Care. Let's keep it simple. Ute has already provided you with the main information. Here is to add that there is an anti-dumping case, which the European authorities have initiated, have started in the first half of this year. For us, it might be prudent to see what will come out of this, and then to discuss next steps as we have announced it. I guess that is what I could add from the perspective talking about the future of Baby Care, the current future of Baby Care. I guess that's it, Andreas. Yeah. Basically, going back to the last point, that means that you wait for the outcome of the anti-dumping case before you proceed with your strategic options. Is that the right understanding? Yeah. Definitely. There are a lot of options we could take, and we do expect the results of this anti-dumping investigations in due course. That means in concrete, September, October of this year. End of September, first days of October, we do expect the announcement of the European authorities in this respect. We will discuss internally next steps and then inform you how and what we'll do further on. Thank you very much. The next question is by Gunther Zechmann of Bernstein. Hi, good morning, everyone. Can I just seamlessly follow on from Andreas's question, please, on the lipid systems? You're guiding now for triple-digit million sales for this year. Can I just clarify that you have a growth next year from just annualizing that sales, i.e., to something at least EUR 200 million in sales next year, then you expect some growth on top of that, so ramping the annualized run rate? If I could just clarify that as a first point. Does that change in any way your view of the EUR 5 billion in sales potential for the overall market for lipid systems, or is that tracking in line with what you were expecting? The second one I have is, given the strong recovery in Performance Materials, does that change your view on strategic options, in any way on the C4 part of the value chain, not just the Baby Care part of the business? Where are we tracking on that, please? Thanks a lot for your questions. I take the second one, and I could keep it very simple. It is a two-letter answer because it is no. Fair enough. With this, I hand over to Ute. Yeah, my answer has more letters, on the first page. As we said, the target in the midterm is the EUR 500 million sales that more or less corresponds with the EUR 5 billion. That market in general, I think, has a high dynamic, as of course, new applications are now underway. You might have seen that BioNTech also looks for malaria and other vaccinations. Of course, we are stuck just at the beginning of this innovation cycle, I think. That will, on our side, ramp up gradually. Next year, sales will be higher. The EUR 200 million are possible, but of course, that also depends a little bit on how the projects ramp up and also how the governments play their role in the vaccination certainty and all that. From that point of view, clear growth rate from this year, EUR 200 million may be a little bit high. The EUR 500 million in the midterm until 2025, I think that's clearly what we can confirm. Thank you. The next question is by Nicola Tang of Exane BNP Paribas. Thanks, everyone. Thanks for taking my questions. Wanted to ask a little bit more about the outlook. You've obviously upgraded the EBITDA guidance, but the qualitative comments for the divisions, apart from the other line, are pretty much unchanged. Could you talk a little bit about what's driving or which divisions are driving the upgrade? Is it fair to assume that it's mainly coming through in Performance Materials, given the beat that we saw in Q2? Have you changed your thinking across some of the other divisions as well? A second question, just around CapEx, more thinking about into 2022. It's been relatively stable at low-ish levels for the past few years, and you're now ramping up with the PA12 plant, that CapEx should be coming to an end. Could you give us a bit of a steer on CapEx into 2022 and beyond and call out any sort of key growth projects that we should be aware of? Thanks a lot. Yeah, Nicola. Good morning. Thank you very much for your questions. First part on what drives the improved outlook. That is broad-based by all our divisions, and I think it's especially important that we point to the structural growth that we see. We do not really see a growth in our growth divisions, which is just backed by economic recovery, but really the strategy execution that pays off here. If you compare to 2019, I think you can see that quite well. The positive dynamic, of course, continues into Q3. We see strong demand patterns across the whole portfolio. Raw material prices and availability, of course, that is a factor to watch. On the other side, we also managed it very well in the last quarters. From that point of view, I think we are able to manage that. On the sales side, we continue to implement our price increases. As I explained, that takes a while until that is now then coming into the numbers. Maybe that's a more support factor even for next year than for this year. Performance Materials we discussed. If you look at the divisions, as we said, the positive trend in Specialty Additives is virtually across all businesses of all regions. Crosslinkers is doing well with the focus on renewable energies in Asia. As we said, the price increases are now coming into effect in Q3 and 4. We have some maintenance shutdowns in crosslinkers in Germany in Q4. Maybe that might be a little bit a drag on the cost side. Again, these are all things that happen more or less every year or every second year. Nutrition & Care, Christian explained the earnings resilience. Of course, solid volumes and sequentially stable pricing methionine, that's one factor. On the other side, we have worked very much on animal nutrition, that they are really improved their operating cost bases, SG&A cost bases, so they are really quite weatherproof now. Further acceleration in our contribution from lipid business or other projects in healthcare. Healthcare is back-end loaded this year, as they have really campaign productions, and the heavy weight is coming in the second half. The very positive development in our care businesses, which now also lasts for some quarters, but that will also accelerate not only in the second half but also into next year as they really worked on the structure of their portfolio, be it products, be it size or other things. Smart Materials, they also see continued strong demand across all industries. We have some higher costs in the first half from our PA12 ramp-up, but that will now start up in the second half, so we will see the first contributions from that. We also had some outages here in our main plant in Marl, which weighed a little bit on the earnings in Q2. That will not reappear in Q3, so that is a structural improvement. Also we have a new silica joint venture in China, which also will start in Q3. We will have additional contributions in those businesses on top of the overall strong demand we see as well. Performance Materials, we discussed that. They will continue to benefit from tight markets, but again, they are more now on normalized levels than at peak levels. I think that's also important to keep in mind that they are now more back to normal from the trough we have seen. I would give you some more about CapEx. Let me keep it like this. When I've taken home in summer 2017, we have harvested something like amount of CapEx, which was as high as Mount Everest. From this point onwards, we have reduced it. We've shrunk it to a level of, as of today, which is around EUR 900 million. This is the level we and I do feel comfortable with, also in longer terms, so with the perspective over the next incoming years. The peak, our peak in CapEx was because of the Polyamide 12 plant in 2020. Thinking, talking about Polyamide 12, PA12, we talk about an overall CapEx volume of around EUR 500 million. In other words, the completion of this project will definitely give us enough headroom to execute our growth strategy in each division sufficiently and even more. Thinking about Specialty Additives, we'll continue with this successful kind of CapEx light approach. This CapEx light approach is definitely, let me say, a symbol of our Specialty Additives business, and that is what will hold true for the future, too. Might be that the high utilization rates require some modular expansions and the bottleneckings. In respect of Nutrition & Care, we are well invested, and the asset base is pretty well invested. Here is limited CapEx needs going forwards. Focus will be here, debottlenecking on more customer finance projects going forward. As you have seen during this conference call, there are pretty attractive opportunities for those products. To sum it up and keep it in a nutshell, first, yes, we do feel very comfortable with the level of EUR 900 million as of today and for future. Second, CapEx light innovation projects will be financed by this and smart modular expansions and debottleneckings as mentioned. In other words, this translates into leveraging of new capacities, and this leveraging of new capacities will result in higher free cash flow and higher ROCE over the next years. That is what I could give you to CapEx. That's very clear. Thank you very much. The next question is by Mubashir Chaudhry of Citi. Hi, thank you for taking my questions. Just one on the near term and then one on the longer term. When looking at the EBITDA margin in Specialty Additives, can you please talk about your expectations going forward? There was a sharp decline in the second quarter. Should we expect that to decline further as the raw materials kind of remain/move up a little bit? That's the first question. On the second question around capital allocation, you talked about the structural improvements in the portfolio. Should we take that as a future M&A is likely to be focused on kind of small bolt-ons, and we shouldn't expect anything large to take place from an acquisition perspective? Thank you. I might take the second question and Ute the first one about M&A. During the course of the last years, we have proven that we have a decent and disciplined M&A approach, which is focused on, we call it bolt-ons. That means, in other words, we are focusing on strengthening our already strong positions in markets where we are tip of the tops. That translates into saying, if I know my competitors, if I know my customers, if I know the technology positions of them, if I know all those pretty well, which is really supportive in respect of minimizing any kind of integration risks. By having said this, there's a second side of this coin, and that means that there is much more synergy potential than if we would change this position. No change in respect of our M&A strategy. That means focusing on decent disciplined M&A approach by those bolt-on acquisitions in Specialty Additives, Smart Materials, and Nutrition & Care. I guess that is the answer to your question. I hope it is satisfying you. Okay. I continue with your first question. Specialty Additives, if you look back into the past, always had a margin around 27%. I think that's the structural margin that they are good for. We also reflect in our Q1 reporting that they had an extraordinary high margin level in Q1, so that was not the normal margin. Do we now see a normalization and going forward, as said, they will be around this level as shown in the past. That's helpful. Thank you. The next question is by Chetan Udeshi of J.P. Morgan. Your line is open also. Yeah. Hi, sorry. Maybe a few questions. First, on PA12, can you remind us how should we think about the earnings contribution from this plant in 2022 and whenever we get the full ramp-up? That's the first question. The second question was, and maybe this is for Ute, how should we think about the total incremental cost this year from higher bonus provisions, raw material price inflation, energy costs? As we head into 2022, of course it's early days, but how should we think about the evolution of some of these costs more so on, say, bonus and some of the other costs which might be under your control in general. Last question I had was just looking at the Smart Materials business. We're a bit surprised the prices were actually flat in Q2 year-on-year, when clearly the raw material prices have been going up since Q4 of last year. Maybe it'll be useful to just understand the dynamics on pricing in Smart Materials business. Thank you. Yeah, Chetan, thank you very much for your very detailed questions. First, on PA12, as for every other project, we have a multi-year ramp-up phase, of course, to full capacity. This year as the ramp-up costs, of course, the startup costs are in the full year. Last year, there was a slightly negative earnings contribution as we had as part of the ramp-up. This year, we will have a positive contribution. Again, the market is very, very tight, so we really start up in a very high demand situation, which is very positive. Also PA12 goes into a lot of eco solutions. If you take, for instance, the gas filtration, gas separation, I think that is all very, very good tailwind. It will clearly have triple-digit sales once fully ramped up, so that's more the 5-year time horizon, and the margin level is clearly above the division margin level. I think that is what we gave as a guidance for PA12, and that is still the case. On the total incremental costs, I think, of course, there is this always a flip side to that. We have also now better cost position as we have higher capacity utilization, so that has to be taken into account as well. On the bonus, it is, as I said, a good double-digit amount that we will have this year. Again, of course, on the back of a much better business performance. With the other costs, I think they have to be seen in sync with better cost bases because of higher capacity utilization. I think that to isolate that may be misleading here and there. To Smart Materials' price development. They have started with price increases already. You see that also in our numbers. Of course, that will become more visible in Q3 and Q4 as it was just starting. They have not such a high influence from rising raw material prices, as they have more inorganic raw materials. For energy prices, they have, in many cases, pass-on mechanisms as well. From that point of view, I think they are able to pass on the energy prices by definition. Of course, we see price increases step by step then come through in the next quarter. Thank you. You're welcome. The last question. Very sorry. We're closing the Q&A session here. There are no further questions. I hand back to you, Mr. Kullmann, for closing remarks. Yeah. Thanks a lot. Ladies and gentlemen, before we let you go, one final remark regarding our Capital Markets Day. As you know, we had initially planned to update you on our growth strategy and especially our sustainability and innovation strategy on the 2nd of October this year. This event will be postponed into the first half of next year, and there are a couple of good reasons for that. First, ESG environment is highly dynamic right now, and we want to make sure to get our strategy and our communication right on such an important topic. Also, we have just finished a series of three division days, and let's keep it like this. Understandably, the investor relations team is totally exhausted for the rest of the year. It is fair to say that we will give them a well-deserved break between the quarterly reportings and leave some exciting content for next year. Finally, that is from Ute's and my side, we do hope the chances for an event with physical presence increase in 2022. Ladies and gentlemen, that is what closes today's call. Thanks once more for your attention today. Hoping to see you soon in person, and in the meanwhile, stay healthy. See you soon. Bye. Ladies and gentlemen, thank you for your attendance. This call has been concluded. You may disconnect.