Morning, welcome to the Celanese second quarter 2018 earnings conference call. All participants will be in listen only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there'll be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Surabhi Varshney. Please go ahead.
Thank you, Brandon. Welcome to the Celanese Corporation second quarter 2018 earnings conference call. My name is Surabhi Varshney, Vice President, Investor Relations. With me today are Mark Rohr, Chairman and Chief Executive Officer, Scott Richardson, Chief Financial Officer, and Todd Elliott, Senior Vice President, Acetyl Chain. Yesterday afternoon, Celanese Corporation distributed its second quarter 2018 earnings release via Business Wire and posted slides and remarks about the quarter in the investor relations section of our website. Today's presentation includes statements about expectations for the future results and plans that are forward-looking statements. Actual results might differ materially from those projected in such forward-looking statements. Additional information concerning factors that could cause actual results to materially differ can be found in the posted materials.
We will also discuss non-GAAP measures, information about which, including reconciliations to their comparable GAAP measures, are posted in the investor relations section of our website. Form 8-K reports containing all these materials are available on the SEC's EDGAR system. We'll begin with introductory remarks from Mark Rohr and then take your questions.
Thanks, Surabhi, welcome everyone listening in today. Our prepared comments were published yesterday. I will be brief and then turn the call over for your questions. We delivered strong consolidated results for the quarter with GAAP earnings of $2.52 per share and record adjusted earnings of $2.90 per share. Robust pricing across product lines resulted in net sales of $1.8 billion with adjusted EBIT margins of 26.6%. All three businesses, the Acetyl Chain, Engineered Materials, and Acetate Tow, grew adjusted EBIT year-over-year. The earnings growth along with a focused effort to convert those earnings to cash generated contributed to our highest ever free cash flow of $500 million in the quarter. We repurchased approximately 900,000 shares and distributed roughly $73 million in dividends this quarter.
For the remainder of the year, we expect Engineered Materials to continue delivering steady growth by extending the success of the pipeline model and executing on M&A. In the Acetyl Chain, we expect marked momentum to carry through the third quarter before normal seasonality in the fourth quarter and first quarter impact that business. We do not see the recent tariff disputes as having any material effect on our business. With that, we are raising 2018 expectations for adjusted earnings to the range of $10.50-$10.75 per share, with free cash flow generation in excess of $1 billion.
Thank you, Mark. I'd like to request all callers to please limit to one question and a follow-up. Brandon, please open the line for Q&A.
Thank you. To ask a question, you may press star then one on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. Our first question comes from Mike Sison with KeyBank. Please go ahead.
Hey, good morning. Nice quarter there, guys.
Thanks, Mike.
First question on the Acetyl Chain. You talked about a lot of outages in 2Q. Can you maybe give us a little bit more feel on the regions where that happened? Then do you expect the utilization rate to stay at 90% for third quarter?
Yeah, let me start this, then I'll turn it over to Todd Elliott to maybe give more color. I think the last call, we gave a perspective that we were in the mid 80% utilization rate. We have seen that push up to the 90 percentile range this quarter, and we expect that to move back down towards the mid 80% range as we go through the back half of this year. Todd, would you like to add color to that and maybe some comments.
Yeah, we continue in an overall theme of a continuing improvement in utilization rates. This really goes back over the last couple of years. We continue to see solid demand growth across multiple end uses. Demand growing at about 3%-4% per year across all these different end uses. Limited supply. Frankly, limited supply since the overbuild back in the 2009, 2010, and 2011 period. We've seen a steady march up in operating utilization rates, and we put that in the mid 80% level ending last year and through most of this year. To your question, there have been multiple effects from combination of Chinese energy reform, environmental reform late last year through the first part of this year, plus a whole series of unplanned outages in multiple regions over the course of the year.
That's pushed up instantaneous operating utilization rates up around the 90% range, certainly in Q2. Some of that will moderate, I think, as we look out. Continued good environment.
Great. Mark, when you think about your outlook for this year, you're awfully close to your 2020 goals already it seems on an EPS basis. What's the best way to think about, I guess, earnings progression into 2019, into 2020, given how strong 2018 has turned out?
I think in May we put forth a view that we would generate About $30 per share equivalent of earnings over three years, $9, $10, and $11 per share. I think we're higher than that number now. I would look at it that way, that somewhere between $30 and $33 per share or some cumulative over that period of time is what I would think. How that actually flows through, Mike, on a quarter-to-quarter basis is really hard for me to quantify in that. We got off to a good start. We're going to finish very strong, probably closer to $12 than $11, in that range, and we'll be somewhere, I think, in the hunt between those as we enter next year. Again, it's a bit hard to call that specifically. It's easier to call the full three years than it is next year.
Great. Thank you.
Thank you.
Our next question comes from Ghansham Panjabi with Robert W. Baird. Please go ahead.
Hey, guys. Good morning. I guess first off, following up on the last question, the mid 80% utilization rate up to 90%. Was that delta purely because of China? Curtailments either temporary or permanent, or was there some other meaningful outages there?
No, that's a global spin.
How would that parse out China specifically?
I think you should look at China, Todd over here, you should look at China as having a sort of a steady erosion, small bits of erosion, to the overall capacity utilization over the next three years and not the kind of short-term impact we have of units being up and down like we've had this time.
Most of the curtailment that we've seen has occurred during the winter months, end of year, start of new year. We saw that end of 2017, start of this year in 2018. Just the overall utilization picture in the mid 80% range is pretty healthy just to begin with. You overlay curtailments, adjustments that we've been describing. On top of that, there have been a series of unplanned outages that really go back to last year.
Most of those are out of China. Is that right?
Even in the other regions. In Asia, I don't want to name competitor names of other parts of the world, and those who have contributed to push up further, up close to 90%. It's a combination of things that keep us hovering in the mid 80-plus range. Again, that's been a supportive environment.
Okay, terrific. Thank you. For my second question, I guess, on tariffs. You cited the potential for incremental growth opportunities given the shift in trade flows, which correct me if I'm wrong, seems specific to Celanese, but is there any risk for growth for Engineered Materials in regions such as Asia? How are you thinking about tariff risks specific to EM? Thanks so much.
No, we don't see it as a real risk. The tariff concept is sort of in and out of the U.S., and the punitive tariffs is in support of that. We have a very global network, and to be honest, most of the material we make in China stays in China, and we have the ability to import into China from most regions of the world. There are a few cases where movement of materials from the U.S. into China on the EM side. On one hand, it's not a lot, and the other part of that, we should have the ability to price most of that out. We don't see a material effect of this.
I'd be so bold to say, I think our network is so unique and our ability to supply locally is so strong, there could be some advantages that surface if this becomes permanent.
Yeah, perfect. Thanks so much, Mark.
Sure.
Our next question comes from Bob Koort with Goldman Sachs. Please go ahead.
Thank you very much. I was curious, maybe Todd, you could talk a little bit about, or Mark, that you gave some more insight into some of the regulatory issues that are confronting companies in China, and I think the way to read it is most of those are slanted towards a benefit for Celanese. I was particularly intrigued by the comments around parks and maybe some additional closures and requests for voluntary curtailments. Can you give us a little more granularity on what you see happening over the next couple of quarters and whether that makes you a beneficiary or perhaps you're compromised a bit by these changes? Thanks.
Yeah. I think the chemical park policy is pretty interesting. This is going to affect multiple provinces. Look, we're studying these as we go and trying to be engaged in Beijing and elsewhere to understand. The Shandong province changes is pretty fresh. Shandong ended 2017 with 199 parks. Their target is to approve only 75 parks plus 10 specialty chemical parks. You think about, what is it, 114 takeout parks, as you look forward. It's one of the first provinces to set standards for future chemical park design and all the regulatory environment. We think that will affect our broad industry going forward. We believe it will. We think already it's affecting when you consider the change in park dynamics and then the relocations and permitting required.
This is evolving, we've got to understand it and study it and assess it as we go forward. The one other note, I think we've mentioned before, the winter season effects relative to energy, gas versus coal, and other steps on the environmental side as well. We were actually approached this summer in Nanjing by the municipal EPA, this goes back about four weeks ago, where they requested not only Celanese, but multiple companies in the park to reduce operations by 50%, citing a target to reduce ozone. Again, those are their words, not ours. Not required. We ultimately did not have to do anything, but it's pretty interesting that that outreach occurred in the middle of the summer.
Only days ago, also in Nanjing, 14 different companies in our park there in Nanjing were brought into a meeting, and another request was made to reduce electricity consumption, citing summer season, peak season for electricity. It's just a series of these sort of heightened steps to work that energy balance and then going forward, like the park referenced, the environmental picture for China going forward. We think it's going to have an effect ultimately, and as we said during Investor Day, kind of call out maybe a couple % utilization change by the end of the decade.
Well, for us, we have a phenomenal relationship. One, we're in one of the best parks that's there, the Nanjing Park. We have a great relationship, as do the other companies in that park with the park leadership. I think you should look at this as being a cooperative kind of process for companies like ours. It's never been to our disadvantage to support and work with these folks.
Right.
I wouldn't expect that to be the case in the future. It does, however, reflect, as Todd said, this continued erosion of the weak and outlying kind of businesses that are there and the continued evolution of those away from operations.
Mark, if I might ask on TCX, you've done a pretty good job of conditioning us to expect not much there. Now you've got some sort of transaction. Can you give us a sense of the scale of that? Does it make sense if, given Todd's fairly bullish view on acetic acid operating rates in the industry, would it make sense for any companies to convert some acetic to ethanol capacity? Thanks.
Yeah. Well, I think we were not able to, at Celanese Corporation, convince the Chinese government to go to synthetic ethanol as a source. You're well aware, Bob, of the money that was invested years ago on that and the energy we put into that. This asset, we shut down the asset. We've written off the asset. We have a great partner in Qingzhou that is there at the park with us. They're our provider of raw materials for the acetic acid business. We've worked with them collaboratively on a number of deals that just haven't worked out yet. This has been one that we kind of jointly surfaced and started working on. They have an interest of really trying to promote synthetic ethanol. They're very well connected politically. We think that is a better approach than us trying to go it on our own.
We have, in essence, sold the assets to them. We've got an LOI to, a lot of work yet to complete this, to sell the assets to them for a nominal amount. There's no real money involved in that. We're contributing our TCX technology to a joint venture. With them in that joint venture, the intent is to promote ethanol from synthetic uses. Our interest in that, of course, is to be the acetic acid provider for that. That's where we are. You should think that we should put this out as not the holy grail of success for acetic acid, but rather, it's one more step that we believe will further keep pressure on this market in Asia.
If we're successful with this, we think as we end this decade next, we should be seeing some acetic acid volumes, some material acetic acid volumes heading this way.
Helpful. Thank you.
Thanks.
Our next question comes from P.J. Juvekar with Citi. Please go ahead.
Yes, hi. Good morning.
Morning, PJ.
Mark, you're shutting down tow capacity in Mexico. I believe that's about 2%-3% of global capacity. Could that tighten up the market temporarily? My second question related to that is, have you looked at this new Juul product? It's a new type of e-cigarette that has taken off so quickly. Do you think that could potentially impact cigarette demand?
Well, I'm going to answer your first question. I'll ask you to repeat the second because I missed it, P.J. You're breaking up a bit. No, there's no material impact to, as your math noted, to global capacity utilization in terms of our pulling up. It's just ability to right-size our asset base with the customers we have and create productivity as a result of that. That's all you should read into that. Would you mind repeating your second question? I'm sorry.
Yeah. This is new Juul product. Juul is a new type of e-cigarette that has taken off very quickly.
Cigarette companies seem to be worried about Juul. I was wondering if you had a view on that.
I'm looking around the room, I think we're not prepared to answer that question with any kind of knowledge. No, it's not been a subject of discussion between ourselves and our customers that are out there. We'll take a look at that.
Okay. Thank you.
Thank you.
Engineered Materials, can you discuss your pipeline for the second half? You mentioned that at your Investor Day that if you don't do any M&A, your margins could improve from current levels. Just talk about the pipeline and where could margins go, with or without M&A?
I think, well, first off, there's going to be M&A. We're continuing to promote that. We're active in the marketplace, we'll be continuing to bring in businesses. You shouldn't have a view that M&A is going to materially change over the next several years in our business. It's continued pressure from that. The one I'm most interested in today is 8% margins to give you a reference point on that. You're going to keep having that pressure on overall margins. We have a good pace underway in the mid-700-ish kind of new projects this last quarter. We should be able to press 3,000 at the end of the year. Maybe a little short of that, but that kind of range.
One of the things that Sutton's been doing with the team, as we're rolling out sort of a EM strategy 2.0, a subordinated strategy, but it's how we approach the market, particularly around how we focus our effort in new projects. That's taken on more of a program focus. By that, I mean is we're looking at the areas where of all the projects we do, where we have the highest margin, we think the highest ability to translate, we're moving our resources more in that area. I'll use medical as an example. We gave an example of a medical kind of application earlier for you guys, we're seeing tremendous upside potential by having this machine focused a bit more.
We think that's going to give the chances we end this year and next, in spite of some pretty tough impacts of the M&A certainly be stable in our margins hopefully start pushing the margins up.
Great. Thank you.
Yeah.
Our next question comes from Frank Mitsch with Wells Fargo Securities. Please go ahead.
Hey, good morning and a very nice first half of the year.
Hi, Frank.
Just to follow up on that last question on M&A. You reiterated that you want to do $1 billion in buybacks between now and 2020. You did $100 million this quarter. You got great free cash flow. How do we think about the order of magnitude buybacks versus M&A for Celanese over the next couple of years?
Well, they're kind of disconnected. As we outlined in May, a fair amount of excess free cash flow. Even with the $1 billion of buybacks, that was still there. We don't think we have to slow down in either one of them. If I was going to steer you, I'd steer you to higher levels in both as we're going through the next several years.
Mark, in keeping with the higher levels steering, obviously you raised the guidance by about a buck and a half. According to our model, about a third of that came in this quarter on the Acetyl Chain side of things. What are some of the assumptions for the back half of the year that have changed for you to lead to that higher guidance?
Well, I think as we roll through this and everything's getting traction, I'll mention a few things that we've been able to overcome and address that have supported our higher guidance. One is that this machine continues to work very well, and it's in the face of, if I can say that, pretty steep pressure in short term on raw materials and energy. We've had to push a lot of pricing. It's a real testament to the quality of the portfolio that we've been able to do that and not really suffer tremendously in volume or anything else. We wanted to. In some ways, we kind of wanted that environment to really demonstrate to ourselves that we really have the power that we thought we would have, and that's been a pretty good story.
The ability of the industry to accept and support the kind of level of pricing that Todd and company are seeing out there has also been good. We're not seeing people run for the woods. We're seeing demand stay pretty good in that. We're not seeing big substitution. I'm looking at Todd when I say that. Even though it seems like these are big, horrific moves, from our point of view, they're not that big. It's just a culmination of lots of little small things that got us to this point. The customer acceptability of it's pretty good. We're dropping about $40 million year-over-year of internal price being transferred to downstream businesses. For the first time in, I think, our history, we've been able to get that through to all those businesses.
We've not seen a deterioration of our margin because of recalcitrance on the parts of other markets out there accepting that drive. Those things just tell me that the level of value that we're generating this business, plus or minus a little bit, is okay, is good. That gives us the ability to step out and be pretty confident of higher levels as we end this year. I'm going to roll into that. I made a comment about fourth and first. We've done a lot of work in this regard, and we see typically 3%-7% volume fall off in the fourth quarter and also the first quarter. Think seasonality impacts on coatings and then Chinese New Year kind of thing. Last year, we didn't have that. Frank, I believe this year we'll have it.
It's kind of my gut, and it happens almost every year. If you roll that through, that could be maybe a $50 million kind of impact for that business, if you look at a little bit of volume, a little bit of price, a little bit of turnaround in there. That's what you're seeing kind of baked in our numbers, a good strong third and then a step back a bit in the fourth. As you look at next year, I think it'll be the same. We'll start a little bit slower in the business, and then I think we'll be right back into some pretty powerful levels like we've been running so far this kind of year to date.
Is it fair to say that you continue to expect EM to be strong, but the majority of the upside in terms of the guidance raise is more tied to some of the positives that you're seeing on the Acetyl business?
The EM has been a straight-line business for us and I think for our investors. We expect EM to generate the kind of numbers we throw out, the plus $100 million per year EBIT. I think that's the machine we've got, and that's what we're focused on. I think that's going to be the real steady eddy there that we've got. We have plenty of M&A activities there that we continue to work as well. I think the story with the Chain business should really be that, hey, none of this should be a surprise to anybody. The market receptivity to the higher valuation to date has been good. Which gives us confidence that it has the ability to carry on for a fair period of time.
Thank you so much.
Sure.
Our next question comes from Duffy Fischer with Barclays. Please go ahead.
Yeah. Good morning, fellas.
Morning, Duffy.
Question just back on acetic acid. As you look at the returns for new capacity for you with lower capital costs and for competitors, what's the likelihood over the next year that we get some announcements around some new greenfield or significant brownfield expansions in acetic acid?
Duffy, we look out, we've kind of shared this with you guys. We shared a bit of it in May. We look out over the next several years. We're adding about 250,000 tons of capacity that Todd has underway between acetic acid and VAM. That, to be very honest, is going to be adequate, we think, for the market the next couple of years with some of the efforts we have underway to unlock some molecules and things like that. We think the market is probably kind of okay. When you look beyond that, though, and that's the kind of time frame you should be looking at, when you get in the '20s, there could be the need for some incremental capacity. I don't think this business supports a full-on greenfield site with all the kind of secondary investments associated with doing that.
I would be really surprised if there was that kind of announcement. I would, however, say from my point of view, that with our cost to do a brownfield expansion, especially in Asia and some areas like that, combined with our ability perhaps to have productivity justify that, in other words, the ability to shutter some other assets that aren't necessarily as economically advantaged as we would like them all to be, then I think we have a pretty compelling story that we could perhaps put forward at that period of time. Todd, do you want to make any comments on that?
Yeah, that configurability, I think that's what you're referring to.
Yeah.
We do think it's an advantage, and we'll keep looking at that and assessing the options there. As Mark mentioned, we're readying that 150,000 tons of new VAM capacity in Clear Lake. That'll start up in Q4. I was just there this week. That's on track to be ready at the end of this year. We have 150,000 tons on top of that on VAM through a technology debottleneck. That'll be deployed across all 5 VAM units. We've got the first technology packages installed in Bay City, Texas. We saw that this week. That's already generating yields up around 5-plus% on top of the output there. That'll be deployed across all 5 VAM units. That's 300,000 tons of additional capacity already kind of baked in and planned forward to support our 3%-5% volume growth target that we outlined in May.
The small step on acetic acid, 140,000 tons that we mentioned also in May, bring that on by 2020. Back to Mark's point, we just continue to look at unique ways to consider highly configurable steps that are capital efficient and kind of marched out over time that meet the customer needs.
Great. Thanks, fellas.
Thanks, Duffy.
Our next question comes from John McNulty with BMO Capital Markets. Please go ahead.
Great. Thanks for taking my question. I guess the first one, Todd, I believe in your prepared remarks last night, you spoke to a quadrupling of the network activations. I guess, assuming that's essentially turning customers on, which I think that's kind of roughly what it is. I guess, can you characterize the type of relationships that those open up, whether they're really just, "Hey, look, you've got a great global platform, and when there's an issue because of an outage, we'll take you on spot," or if these are longer-term type relationships. I guess, how should we think about the benefit of that conversion on these network activations?
Just to recap what these are. This is when we gather data from many sources around the industry, process that data, and try to distill that into insights. We have two or more insights and connect that with what we believe is the leading network, asset yields network in the industry. We operate that network, look for options that emerge out of that, and then activate something. That could be a combination of things. In the second quarter, with 250 activations versus about 50 last year, most of those were price activations. That's where most of those were. That's a combination of working out there in multiple geographies, multiple product lines, many different cases, different customers to activate different price changes in the quarter.
There were several on the supply side, frankly, that within our own network, in moderating, increasing, changing, shifting our own network to produce more or less, depending on the region as well. The other piece there is on the supply chain side. This is a combination of sourcing or moving product from region A, B, or C to best serve our global customers and also take sort of the best network optimized movements to support our business. These can move around. They can be different sources or different types of activations, depending on what's going on. It really is supported by the broadest network that we believe is out there and really working those nodes and working those degrees of freedom to help the business generate value.
John, I think the way I would characterize this too is that we're students of our own business models, and we're students of the industry, and we put this in place. Todd's team put this in place as a method of really assessing our effectiveness in really creating opportunities and finding opportunities and acting on those opportunities so we can measure the effectiveness of that. It's been a really good process for us because what we found is that as we can increase our degrees of freedom, we can enhance further our opportunities to drive profit.
Whether that's different logistics systems in places, contractual arrangements, whatever those things may be, it just gives us a chance to continue to support this market, and we think a very positive way for our customers with a lot of degrees of optionality to give them the best product at the right time at the market competitive price for them. That's been the work we've done there.
Got it. Okay. No, that's definitely helpful. I guess another question, just I know you said in terms of the tariffs, it sounds like there's really not a lot of exposure there. I guess one question I had, though, with all the noise around the tariffs and with all the end markets that you indirectly end up touching, have you seen any demand related reactions from some of the tariff noise that's out there, particularly in China? Is it having any impact in terms of how kind of the end customers for your products react or are consuming the products right now? Or are you too far away from kind of the end customer to actually see it at this point?
No, it actually is having zero impact. On companies like ours, there's no impact. On our customers, there's no impact, and it's not even a subject of discussion. I think if you're Harley-Davidson and you're selling 70,000 bikes into Europe and it's a $2,500 charge per bike, then you're talking $70 million or $80 million, whatever the number is, then that's an impact. That's not our business model. I think this is a political charade to some extent. You've got leaders of countries kind of badmouthing one another over it. Practically speaking, from a commercial point of view, we don't see, nor do I think many multinationals would see a huge impact of this swirling around is my kind of spin on that.
Unless you are very succinct, very focused, one product line, with no ability to produce outside the U.S., you might get beat up a little bit. No, we don't see it as a big deal.
Great. Thanks very much.
Sure.
Our next question comes from David Begleiter with Deutsche Bank. Please go ahead.
Thank you. Good morning.
Morning, David Begleiter.
Mark Rohr, on Acetate Tow, can you give us an update on any strategic options you're pursuing here? Is that still a very high priority, or is it maybe less a priority given the performance of the rest of the businesses?
Well, I won't give you any direct color. I think we continue to look for ways to make sure that business has stable earnings, and we've had a good first half of this year with regard to that. We'll be flat year-over-year, so you can do the math on that. We'll be down a little bit in the next two quarters, which is pretty typical for that business being a little front end loaded. Our view is really how do we make sure we keep this business flat 2018, 2019, and 2020. The Ocotlán shutdown was a piece of that. It gives us a chunk of that $50 million that we were going after to cushion that business, but it's only a chunk.
Our first priority is to continue to focus in and take those steps necessary for us to self-generate that $50 million of cover that we think this business needs to make sure it's flat as we go through these next three years. That's the highest priority, David Begleiter, where we spend most of our energy and effort. Second to that is we continue to look for ways to work with others to unlock additional synergies. We've not reached a point we can talk about any of those yet. It's a secondary kind of consideration for us. It's certainly not the end of the world if those don't work out, but we're hopeful we can find a way for one of those to work out. The last thing I'd say is strategically it is very much our strategy to make this topic de minimis.
We want to do that not by reducing earnings in it, but by maintaining earnings and also growing business elsewhere. It's becoming a smaller and smaller portion of our free cash flow. If you set aside the dividend from China, which in itself is pretty secure, and we think for a very long period of time, you're getting into now to a business that's certainly less than $200 million of contribution in what's going to be well over $2 billion of EBITDA this year. We think we're heading all three of those in the right direction.
Mark, you touched this earlier, in terms of these high prices in acid and VAM, you mentioned no demand destruction or substitution yet, are you concerned at some point might see some, and at what level do you think that might occur?
Well, I think the way I characterize this is I don't think the price is very high. I think it's adequate. I say it because if you look at it from a point of view of the average producer out there, they're not making our margins even today. Methanol is north of $400, maybe $500 in China. Coal prices are up and yada, yada. These guys are not raking in tons and tons of profit. We've seen recently that bad debts out there in China and the negative consequences of these enterprises, these big state-owned enterprises failing is pretty horrific. The first position I'll take is pricing's not that high. It's what it should be kind of level. We've not seen any indication and don't believe that there's going to be a real impact on consumptive materials.
If you look at the role that acetic acid as a derivative plays in the end product game, it's kind of de minimis. Higher oil prices I think directionally helps that, David, I'll say that. Yeah, if oil prices drop back to $20 a barrel or something horrific like that, then you could get some substitution to oil bases again, maybe. I think in the sweet spot we're in now, which is oil $60-$80 Coal under the pressure it's under, the fact that from a grassroots basis, there's still not a lot of great return in this business. We think we're in a pretty sweet spot. We should stay there for some period of time, and I don't really see a lot that would knock us materially off of that.
Thank you.
Sure. Thank you.
Our next question comes from John Roberts with UBS. Please go ahead.
Thank you.
John.
In the Engineered Materials segment, is there a way to think about how much of the raw material inflation is just transfer pricing from the Acetyl Chain segment, how much is external pressure that you're facing?
Yeah, John. I would characterize it as almost all external pressure. There's not a lot of transfer price impact in EM from the upstream side.
Okay. Is there a way to think about the contribution of network activations to the Acetyl Chain segment? Is there sort of a base level of fee income or a base level of margin contribution that you think that provides above which we have just the market ups and downs on top of that?
No, John. No, it's not. A lot of these indirectly will have zero contribution for just for that one activity, but it avoids something on one end. No. We don't break those down by dollar per nodal activity contribution.
Okay. Thank you.
Sure. Thank you, man.
Our next question comes from Laurence Alexander with Jefferies. Please go ahead.
Good morning. Two questions.
Morning, Laurence.
On Engineered Materials, can you discuss whether the average project sizes are getting bigger or smaller, if there's any particular trend in how customers are responding to your initiatives? Are they giving you different types of problems? Also, back to the question about the bridge for 2019. You often have, or in the years past, you've had multiple levers that you could pull to sort of try and keep roughly on, call it, a 10% kind of CAGR. In the back half of the year, you'll be at about a $10 run rate. Is that the way to think about the business, and then you maybe hit flyups? Or do you see enough sort of internal levers to pull that Acetyls profits can be flat year-over-year in 2019?
I think what I'd like to say on that is that, I don't want to not answer your question, but I'm kind of going to do that, Laurence. We're already looking hard at next year. That's from a seasonality point of view, a little bit ahead of schedule. When we get into next quarter and next quarter's call, we're going to devote a lot of that call to next year.
Having said all that, when we look at the increase in year-over-year, this modest increase in Todd's business, I think what you're going to see this year is you're going to have a strong front end and a little bit weaker back end of it, which is really driven most prominently by, I think, seasonality rolling in like it historically normally does, plus the big VAM turnaround outage and things like that are going to impact us in the fourth quarter. I think you'll see a similar kind of start. Next year's going to be maybe a little bit more back end loaded than front end loaded, if I could say that. When I look at it, again, I'd just simply say that if you build it from the base up, I don't think coal's going to change in China.
I don't think the environmental regulation's going to change in that part of the world. I don't think methanol is going to materially change with the arbitrage that's available between coal and methanol and ethylene there. I think the fundamental raw material and demand base of that business is going to stay the same. From a consumer demand, Todd's laid that out, I think, with a lot of specificity in May. We've never seen that move around a whole lot. So whether that's 2% or 3%, it kind of doesn't necessarily matter a lot in the scheme of things. Our business is going to run at capacity utilization moving over time towards 90.
I think we're in a period of time where we're going to have, and I think it's a long period of time, a very good business at the kind of profitability levels we used to see back in the mid-2000s. In the early 2000s is what I think we're in for. There should not be any reason for us not to be able to continue to grow earnings over this period of time. Again, if it's 30 going to 33, it doesn't necessarily mean the same as we had with nine, 10, 11. I think it could be a little bit flatter next year than that nine, 10 or 11 would projected for us in our Strategy 3.0 rollout. Yeah. Just to take your first question, Laurence, about project size. I think we've been pretty clear.
Our sweet spot is in the $few hundred thousand dollar range in terms of projects, we're not seeing that materially change. The power of our model is being really disciplined in the types of projects that we work on. As things get too small, the potential value of us putting efforts there becomes de minimis. On the flip side of that, larger projects tend to be a bigger lift to be successful. We're very focused on improving our win rate, keeping our project size kind of in the area where we've proven successful is critically important for us.
Thank you.
Our next question comes from Vincent Andrews with Morgan Stanley. Please go ahead.
Thank you very much. Two questions. First, just quickly, do you have an organic volume number for Engineered Materials this quarter?
No, we don't. Broadly speaking, we think that half of our volume growth is organic and half of it is through M&A in that process, and we don't parcel out. There's no part of that equation If we're going to parse it out, I have to give you, which is how much material we lose in terms of volumetric leakage that occurs in this business, which is not linear. If you think of a rule of thumb of 50/50 is as good as we can get with it.
Okay, very good. Just in the Acetyl Chain, I'm just trying to understand sort of the bridge sequentially, because I see sales were down, but obviously the profit was up. That applies some type of cost benefit. Was it just a question of lower ethylene contract prices being a little bit stickier, or what sort of was the dynamic that allowed that to play out?
I think we're shaking our heads a little bit. You're talking about the first quarter to second quarter or second quarter to end of year?
Sorry, first quarter to second quarter. Your sales are down in 2Q versus 1Q, your profits are up. I'm just trying to understand what happened on the cost line.
I would focus on the price side as really being the major contributor to our earnings performance in the second quarter. That's really the story is the combination of utilization rates, pricing margin increase. Raws are relatively flat, frankly, and have been most of the year.
We had some turnaround activity in there in Q2 that wasn't in Q1. Maybe part of that's dropping out.
Okay. All right. Nothing in particular. Thanks very much.
Yeah. Thank you.
Our next question comes from Arun Viswanathan with RBC Capital Markets. Please go ahead.
Great. Thanks a lot. Just wanted to clarify on acetyls here. You've entered kind of a nearer level of earnings power in the business, and it sounds like you do see kind of a positive supply demand balance for the next several years. I guess, are you actually expecting earnings to kind of continue at this level and trajectory? What would be kind of one or two swing factors or two or three swing factors that would prevent that from happening? Thanks.
These are big volume businesses, product moved around the world, so it can move day to day in that process. What we said in May is that we think this is a 20% margin business through the thick and thin of things, and that's still what we kind of believe. We believe in this three-year period, we're going to be averaging that 20%, maybe a skosh above that through that period of time. Certainly, you can go through a short term swing if raw material prices really spiked up or coating sales really fell off. You could find yourself move around a little bit. But we think, yes, we think we've reset that margin from a mid-teens level to a 20% level. We don't see a reason why that 20% level, and that's our margin, not industry margin.
We don't see why that level shouldn't exist throughout this three-year period. We believe we can set the stage for that to continue beyond that period through a series of smart investments and cooperative support agreements we can put in place. We're pretty comfortable that this business is going to stay pretty tight for a fairly long period of time.
Great. Excuse me. On the earnings trajectory over the next several years. If you expect this to kind of remain in a similar level, would you be in a position to use capital deployment, whether it's in the form of buybacks or M&A, to kind of keep you on that trajectory of 10% or 12% earnings growth? On that note, you highlighted some potential debt capacity at your investor day. Have you further thought about that and deploying that kind of
Yeah. I'll make a few comments, and I'll let Scott Richardson as well to step in here. Yeah, when you look at it, we don't have any pulse rate in terms of anxiety about whether we can predict earnings to the Nth degree like I think all you guys would like us to. We're just focused on generating earnings, and we'll happily trade off or do whatever we need to do in the process of period to period to make that sort of happen on a growth basis. What I would look at this as a view that we think this business has reset a bit sooner than we anticipated, probably advancing it by nine months or so, what we kind of anticipated in our three-year plan.
We think that if you look at out there in 2020, we'll be closer to 12 than 11 in that number. We think this profit is going to, for the most part, stay with us through that period of time. It could ebb and flow a little bit as we go through that period. I don't know if I'm really answering your question. I think for us, we feel like whether it's $30 cumulative over that three-year period or 33 cumulative, I'll be flippant about it's kind of indifferent to us. We think we're going to be in a period of very good and strong, solid earnings, and we'll do our best to project for you just how that's going to flow as we get further along.
I would just add, it's critically important for us to be disciplined stewards of how we utilize that cash flow. We have a prioritization of uses of cash that we really stick to and organic growth in our businesses being first and looking at attractive investment second, and then being very consistent, being a consistent increaser of the dividend and then of buying back shares. Depending on the timing of some of that cash flow and where the M&A pipeline is, there may be times at which we fluctuate on the levels that we deploy in each of those areas. That's really kind of how we look at it strategically.
Great. Last one is just, you had discussed the possibility of a methanol investment. Maybe you can just discuss that further and also your possibility of potentially separating the businesses. Is there still a large dis-synergy component that you'd be concerned about? Or are you working to minimize that? Thanks.
I think the real key for us in all of our investments, for all of our businesses, is can we make sure that we're not withholding cash for any business in that process. I'm happy to say we've never done that, certainly since I've been here at Celanese. As we look forward, there could be more organic growth opportunities surfacing in the Chain business that it could well serve it to be a separate entity versus a combined entity. That's not an imminent issue for us, or topic, but we see this business as having lots of opportunity to, in theory, seek investments either directly or with partnerships to grow its scope around the world and better position itself to keep its earnings growth underway without regard for a subtle change in asset price in China.
I think you should expect us, in the months and quarters ahead, to talk more about organic growth and organic growth opportunities in that process. I think likewise, we continue to see, it's been a few months since we closed the deal. We continue to see plenty of opportunities in EM. Those organic investments are also very important for us and very important for our investors to keep that business growing at the pace it's been on. What I'll just tell you here is it's our intention to fund both of those things and make sure we fund them. We think we can do that. Today, we've been able to do that very well as being a combined entity. At some point, if we couldn't do that as a combined entity, we would be separate entities to make sure we maximize shareholder value.
Thanks.
Yeah. I think it's the methanol, just a direct comment on methanol. Methanol continues to have an attractive play for us. I think the concept of methanol, though, I would posture it more as we get to looking at additions to acetic acid, when they're appropriate down the road, methanol could be a piece of that, either independently with us doing it, or with somebody else doing it, or as a partnership.
Thanks.
Sure.
Brandon, we'll take one last question and then wrap up the call.
Thank you. Our last question comes from Kevin McCarthy with Vertical Research Partners. Please go ahead.
Good morning. Thank you for squeezing me in.
Hi, Kevin.
Mark, dating back to your Investor Day, I think you said at that time in early May that you were exploring multiple options for a new world scale acetic plant. I realize it's only been two and a half months, but can you provide an update there? Is that still an active ambition on your part?
Yeah, it is. I think what would be of interest to us is doing it in a way that I'm not dependent on new volume growth to satisfy it. We always like to do these things in a way that the productivity contribution made by this investment is sufficient to carry the investment. Todd is working hard to find ways and options to create scenarios where we can expand in a way that from a market point of view, it's incremental. From an internal point of view, it has a very high return, and it's not totally dependent on what the gross market is doing. Yes, it's still of keen interest to us, Kevin, and we're working hard. As soon as we get to the point we have more details to share, we'll do that.
Finally, at the risk of beating a dead horse, want to come back to acetyls and kind of the cyclical move, or anyway, the move we've seen there. How would you characterize that business relative to your view of normalized earnings power? Normally when earnings double, let's say EBITDA in your case has doubled broadly over the last two to three years, and you've got a nine handle in the first half on the operating rate, things start to feel pretty full. On the other hand, you've described price as adequate, and you've pointed to some interesting and unusual environmental restrictions in China that really could have some legs. I guess I'm trying to parse out, is the current level more of a new normal in your view, or above normal? How would you characterize that?
Well, I certainly think that the period that we went through, the 2012 through 2016 period is abnormal. It was abnormal as it reflected this obscene investment in China in particular, and all these assets and just the crumbling of capacity utilization. Whenever you do that to any business, it just gets goofy. We had a lot of volatility in earnings and those things. I would say through that period of time, though, Kevin, we were able to predict, I think pretty accurately where we are. We see these changes as not being unusual. I know that may seem flippant to you guys, but we predicted this would happen. We've talked a lot about it in every-- back in 2015, we talked about it. What we missed, I think, was probably six or seven months. That's what we missed. Eight months.
We didn't miss it. I think we're in a period where this business is healthy. That's how I would describe it. I don't think it's overpriced or it's over-amped. It's healthy. I say it because I think if you look at the largest market in the world in China, it's still a marginal business for them. It's certainly profitable at today's rates, but it's not crazy profitable. It's probably not even in the Chinese market today, given the cost associated with it and the environmental concerns, even attractive economically for them to reinvest. We think that's a healthy place and a natural place for it to be. Yeah, I do expect this to change as we communicated in May. I do think this is, for us, a 20% margin kind of business.
I think in the Asian markets, it's low teens to mid-teens. I think that's what you've got, a 500 or 600 basis points, 700 basis points gap between their world and our world. I think, yes, I think we're going to be here, ± a little bit, for some period of time.
That's very helpful. Thank you.
Sure.
We'll now conclude the call. Thank you all for your questions and for listening in this morning. We are available after the call to address any further questions you may have. Please close the call.
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