Good day, everyone, and welcome to the Eastman Chemical Company Fourth Quarter Full Year 2018 Today's conference is being recorded. This call is being broadcast live on the Eastman's website, www.eastman.com. We will now turn the call over to Mr. Greg Riddle of Eastman Chemical Company Investor Relations. Please go ahead, sir.
Okay. Thank you, Holly, and good morning, everyone, and thanks for joining us. On the call with me today are Mark Costa, Board Chair and CEO. Kurt Espolon, Executive Vice President and CFO and Jake LaRoux, Manager of Investor Relations. Before we begin, I'll cover 2 items.
First, During this presentation, you will hear certain forward looking statements concerning our plans and expectations. Actual events or results could differ materially. Certain factors related to future expectations are or will be detailed in the company's fourth quarter full year 2018 financial results news release. During this call, and in the accompanying slides and in our filings with the Securities And Exchange Commission, including the Form 10 Q filed for third quarter 2018, and the Form 10 K to be filed for full year 2018. 2nd, earnings referenced in this presentation exclude certain non core and unusual items Reconciliations to the most directly comparable GAAP financial measures and other associated disclosures, including a description of the excluded and adjusted items are available in the fourth quarter full year 2018 financial results news release, which can be found on our website www.eastman.com in the Investors section Projections of future earnings exclude any non core unusual or non recurring items.
And with that, I'll turn the call over to Mark.
Thanks, Greg. Good morning, everyone. I'll start on Page 3. Despite challenging short term dynamics in the last few months, of 2018. I'm proud of our accomplishments for the full year.
We delivered 6% top line growth, driven by strong volume growth in our specialty businesses, contributions from product lines across our portfolio. We also made excellent progress converting our top innovation programs into commercial orders. With double digit growth in 2018 and new business revenue from innovation, which I'll talk more about in a moment. Beyond creating our own growth, we are positioning ourselves for long term sustainable growth. We increased our growth investments by $50,000,000 during the year, which includes 10 new start plant new plant startups last year, which is a record for us to support the robust growth in our specialties over the last several years.
We've talked about our larger expansions of Triton PVB resins and Krystex on prior calls. And we also added smaller increments of capacity products, including key tones and performance films. Our increase in gross spend also includes investments and capabilities to further strengthen our application development capability. And while we ramped up our growth programs, we also remain disciplined in our cost management to offset inflation. Our cash engine generated approximately $1,100,000,000 of free cash flow for the year, about a 10% yield.
And we pushed that cash to work returning $718,000,000 to stockholders through a combination of share repurchases and an increasing dividend with 2018 representing the 9th consecutive year we have raised our dividend. In this current environment, we continue to execute on what we can control. Namely innovating through our enterprise, managing costs and allocating our strong free cash flow in a disciplined manner. And we see strong evidence that these core elements are working, despite the significant macroeconomic challenges we faced in Q4. On Slide 4, a key driver of our success, as I mentioned, is our ability to convert our top innovation programs into commercial orders.
I'm pleased to report that we're seeing exciting progress across the portfolio with $365,000,000 of new business revenue from innovation in 2018. Growth that continued through the fourth quarter. Here are just a few examples. In AM, we delivered 7% volume growth in Triton, This was underpinned by continued growth across a diverse set of end markets and double digit growth in China despite the headwinds from the trade dispute. In Performance Films, we once again delivered double digit volume growth in our 2 largest markets for window films, North America and China.
We also continue to build momentum in paint protection film with the launch of 2 next generation products. Also in AM Our interlayer business continued to benefit from our innovations in automotive with our products and heads up display growing at 25% in 2018. At the same time, we are building momentum in architectural with our general programs and the launch of a new structural product called Saflex DG and saw very strong growth, particularly in Europe in, in the Architectural Business. In AFP, strong node adoption by more than 10 customers of our new generation Crystex Cure Pro, the newest innovation in soluble sulfur. With this vulcanizing agent, tire manufacturers can improve productivity, achieve better operational control, and realize cost savings.
In Care Chemicals, we achieved a 12% volume growth in our water treatment business over 2017. As municipalities around the world, adopt global water treatment standards, especially in China. Finally, in Fibers, we continue to accelerate our growth in tech styles with 30% growth led by our new product line called NIA. These and many other examples of new business revenue growth from innovation confidence that we can be resilient even in an uncertain business environment. In 2019, we expect to deliver another double digit increase in new business revenue closes from innovation and are on track to generate approximately $500,000,000 in new business revenue from innovation in 2020.
With that, I'll turn it over to Kurt.
Thanks, Mark, and good morning, everyone. Thanks for spending some time with us today. I'm going to start out with a few comments on our full year 2018 performance on Slide 5. And given the current business environment, it's important to remember through 9 months, we were delivering strong results consistent with our long term strategy discussed last year at our Innovation Day. Through the 1st 9 months, our revenue was up 8%, our EBIT was up 6% and our earnings per share was up 13%.
And we were delivering these results despite $240,000,000 of higher raw material and distribution costs. Historically low spot ethylene prices and higher costs resulting from increased growth investments and the industrial gas supplier disruptions in tech Key to this performance was successful price improvements relative to raws through the third quarter, strong cash generation and a weaker U. S. Dollar. As the third quarter ended, beyond normal seasonality, and prices and related raw materials.
On the destocking, we believe that the amount occurring above normal seasonality is largely in where we mostly sell specialty products, which therefore drives a negative earnings mix shift. And given the large drop in Brent beginning in October, we had a harder time raising our prices, but we still had $90,000,000 of higher raw material and contribution costs year over year due to the 3rd quarter flowing through our inventories. The result is that our 4th quarter results were more challenged than we were expecting especially as the quarter progressed. With that said, given what we know today, fourth quarter will get progressively better in 2019. And we're already seeing evidence of improving order patterns sequentially into the first quarter.
Now on Slide 6, I'll start segment results with Advanced Materials, which showed strong volume growth and mix growth in our premium specialty products for the 1st 9 months of 2018, offset by some short term dynamics in the fourth quarter. Looking at the full year, Full year EBIT increased due to higher sales volume and improved product mix, partially offset by higher raw material costs, particularly for paraxylene in the last 4 months of the year, and growth investments of approximately $25,000,000 for the full year. In the fourth quarter, sales revenue decreased mostly due to customer inventory destocking in specialty plastics, as a result of economic uncertainty created by the U. S. China trade dispute.
EBIT decreased due to lower sales volume and higher raw material costs, partially offset by improved product mix. Which was less than 4th quarter, Advanced Materials grew volume and mix in performance films and advanced interlayers in both the auto and architectural markets. In auto, both interlayers and performance films grew faster than the global auto market due to their breath of innovation products. And in the architecture market, which now represents just under 50% of the interlayer sales, We are seeing strong growth, particularly in Europe, as we benefit from trends towards more windows in commercial architecture, trends we are well positioned to serve. Looking ahead to the full year of 2019, we expect strong growth.
While orders in January have improved sequentially, we expect some inventory destocking to persist in the first quarter impacting our specialty plastics business. We also expect higher costs in paraxylene to flow through inventory temporarily impacting margins in the first quarter. And we will not face the same step up in growth costs as a headwind coming into 2019. As those issues moderate, we expect Advanced Materials to return to robust growth in the final 3 quarters of the year. Putting it all together, we anticipate Advanced Materials EBIT growth to be at the high end of the 7% to 10% provided at the For the full year, sales for additives and functional products revenue increased 9%, primarily due to higher sales volume higher selling prices and a favorable shift in foreign currency exchange rates.
Higher sales volume was attributed to strong volume growth in Care Chemicals coatings additives, animal nutrition and tire additives. Full year EBIT increase due to higher sales volume and a favorable shift in foreign currency exchange rates, partially offset by increased growth investments of approximately 20,000,000. For the fourth quarter, sales revenue was flat as higher selling prices were offset by an unfavorable shift in foreign currency exchange rates. EBIT declined as higher prices were more than offset by higher raw material, energy and distribution costs. The decline in EBIT in the 4th quarter was off which offset strong earnings growth through the 1st 9 months of the year was due to a few factors that played out simultaneously.
First, destocking and coatings and tires within China and Europe weighed on product mix as these products have higher margins relative to the segment average. 2nd, competitive dynamics in adhesives continued to limit upside in pricing, while higher oil based raw material costs slowed through our inventory from the third quarter. And third, higher growth investments and the impact of lower capacity utilization. Looking ahead to 2019, we expect higher raw material costs to continue to work their way through inventory in the first quarter. While we see a pickup in orders, For the balance of the year, expect the same cost headwinds as last year.
All in, we anticipate additives and functional products to grow EBIT, at the low end Next to Slide 8 and chemical intermediates, which overcame numerous challenges in 2018. For the full year, sales revenue increased as higher selling prices across the segment were partially offset by lower sales volume due to the actions we took to mitigate historically low spot ethylene prices. Full year EBIT declined as an improvement in spread in our derivatives was more than offset by headwinds from merchant ethylene. In the fourth quarter, sales revenue increased mostly due to increased selling prices, partially offset by lower sales volume attributed to merchant ethylene. EBIT declined due to higher raw material, energy and distribution costs, partially offset by higher selling prices.
Volatile raw materials had an impact in the quarter as higher costs were still flowing through inventory, while market prices before raw materials dropped rapidly creating a short term disconnect between costs and pricing. For the full year, we expect depletion of our RGP project. And second, we do not expect to have a large industrial gas supplier outages repeat in 2019. The lack of these headwinds when netted with some expected softening in acetyls and in some olefin derivative products in 2019, lead us to expect 2019 Chemical Intermediates EBIT to be similar with 2018. Finishing up with the segment reviews on Slide 9 with fibers.
Looking at the full year, sales revenue increase due to higher sales volume, primarily due to continued growth in the Textiles innovation products and non woven products previously reported in other. Textile's volume growth was 30% in 2018. The sustained volume growth of these products is a great story demonstrating how these product lines are contributing to stability in this segment. EBIT declined at lower acetate total selling price were partially offset by higher textile innovation product volumes. Toll volumes were relatively flat for the year.
In the fourth quarter, sales revenue increased due to continued strong volume growth in textiles, innovation products, and higher sales volumes, primarily to nonwoven innovation products previously reported in other. EBIT declined due to lower capacity utilization related to year end inventory destocking in the quarter. Now a few comments on 2019. First, we have fairly good line of sight into customer order patterns in this business. We are also now qualified to shift into China from our tow plant in Korea, mitigating some of the impact we discussed last quarter associated with shipping tow into China from the U.
S. We expect stability in 2019 as we continue to stabilize tow and benefit from strong techiles volume growth that builds throughout the year, which offsets the gradual decline in the toll market. But different from past years, the 1st quarter is expected to be the lowest quarter for tow due to customer volume patterns partially attributed to rebuilding imports into China and a few the same in 2019 compared with 2018. On Slide 10, I'll transition to some corporate financial highlights. Cash from operating activities was over $1,500,000,000 and free cash flow came in close to target at approximately $1,100,000,000.
We continue to demonstrate our ability to convert earnings into cash and manage our working capital. The Eastman team knows the value of converting earnings into cash especially our BA credit and cash management teams. As a result, our free cash flow conversion was over 92% in 2018. We returned $718,000,000 to stockholders in 2018 through share repurchases and dividends And I'm proud to say that we've increased our dividend for the 9th consecutive year. Our full year 2018 effective tax rate improved to 16% from our previous outlook as we got better clarity on the impact from the Tax Reform Act.
Looking into 2019, I expect our effective tax rate to be between 16 17% and we'll work hard to have that towards the bottom end of that range. I expect our free cash flow to be greater than $1,100,000,000 in 20 team will remain disciplined with our use of cash across the various buckets. I expect a growing dividend, debt repayment, but to be a lesser extent than 2018, share repurchases and absence of bolt on acquisitions, And I would remind you, we should always expect that we'll fully deploy to further help you
We have a number of growth drivers as we enter the year. As I mentioned earlier, we are doing a great job of driving new business revenue as we leverage our innovation driven growth model. Results in our specialties growing faster than our end markets, and we expect new business revenue from innovation will increase to greater than $400,000,000 a share. We're also taking a more aggressive approach to cost management to hold manufacturing costs flat, offsetting not just inflation, but also the annualized effect of growth investments this year and a much higher shutdown schedule. This is different than 2018 relative to 2017, we had a roughly $125,000,000 headwind comprised of growth investments, the industrial gas outages, and the ethylene headwind which we have now neutralized with the RGP investment.
We were also chasing increasing raw material costs, especially in the back half of the year. In 2019, we're also managing a few headwinds. As we mentioned, we expect global growth to be slower this year due to China trade issues in the Europe European economy slowdown with Brexit and other concerns. On the U. S.
Trade dispute, we are expecting it to get not expecting it to get better or worse from the current situation in our guidance. We are projecting the dollar euro exchange rate to remain about where it is through the end of the year. This would be about a net $25,000,000 headwind with about half of it in the first quarter. And we're expecting pension expenses to also be about $25,000,000 headwind for the year. On spreads, we expect higher cost raw materials to continue to flow through until about the end of the first quarter.
After that, we expect to benefit from the flow through of lower raw material costs. So putting all of this together, we expect that EPS will grow between 6% 10% for the year. Given what we know today, growth will likely be towards the bottom end of this range. You'll recall that our Innovation Day in February of our last year Our long term EPS growth projection was in the range of 8% to 12%. The difference between the midpoint of our long term range and the range I just gave you for 2019 is primarily due to the lower expected earnings in the first quarter due to raw material flow through and the destocking playing out and the substantial currency headwind we face.
One other comment on the first quarter is that although we are expecting EPS to be down year over year, we are expecting strong improvement sequentially and indicated that the headwinds are lessening. Lastly, I would add that there is obviously some uncertainty around all of these assumptions, that we've made for the year. And so we'll know more as we go through the first quarter. Finally, let me bring everything together. On Slide 12, what you see is our innovation driven growth model, which we first discussed with you at an innovation day last February, and that I've referenced a number of times this morning.
This model is essential to our winning strategy and given the progress that we've made, we're confident we're on track. The headwinds we faced in the fourth quarter and that we see right now looking forward is transitory. And even this uncertain global business environment, we're poised to deliver resilient results with solid EPS growth and a strong cash flow generation. As you look past the first quarter, we will be back on track for our long term EPS guidance range of 8% to 12% As I look forward, given the progress that we've made and the commercial, the commitment that I see from the Eastman employees around the world, I'm more confident than ever in our future to date, and I look forward to creating a lot of value for shareholders, both in earnings growth and cash flow. With that, I'll turn it back over to Greg.
All right. Thanks, Mark. As usual, we'd like to get to as many questions as possible this morning. So I ask that you limit yourself to one question and one follow-up.
We will now take our first question from David Begleiter from Deutsche Bank. Please go ahead.
Thank you. Good morning. Mark, just on the guidance, obviously on the lower end of the range bias, what are the range of outcomes that could actually result in either guidance being at the very top end or the very low end of the guidance range?
Sure. Good morning, David. So there's obviously a lot of uncertainty right now as we sit here in January looking forward, especially on whether or not the trade dispute gives resolved what happens in the European economy. And so the real wildcards here are the macroeconomics. From a from what we can control point of view, I have a lot of confidence and innovation that we're delivering our ability to grow faster than markets.
We've already shown, even through the fourth quarter, where we have innovation in the interlayers performance films, for example, we grew much positively both in volume and mix relative to a down market. So we feel the growth engines are intact, but there's just a macroeconomic uncertainty. So the trade war gets completely resolved. That's going to be upside for us. If Europe doesn't have the headwinds people who are concerned about upside for us relative to our forecast.
And obviously, if the reverse happens, that's where the downside occurs.
Mark Justin Advanced Materials, the 2% decline in volume in that segment, can you talk about what volume was tracking until destocking the world slowed, was it more of a normalized number, perhaps October in early November?
Yes. So the demand pattern there is, it's important to things out. So performance films and interlayers had a really good, 4th quarter. So they continue to deliver good volume and mix growth The auto business, even though it was challenged, especially in China, we still delivered growth. And the architectural market also very strong where our interlayers go into a lot of laminate glass, especially in Europe growing much faster than the underlying market because buildings are moving to a lot more glass on the facade.
So we get a lift well above, actual construction rate. So the real challenge to add in specialty plastics David, and it was principally in China for them. When you think about a lot of our specialty plastics business, It is principally products we sell that are made into consumer durables that are then sent back to the U. S. And Europe.
So heavily export driven from China to the U. S. And so as those customers were worried about, where the trade war was headed they started, because they didn't think they could handle the 25% increase on January 1, they started aggressively destocking. And really taking inventories down to almost 0 and would only order raws when they received an order, from their own customers. So that really was the story on, the demand decline.
And that has a pretty significant mix effect for us, on a regional and product basis because It's important to remember that in China, we only sell our high value specialties for AM and AFP. The lower value, chemical intermediate products are almost entirely in North America. So when you have a slowdown in China, it really comes with a negative mix effect.
Very helpful. Thank you.
We will now take our next question from Frank Mitsch from Fermium Research. Please go ahead.
Hey, good morning folks and thanks for the color on the on the outlook. I just want to get a little more granular in terms of your expectation, since you have such a large business over in Asia and in China, that impacts 3 of your four segments, What are you baking in in terms of an expectation post Chinese New Year in terms of volumes coming back? Are you expecting any kind of normal bounce back, higher bounce back, lower bounce back? What is embedded in your estimates?
Well, I think that there's you have to break it down into a couple of different components. So I'm going to deal with the destocking part first and then I'll talk about primary demand. So on the destocking side, if you think about what I just said in the last question, that destocking is actually playing itself out fairly well. And we have line of sight that that will be completed by theendofthefirstquarter in specialty plastics. Same thing is true in AFP where we see destocking should play out by the end of the first quarter.
So that, I think, something you can see coming to an end. The primary demand question really is about the Chinese consumers. And AFP really has more sort of Chinese consumer exposure than AM does when it comes to this demand question because their products have a tendency to stay more in China. And, what you have is Chinese consumers are worried about their economy the government was already slowing the economy down in the first half
of
twenty eighteen. And then the straight issue sort of was a trip wire to really make people nervous. Especially businesses about what's going to happen going forward. So you see people holding back on high ticket items. That's why you see the car sales down in the back half of last year as you can all see.
Same is true for appliances or any other high ticket item. And so people are being conservative. My personal opinion is, If the trade war doesn't escalate further, that fear subsides. Things are going to be viewed as more stable, and we will expect some demand recovery but modest. If the trade war gets settled, then I think you could see a more material restocking event than what we have in our forecast.
All right. That's very helpful.
A question and a follow-up for Kurt. Obviously, you did a nice job in reducing debt. Throughout 2018. I guess, partly at the expense of buybacks being slowed during the fourth quarter, how should we think about Eastman and buybacks in 2019?
Well, sure, Frank. First of all, as you think about the free cash flow greater than $1,100,000,000. We're going to be funding that attractive dividend that we have seen increase again this past year. On the deleveraging side, we believe that deleveraging can moderate some compared to last year. And so I always throw people out there right now assume kind of roughly $250,000,000, but we'll modify that during the course of the year, maybe a little lower depending on how EBITDA grows during the year.
And I think as we go into 2020, the deleveraging should be pretty much behind us to a greater extent. As we think about EBITDA growth going into 2020. And so when you look at all those factors, then, the remaining amount of that cash flow should be for, share repurchases. And now what you saw in 2018, and you see a similar effect in 2019, We did a fair bit of our share repurchases in the first half of the year, and you should see a similar effect, this year. Quality, Frank, we probably could have done a little bit more in the fourth quarter, that's on me, did want to hit our deleveraging targets.
And as the cash flow came in strong, I kind of missed the window to maybe do another $25,000,000 or so more. But regardless, I've already made up for that as we started this year, because we're in the market as you would expect, especially where valuations are.
We will now take our next question from Vincent Andrews from Morgan Stanley. Please go ahead.
Thank you, and good morning, everyone. In adhesive resins, the impacts on the new capacity, obviously a bit more pronounced in the 4th given everything else that was going on. But, where are we in that process and sort of what type of impact have you baked in for 2019?
Sure. Good morning, Vincent. So adhesive capacity that came online that was sort of substantial with Exxon really didn't become effective until the back half of this year. And the impact it had on pricing was holding our prices relatively flat through the end of the year as opposed to what we've been doing, which is successfully increasing prices with raw materials up until that point. So you had, you know, raws go up quite a bit with oil through the third quarter that flowing through very slowly in the fourth quarter.
And we lost our ability to raise prices to offset it. And so that's a bit of the impact that you have. As you move into the first quarter, what we expect is prices to start coming off a bit But we also expect raw material flow through to help, offset some of that, and mitigate some of that challenge. But it's going to be a challenging year in 2019, and part of the challenges we have to overcome for AFP and we have plenty of growth to do so. I would even know within adhesives, it's important to keep in mind that this is a very strong growth market on the end markets, hygiene, hot melt adhesive packaging, has very strong underlying growth in the sort of 5% to 7% range.
On top of that, because the sustainability trends and sensitivity to odor and So there's a strong drive to convert rosins, which don't measure well on those criteria over to hydrogenated hydrocarbon resins, which are the cleanest of what's available in the market today. And then on top of that, we just launched a new low odor, low VOC product as by far best class in the world, and are modifying our capability to produce that and go commercial on that product in this year. So that's going to be a real help. And we're seeing really strong growth in the polyolefin side of the business, which is sort of new for us, but we launched some new products as we've told you in the past on AirFins. What we call airfin, that you pair with resins, and that's going really well.
So a lot of growth going on there, we've been clear that this sort of spread compression was coming or we're working our way through it and feel great about this business long term. It still has margins above the company average, and it has a lot of innovation opportunities for us going forward.
Okay. And just as a follow-up, think this might be the year that the excess ethylene capacity is monetized?
I would say on the excess ethylene, we have dealt that through the RGP option. That RGP option is, can be adjusted back to normal operations if the markets improve. Until that happens, we're not doing much more with the sale of excess ethylene until the market improves I know there's interested parties, but right now until the market improves, there's not much we can do.
Vincent, the value of it right now doesn't make sense. In addition to the RGP, which sort of eliminates all the downside risk of the ethylene to propane volatility, which is up and running, by the way, already ahead of this call. We do believe the market situation should improve materially in ethylene in 2020 from what we can see as they add a lot of export capacity to ethylene to get that excess quantity that's been holding prices down out of this U. S. Market.
Okay. Thanks very much guys.
We will now take our next question from Jeff Zekauskas from JPMorgan. Please go ahead.
Thanks very much. Can you talk about the propylene complex in 2019 in that, I mean, just, I guess, using polymer grade prices, they've come down from, say, $0.60 to $0.40 and you sell a lot of propylene derivatives. What might be the year over year economic effect of that change for you in 2019? And how does it work in Eastman?
Well, maybe I'll answer that question, Jeff, is really what we're assuming on Olefins spreads and maybe that helps address your question. Is, right now, we're expecting that propylene propane spread to be about the same in 2019 compared to 2018. And we expect the ethylene propane spread to be a little bit better that Mark mentioned, but still challenge relative to what we consider normal. And then the impact of propylene on our derivatives in CI, that's where you're really looking at. You got to go segment by segment business by business on what the pricing is relative to the performance.
And what we're seeing there, as I mentioned, a little softness in acetyls and a certain olefin product lines, we expect some softening relative to 2018, but offset overall by the cost improvements we expect in CI.
Yes, Geoff, while the propylene prices are off, you got to remember the propane prices are also off quite a bit. And so the spreads are holding fairly well. And, while we do expect some prices to come off in the propylene derivatives and the acetyls, we have a nice offsetting situation where we've eliminated the headwind from ethylene with the RGP investment. We have the lack of industrial outages in this segment going to hold cost flat. So that nets out to why we can stay stable this year versus last year.
And
for,
for my follow-up, is the raw materials that went up in the 4th quarter, I take it that was ethane propane and paraxylene and ethane and propane have obviously come off and paraxylene has come off. And that's why you believe that you'll begin to have relief in the second quarter, as you work your and volume slowed down. So you've got extra stuff that you have to sell in Q1. Is that the general dynamic going into 2019?
Yes, you described it well, Jeff. I mean, oil related items spiked in the third quarter, propane, paraxylene, and the like. Those have started to come off in 4th quarter. We couldn't turn them over quick enough because of the destocking in our own normal seasonalization. Those will work its course through first quarter.
And as those come up, you'll see the benefit in second quarter, absolutely right.
The only thing I'd add to this was benzene was also incredibly high in the third quarter has come off dramatically, as you know. And it's not just the flow through of the high cost raw materials. Remember that when demand is really slowing down like that, you also can't buy that much the cheap raw materials, in the fourth quarter. So it really slows your turnover rate. Now that volumes are ramping up, we can both flow throughout the high cost as well as get a lot more of the low cost in a lot faster now.
We will now take our next question from John Roberts from UBS. Please go ahead.
Thank you. At the end of the presentation, it says you're assuming Brent crude will be similar to current levels. It's been so volatile over the past couple of months. Could you just talk about what you mean by current level? Is that rising through the year like the futures curve or average for the 1st 2 months of this year?
Or what do you mean? And then related to that, is it more important that oil just be stable, that's there? And so it could average in a pretty wide range and you could make your guidance as long as it's stable and not going and down and up and down?
So, to answer the first part of the question, we are assuming close to, I think, what the curve is. So, you know, oil sort of in the low 60s, moving up to the mid-60s, through the year, sort of what's embedded in our forecast On the volatility question, stability is far better for us than volatility, when it comes to oil and how it impacts raw material costs. And if it stays stable in the 60 range, we feel very good about our forecast. It pops back to 85. Obviously, we'll get back into having Chase had rosa, but hopefully that's because demand is incredibly strong and the economy is recovering if we're in that scenario and we'll have the pricing power to do so.
And then it seemed like you had really strong performance in Saflex in the quarter. And it was that in spite of inventory destocking your channel supply correction, and so that it gets even stronger as you get into the second and third quarters?
The Innovative business was really pretty stable. It wasn't much of a destocking event there. That was really isolated, especially plastics. So there we have such strong growth in innovation products with heads up display and acoustics, that are very high margin. So as those are growing at very high rates, the margin mix upgrade you get is great.
So the overall square meters could be down a little bit with the auto market, but the volume mix situation is actually quite strong. And I think that trend just continues as we go through the first quarter, same in performance films, it's remarkable that not only was North America a great story of growth, but China was a great story of growth through the fourth quarter, even with car sales being down because their paint protection films are growing at incredible rates at very high values, as we penetrate and develop really that market. So and that trend again will continue, as we go into the first quarter. So the destocking demand situation is really about spivo as well as a raw material situation was also entirely about, especially plastics, where you had such a dramatic spike up in PX. Which was a bit unique relative to the other raw materials in the third quarter and having to sort of get that through the system.
Thank you. We will
now take our next question from Kevin McCarthy from Vertical
Research Partners. Please go ahead.
Yes, good morning. Curtis, I was wondering if you could provide some color as to what you are assuming for 2 things, working capital and cash taxes in formulating the free cash flow guidance for 2019?
Good morning, Kevin. So yes, we're expecting another strong cash flow. If I think about just the moving parts, it's not the 2 that you mentioned. You know, we're expecting earnings to improve. So that should help us translate into cash, because we know how to convert earnings into cash.
Working capital shouldn't improve compared to 2018 because we're not anticipating that same impact of higher raws as it flows working capital items such as inventory and receivables. We'll still have some growth in working capital, for our growth programs, but as a whole, the value should improve, during the course of the year. I'd also mentioned that you'll see in the appendix, we are going to moderate slightly our capital expenditures So offsetting all those positive things, you did see a step up in cash taxes or you will see a step up in our cash taxes in 2018 as we no longer enjoy the benefits of those NOLs from the solution acquisition. And I think that'll continue in 2019 as we moved back into more normal cash tax payments. And that headwind could be, say, $50,000,000 to $75,000,000 on higher cash tax payments.
In 2019 over 2018. But again, we're going to generate greater than $1,100,000,000. And over the course of the year, we'll see how much greater over one point one it will be.
Okay. That's helpful. Thank you. I realize the new textile products are not enormous for you, but would you comment on how big that business is and would you expect the growth profile, to remain in the 30% range, going forward?
Yes, we've had tremendous success in this business and really exciting because it's the really core to our story of Eastman and how we take these world class technology streams develop all these new applications have created this diverse set of products off of the cellulose Extreme just like we've done in polyester and several other streams. And, And we're really proud of the team who engaged in this. And so it's now probably about 16% of our revenue in the Fibers business. And if you look back 3, 4 years ago, it was a much smaller percentage. So we're really changing the mix and quality of where we can get growth in the, into the fibers business in these new growth applications.
And, that gives us that confidence of stability and looking for a very modest kind of growth out of this business if you look at the long term.
Thank you very much.
We will now take our next question from Lawrence Alexander from Jefferies. Please go ahead.
Good morning. One end market question and one high level question on the end markets. Could you give a little bit of around the world take on what you're seeing in commercial construction trends? And secondly, can you give a sense for how lean you think Eastman is now? And what I mean by that is if demand does surprise on the downside, in the back half of 2019 or 2020, how much room is there for cost cutting in response?
Sure. So from a commercial activity point, commercial construction point of view. I think that was your question, Lawrence. Europe has actually been pretty strong. There's a nice backlog that we can see of commercial buildings going up and they have a lot more glass on them, as I mentioned earlier.
And that's been driving very strong in Europe. Same in North America, we see commercial construction fairly good. China is a little bit of wildcard and not relevant to us. As much on the commercial side because we don't really sell our interlayers into that market. And if you think about our coatings business, with our textile and other architectural additives, that's a little bit more residential oriented than it is commercial oriented in the volumes.
And that overall, I think, has been relatively stable for us and a good source of growth, net of the current economic situation. When it comes to your second question, which is, if, we head into more of a recessionary kind of situation, what we can do with costs I'll break that down into sort of two parts. So on the manufacturing side, one of the big advantages we have of our large integrated sites how we staff and operate them, to give us flexibility in our cost structure, when things are really strong like the 1st 9 months of last year versus where we are now versus that decline in demand question. And the way we build in that flexibility is quite a few of our employee base or contractors, and we also use a lot of overtime, to run the plants really hard. And what's nice about that, is, as demand comes off, you can pull that lever and reduce those spends quite quickly, which we already have started doing in the current situation.
And if demand falls further, you can pull those costs down even faster, with less volume. So we have some flexibility built in there that can be meaningful to manage our cost structure. On the SG and R and D side, it's a little bit different. If you look at, where we've been in SG And A And R&D, we've been quite successful in holding the costs relatively flat through productivity. And I would mention that's actually true for the total complex, right?
So if you look at 2014 through 2017, we did about $1,000,000,000 of cost savings productivity that allowed us completely offset inflation in that time period. As we told you in 2018, our costs were going to go up about $50,000,000 by the way, most of that is in manufacturing, not in SG And R&D, but it was a $50,000,000 headwind to us last year against variable margin growth. And now we're going to take it back down to being flat. So I think that the SG and D, though, has less flexibility for pulling it down. Because we're already so efficient.
On that side, we're already in the bottom quartile of SG And A And R&D as a percentage of sales in this industry, and we have one of the most successful and robust innovation portfolios. So we're already being incredibly efficient with our spend on that side of things. And We are increasing growth investments, in the commercial R and D area there, but we're offsetting it with cost cutting everywhere else. So there's less ability to sort of pull that number down in a meaningful way and stay on strategy with our innovation and growth. But net, I think we feel very well positioned for all of this.
And I'd also mention on our cash flow side, if you go into a slowdown like that, you free up a lot of cash in inventory receivables. So we feel very confident of our cash position, in a more dramatic slowdown.
We will now take our next question from Arun Viswanathan from RBC Capital Markets. Please go ahead.
Guys. Good morning. Just wanted to understand, maybe you can just give us your commentary on some of the end markets Automotive, obviously, has been an area that we've seen quite a bit of destocking, especially in China, and pulls and pullbacks and builds How does that affect your business? And maybe you can also touch on what you're seeing in paints and coatings. Thanks.
Sure. So overall market on the transportation sector, I would say, has been relatively good last year, obviously slowed down, especially in China in the fourth quarter. And as I mentioned earlier, despite that in, advanced materials, we were able to deliver strong volume and mix growth through the end of the year. When you get over to coatings and, tires in the AFP segment, It's a little bit different. We're a little more tied to sort of the actual underlying market trends.
We do have some robust growth in things like resins in tires, as well as some of our ketones and other growth projects inside coatings, but we're going to track a little bit more with demand there. And that's where you saw some of that destocking take place. I would and it was there's a lot of it going on in China and I would mention some of it also going on in particular in tires in Europe. In the tire market, the tire producers have a bit of a slinky effect sometimes, through the year on how they produce relative to what's flowing through their relatively complex distribution and retail channel So every once in a while, you go through these corrections of they've produced more than where demand's at. And we saw some of the inventory correction going on in China and Europe, in the 4th quarter, and you can look at the tire companies, they all identified that markets are sort of slowing down.
Important thing to keep in mind though about these businesses is exposure is quite different for us when it comes to OEM. And and aftermarket. And we're a lot more balanced. So in AFP, it's about fifty-fifty, in the OEM exposure versus refinish really in coatings in tires is actually 25% OEM, 75% refinished. And you also have to remember that we're much more levered commercial tires than passenger tires, in the amount of KRYSTEXX that is consumed in the much larger rubber content of a commercial tire.
So it's very dangerous to over interpret a decline in OEM personal car production, as a headwind for us across our businesses.
Great, thanks. And just as a follow-up, you'd mentioned that AFP could be, maybe at the lower end of, say, 5% to 7% and AM would be at the upper end of 7% to 9% EBIT growth for the full year. I guess both of those imply a pretty sharp snapback in Q2 through Q4. So maybe you can just give us your confidence level in that. And just asking because, again, there seems to be some concern about the level of stocking versus declining primary demand.
So if it is more of the latter, just wondering how we get that sharp snapback in Q2 through Q4. Thanks.
Yes, great question. Obviously, when we spend a lot of time debating and as we said, we're in an uncertain world right now, so it's a little hard predict what the macroeconomy is going to be for the year. So what we're assuming is a slow growth world, not as robust as the first half of last year. And that is a planning assumption. The we are pretty clear in our line of sight to inventory destocking going on in coatings and tires and especially plastics, with these very high value products.
And so you can only destock for so long. And so you can see through that. And then AM, again, I told you it's all predominantly exports back to the U. S. So as long as the U.
S. Consumers in place, the destocking will hit an end, and then demand will recover. So we actually feel pretty good about that. Coated, tired, a little more exposed to the Chinese consumer. So that's a little bit less clear, which is why we're being a little more conservative in our guidance in AF P than in Advanced Materials.
And but we still see destocking coming to an end. The question just is where is the Chinese economy for the rest of the year. And our belief is it's actually still relatively good right now, but there's a lot of short term caution by consumer and if the trade war doesn't escalate, it will come back.
We will now take our next question from TJ Juvekar from Citigroup. Please go ahead.
Yes, thank you and good morning. Good morning. Mark, you talked about tire products and destocking there. So on Krystex, you had some smaller players shut down in China last year due to environmental reasons. But now with the auto industry slowing down, where do we stand on Krystex inventories?
And was Krystex a big contributor to the 400 basis points margin decline in AFP in the quarter?
No, Cristex wasn't a big contributor. I mean, most of the, I mean, there was some destocking of Cristex of course, like some of the very high value additives we have in coatings and that contributed to some of the headwind But, the bigger factor was obviously just high raw material costs flowing through relative to pricing, for the overall segment. And we feel great about Crystex going forward. I mean, it's it is a market that's had waves of competitive activity. As you noted, some of those competitors have left There's always new competitors coming back in.
And that's why we focus on innovation versus just looking at supply demand balances. For our future. And this is a place where we've been incredibly successful in innovation. So the new KRYSTEX plants up and running well in, in, last year for the Cure Pro and Cure product lines, which provide far superior heat stability and efficiency in helping the tire plants run incredibly well. We're talking fairly meaningful improvements in entire plant productivity because this mixing step where our product is used is typically the bottleneck for running a fast.
So the adoption rate's been great. We're focused on innovation. This is all patented. And we've even got another generation product beyond this one that is sort of revolutionary and what we can provide to the tire companies, on the horizon that takes us even beyond this. So this is a business that's got a lot of innovation opportunity, in ways to keep it moving.
Great. Thank you. And then I want to go back to your RGP project on the cracker. Looks like that $20,000,000 investment is working well. Can you quantify the benefit in 2019?
And as you make less merchant ethylene, you how much less propane and hopefully, do you buy? Can you just give us the mass balance around that? Thank you.
Well, I'll start and I'll ask Greg to give you some of the mass balance stuff because he's help and communicate that. But I'm not going to give you a specific number, just on the improved ethylene. I would say that's embedded in our overall guidance. In CI. What the benefits are is it's simply we produce less merchant ethylene and thus the pressure we felt on that in 20 18, which you can quantify pretty easily with the market data.
We're just not going to have that merchant ethylene sale, and I'll let Greg talk about the balance.
So if you remember, on a corporate basis, we produce about 1,400,000,000 pounds of ethylene, about half of that we sell into the market. And with the RGP investment, we'll be producing about 80% less of the ethylene that we would normally sell into the market. So obviously, much less exposure to the merchant ethylene market as a result of this project as opposed to what we normally have.
It's also a great volatility reducer because PGP to RGP is very stable. If you go look at history relative to what you can see on the propylene and ethylene relative to propane. So, it also sort of mitigates volatility as well.
But you also buy less propylene, right?
We're buying, No, actually because of the Yes, for fire grade.
The being substituted, which is obviously propylene as a feedstock, it actually produces just a little bit more propylene.
And P. J, we'll send you a chart that we have that can help you manage it out through this balance site.
Great. Thank you.
We will now take our next question from Duffy Fischer from Barclays. Please go ahead.
Yes. Good morning, Phil. I just want to understand better when your customers destocked in Q4, did you guys get the of that and that you had to eat some inventory or were you able to ramp back your production enough that that wasn't the case And if it was, can you kind of help us size how much on your balance sheet was in excess because of that effect?
Sure. No, because of the stocking kind of played out through the quarter and was more pronounced as we ended the year, we, in fact, had difficulty adjusting our operations fully overcome the destocking in our own production rates, the size that, maybe just look at the difference between our targeted free cash flow and what we achieved maybe that'll give you some sense of what that inventory effect was.
Okay, great. And then, just a second one, on the ability now to ship tow in China from Korea, is that meaningful or not meaningful for the segment?
It's meaningful in keeping the segment stable. So when you look at we had tow sales into China until August in 2018, and if they had it's stuck to their policy this year of no tow from the U. S. All year without qualified in Korea. That would have been a headwind for us by getting Korea qualified.
That allows to keep things relatively stable to 2018.
Okay. We will take our last question from Matthew Bear from Tudor, Pickering, Holt. Please go ahead.
Hey, good morning, everyone. I was a little surprised at the quarter over quarter decline in CI. Just given that propane cracking margins seem like they should have improved for you. Could you just walk through the main moving parts here and perhaps provide some sort of breakout of the impacts you saw in intermediates versus means versus plasticizers? Thanks.
So, 1st of all, we weren't selling ethylene in the quarter and have some of the unabsorbed fixed costs as a result of that. 2nd, you have prices coming off with the raw material environment as they tend to do in chemical intermediates, but still the slow flow through of raw material costs on that basis, in particular in some of the acetyl products and a few of the Olefins products. So that really is the what drove the earnings to come in year over year lower. If I
could add to that math, you don't forget, we were not able to turn our inventory over. And so we have still have that higher valued inventory sitting in our manufacturing sites, a good portion of that is attributable to CI. And we're a rifle shop, and you know what that does to our earnings in a particular fourth quarter item.
Even CI is seasonally lower in volume sequentially from the third quarter 4th quarter. So that's just spike in raw material the third quarter is a real tough timing in the year to get rid of it. So I just want to wrap up and say that, obviously, we recognized fourth quarter was tough in the first quarter is not what we want it to be. But as we look at the future of this company and all the investments we've made, that innovation driven growth model really does give us the ability to push through this kind of environment, continue to create value, fine wise to grow. And we're also sensitive to the environment we're in right now and aggressively managing costs, more than normal.
To make sure that we translate variable margin growth from the top line, to EBIT a lot quicker this year than what we were able to do last year with the headwinds that we had relative to what we're expecting this year. So that leverage, I think, is an important part as you think about the overall math in a slow growth world this year, being able to deliver, quite strong earnings growth once we get past the first quarter. So appreciate all the questions. And thank you.
Sorry. This concludes today's call. Thank you for your participation. You may now disconnect.