Everybody who's in the room, my name is Mike Leithead. I head up the U.S. Chemicals and Packaging efforts here at Barclays. Pleased to have Mark Costa, the Chairman, CEO with us today. Greg Riddle, who heads up the IR efforts, is over there as well. We'll quickly run through some of the audience response questions. There are seven standard questions for everybody in attendance that we do for all companies. We'll fire through those fairly quickly so if everybody can man the monitors. Question one, do you currently own the stock? Overweight, market weight, underweight, or no? Unfortunately, Mark, you can't get a clicker.
No, I know.
You can't be having the one button. Okay, some opportunity here. Next question. What's your general bias towards the stock right now? Positive, negative, or neutral? Okay, mostly neutral. Next question. In your opinion, through cycle EPS growth for Eastman will be above peers, in line with peers, below peers? Okay, pretty mixed there. Next question. In your opinion, what should Eastman do with the excess cash? Bolt-on M&A, larger M&A, repos, dividends, debt pay down, internal investment. This topic's never come up for you. Okay, fairly mixed, although I think repurchase is probably the favorite. Next question. In your opinion, what multiple of 2023 earnings EPS should Eastman trade? There's no seven option, Greg. Okay, next question. What do you see as the most significant share price headwind facing Eastman? Core growth, margins, capital deployment, or execution strategy?
I think we just have one more around ESG, and then we'll dive right in. Okay. Last question. Does ESG play an active role in your decision-making process for the company? Yes, it's a positive factor. Yes, ESG is a negative factor. No, ESG does not play any role in our assessment right now. No, but we do plan to incorporate ESG going forward. No, but it does not play a role as the leading answer, but you do have some people that say it's a positive factor, and I think we'll definitely get into that in a second. With that, Mark, again, happy to have you here with us. Let's maybe start off big picture for everybody. You guys obviously touch a lot of end markets or in a lot of different regions.
Can you just maybe do a quick tour around the world, just kinda what you guys are seeing in terms of growth outlook coming out of the fourth quarter here?
Sure. Obviously, the fourth quarter was really tough in the macro, I think probably for the whole industry, but each of us have different end market exposures. As you said, Eastman is very diverse, and it's in market exposure. What I'd say is the slowdown in the economy and the destocking that occurred really happened across all markets in the fourth quarter, and we're seeing it resolve in different ways into the first. On the stable markets, which would be, you know, sort of ag, pharma, medical, consumable kind of applications, personal care, demands are relatively stable. There was still destocking there, but most of it's playing its course. You know, we believe that'll be over, you know, sort of as we speak, going through this quarter.
Then we get back to sort of where the underlying demand is in those markets. When it comes to the more dramatically affected markets, which is consumer durables, BNC and automotive. Starting with automotive, you know, we've been at globally at sort of what 80% of sort of 2019 levels in production and sales due to supply chain. I think that we expect that to continue. It's a little bit of a, you know, headwind in 1Q sequentially from 4Q in our view of the world. Mostly it's China, where we see the softness as opposed to anywhere else relative to 4Q, and modest to be clear. We're not expecting much of a recovery. A little bit of modest recovery in automotive in the back half of the year.
When it comes to consumer durables, which is the most impacted market that we serve, this is small appliances, electronics, housewares, those kind of items, that are going into that market. you know, we saw in primary demand probably being down around, 10% at the retail level with consumers. With destocking, we were down about 40% in the fourth quarter. We see that destocking continuing through this quarter, in a pretty dramatic fashion because the retail inventory got built out of control last year. you know, the destocking is occurring. The good news from what we're being told at the retail level is the destocking seems to have been complete. They're more aligned with where demand actually is, but they're still cleaning out of the channel going on. That, you know, is occurring in this quarter.
We think it'll start resolving as we go into the second quarter, and get a lot better than where we are now as we go through the second. Right. The Building & Construction, I'd say, is the hardest one to estimate. It's been down and challenged in China for a very long time. I don't think there's any step down there. It's already been bad for a while. It's like auto, man. Europe has also been down for a while. It's really more about how North America trends from here. I'd say that's more difficult to predict. It's in the mid-single digits as far as revenue goes for us. Even though it's unpredictable, it's not a big part of our portfolio.
Great. You did touch briefly on China, obviously a hot button issue of sorts here.
Yeah.
I mean, what's your current sense, or maybe it's too soon, just out of Lunar New Year, just kind of what you're seeing on the ground there, in terms of business activity and how you think about that?
In China, I think everyone's had this great hope of some big rebound post-Chinese New Year, with, you know, consumers sitting on, you know, depending who-what source you look at, over $2 trillion in cash. We're not actually seeing that, in any sort of specific way yet in China. It's sort of like all the articles you read. Our demand structure, in the market would sort of confirm things are pretty slow to recover there. I would say things connected to travel are doing well. Cosmetics is actually recovering really well, you know, which is another end market that we serve. But, when it comes to automotive or housing, those kind of bigger durable markets, no sign of any significant improvement yet. Yep.
Okay. As we think about 2023 and with your 4Q results, you laid out a pathway to strong performance in 2023, about 10% EPS growth, if we kind of put the pension to the side for a little bit. Can you maybe just talk about the factors that give you that confidence in that improved performance? Part of it is obviously the destocking normalizing and factors like that, you're also doing a lot on the cost side as well.
Sure. You know, obviously, we're not seeing a huge improvement in our guide for first quarter. The real question becomes, okay, things are getting a bit better because we're finally starting to get some raw material tailwind into the first quarter from the fourth quarter. Starting to get some of the cost reduction impact, but modest. Demand, I think we would say, is remaining challenged, you know, at sort of 4Q levels as we go into the first quarter. That's playing out to be sort of as we expected. I'd say spreads are probably a little bit better than we expected. Costs or management's happening a little faster than we expected, and consumer demand is a little softer, you know, than we expected. Net, we feel really good about the 1Q range.
It's relatively low when you look at our full year guidance. The big question is, how do you get the step up from 1Q into 2Q and beyond, right? There are three main components of that that I'll start with most, you know, controllable in our, in our side to what is more about, you know, uncertainty in demand. The controllable side, $200 million of cost, net of inflation, you know, that's very controllable. About $125 million of that's in manufacturing, and those actions have already been taken. We know those costs are coming out, but they're flowing into inventory, you know, and then they have to flow out of inventory, so you don't see the benefit of that until you start getting into the second quarter.
The second part on the about $75 of the $200 million, which is non-manufacturing, about half that's external spend, which we've taken action on. Some of that will help this quarter. The rest of it, which is restructuring of headcount, we just executed that program last week, so some of that benefit will show up, but it's really about 2Q. When you think about that, most of that $200 million starts to show up in 2Q, that's part of your step up from 1Q to 2Q. The second is how we're managing, you know, price versus raw materials. The pricing and the specialties in particular. We've had about $2.4 billion of inflation over two years, or $1.3 billion last year. Two-thirds of that's in the specialties.
We've got great pricing in place that kept up with all that inflation. Now we need to have the discipline to hold onto that pricing to expand our margins back to where they should be, and are gonna be very disciplined in managing that pricing. We can already see, you know, meaningful raw material tailwind starting to show up in 1Q sequentially from fourth quarter. That will continue and pick up pace as you go into the second quarter for the same logic, which is inventory trends have been low to benefit from the lower natural gas that we have now and some of the lower raw material prices. As that volume moves through the system, you know, the cost will flow with it. That's your second step up.
That's pretty controllable in what we see. Third, of course, is what happens with demand. The part that's destocking on the stable markets, which is half our revenue, we can see resolving, so that we feel pretty good about. Consumer durable and building construction are the two places that, you know, there's a lot of uncertainty. The destocking is so extreme in durables, there's only so many months you can do it at that level and you're out of inventory. We think good portion of it will be over from the fourth and the first quarter as we move into the second. Where primary demand goes, we're not assuming much recovery from where it is right now, so weak, in how we built our guidance. You know, if there's some recovery of demand, obviously that's gonna be upside to our guidance.
If there's a severe recession, obviously that's a different scenario.
Got it. Okay. Maybe to dig in a little bit on the specific businesses, let's start with Advanced Materials and AFP. Those are probably two of your fastest-growing, more specialty businesses. Can you maybe speak to the two to three-year outlook for those, as we kind of get past these, I'll call them one or two quarters of distortions?
Right.
Just what should investors really start to appreciate more about those businesses or those segment results?
Advanced Materials, which has been our strongest growing business and very reliably growing business for over a decade, obviously took a hit this year. But it's a business based on innovation and growth in products like Tritan that's BPA-free, that's had a tremendous track record of growth. A variety of copolymers that are also winning share every day from its alternative materials. The interlayers business, also on track for strong innovative growth with head-up display and acoustic in, you know, next generations we've just introduced that are going really well. EVs, which is about 12% now of our revenue in this business, that grew 70%, you know, from 2021 to 2022 is a great story. The value per EV is about 3.5x an ICE car.
Lot bigger sunroof, more laminated glass, not just the windshield, and a lot more functionality 'cause they need acoustics, 'cause the car has no noise, so more sensitivity to sound. They need the head-up display. A lot of the buyers want that in these kind of cars. They need solar rejection as an additional functionality because it's basically a greenhouse with a huge sunroof. Solar rejection of keeping that heat out of the car reduces air conditioning load, gives you more range. There's just a lot more value opportunity. That's all going really well, and the performance films business literally held flat last year in a really tough economic environment. This is, you know, gonna grow this year, their paint protection films, et cetera.
On innovation side, very well positioned to create their own growth once you get past all this destocking. It's important to note a lot of these end markets I just mentioned are very high value. When demand came off in the fourth quarter or in the first quarter, that value relative to the fixed cost, you know, has a pretty big negative impact. But the reverse is equally true, right? When you get past the destocking, consumer demand stabilizes, you know, all that earnings will snap right back. Then you've got that innovation growth on top of it. Then you have the recycled content, which I'm sure we'll get to later, adding to the value proposition of the growth in the Advanced Materials.
Yep.
That's one big driver. The second big driver is the spread improvement. This is a segment that has the opportunity to be disciplined in price. If we just look at where raw material prices have come off now, without it getting any better from here, you know, there's a substantial amount of spread improvement in this segment, more than what we talked about last year, which was $100 million. We have a lot more inflation, the spread improvement opportunity is even bigger. We see that as a big driver and then, of course, part of the cost reduction. AM, I think, is positioned for long-term steady growth, you know, once you get past sort of these short-term market dynamics.
The circular economy, which is very levered in that, which I'll save for later, is a bigger driver of growth for that segment, especially in 2024 when the plant starts up. AFP is a more modest growth opportunity. When you look at, you know, the challenges we faced last year in that segment, we did relatively well in improving earnings, you know, through discipline in both strong demand, managing spreads really well last year. We're gonna have a bit of a headwind in demand this year with building construction in particular, and some one-time projects in fluids that won't repeat this year that helped last year. Spreads won't be as much of a tailwind because we managed spreads so well last year, we don't have as much expansion this year, right?
'Cause a lot of the business in that segment is on cost-plus or contract. More stable business will be a bit down this year, but it'll sort of come right back with demand as you go into 2024 and 2025, presuming, you know, we're in some sort of economic recovery from current conditions.
Great. Okay. One area that probably gets overlooked in your 2023 guidance with all the moving pieces is a really nice improvement in the fibers business and the tow contracts there. As Greg can attest to, I probably geek out on this stuff more than most analysts 'cause my former boss made me spend way too much time on it. Shout out, Duffy. Can you maybe unpack that a little bit, just where the industry currently stands today versus maybe the past few years and why we're seeing that nice improvement this year?
The tow business was a phenomenally good business of steady earnings growth and steady margins for two decades, if you wanna go back and look at the history. It grew to a pretty substantial amount of earnings in 2014. A few things changed then, that created a competitive dynamic when the Chinese enacted a corruption crackdown on smoking, gifting of cigarettes and all these parties and everything that was going on. There was an overstocking of retail inventory. That's a long story, as you know. T hey added some additional increments of their own capability for making it, right? You had this step change of competitive dynamics that happened in 2015 and 2016 that led to a drop in demand as well as some erosion of margin.
Over that decade from from 2015 to now, a couple of things happened. One is demand didn't drop nearly as fast as what people thought. Only declined about 1% because the growth of heat-not-burn cigarettes that turned out needs more tow, not less tow, which was not our original assumption, to actually deliver their performance. That stabilized 'cause that's growing at 15% from a small base, but enough to offset the overall market decline. Over a decade, about a 10% decline in demand, but we took out 15% of the capacity across the different companies in the industry, including us. We didn't shut capacity down. We actually converted it to making textiles, but other companies shut capacity down.
These specialized products like slim cigarettes require a higher performing filter or TiO2-free, you know, filters, et cetera, all had a hit to effective capacity in the 10%-15% range. When you put all that together, utilization is now above 90%. The market's relatively tight, and we're a very small percent of the final price of a cigarette.
Mm-hmm.
you know, and not selling cigarettes is a really bad outcome for those companies, and the amount of margin that they make. They're much more focused on security and companies who are committed to serving this space and treating the customers with respect and trying to have a stable relationship. I think we've done that really well, and able to get, you know, multi-year contracts in place, you know, at these much higher prices to get our spreads back to what we'd say is a normal specialty margin. That's gonna be over $275 million of EBIT, which is a big improvement from $140 million, and really helpful when you think about this year and from an earnings growth point of view, because. The fibers recovery offsets the normalization in CI.
Yep.
Right. Cost cutting offsets the headwinds and pension, which is non-cash, but still offsets it and the return to sort of normal variable comp. You're just down to will the specialties grow or not to get to that five to, you know, sort of, you know, 15% growth. When you know, when you look at the spread tailwind and any kind of just stability and demand, you know, it's easy to get to those numbers.
Great. Maybe one final one on the base business before we pivot over to ESG or circularity, 'cause I could spend another half an hour just on that. One priority in your time, I think as CEO has been the portfolio shift at Eastman.
Yeah.
Improving the product mix, improving variable margins. When you take a step back, is the portfolio today mostly where you want it? Is there still, I know it's never perfect, but I mean, is it mostly where you want it to be or how would you think about that?
No, the portfolio is where we want it to be for today. I think that on the specialty side of the portfolio, we feel very good about the portfolio. The set of businesses we have in AM are great. you know, the coatings business, the fluids business, the personal care business, all of that is great in AFP. Fibers is returning to a more stable industry structure. It's unlikely anyone's gonna add capacity to that industry, given its capital intensity, and it's sort of a structurally dis-declining business.
Now we've got all these growth businesses on top of it in textiles, which is going exceptionally well with our sort of claims, both on beginning of life and end of life, and this new Aventa product for food service that allows us to have a cellulosic drop-in replacement polystyrene, with that's certified to biodegrade in landfill. You know, that's a compelling portfolio to turn the cellulosic stream, not just the polyester stream, into sort of a growth story. Then you've got, you know, the CI business. Half of that is extremely stable, attractive business in functional amines for ag and personal care and pharma, which is 70% of that amines demand. Then you've got a small but stable acetic anhydride business, and that's half of the EBIT last year.
It's gonna be even more than half this year when you look at what's in CI. Yeah, there's some volatility in olefins that make some important, you know, intermediates for our specialties, but it's now down to, you know, less than 10% of the story, when you really get down to it. That portfolio, together with the cash it produces, is good for where we are today in allowing us to have the structure in place to make these investments in the circular economy on top of this core business that I think is pretty attractive.
Great. Okay. Maybe now we can pivot. Eastman, I guess, in my view, has one of the more interesting ESG or circular stories in the space, frankly. Molecular recycling technologies, three new methanolysis projects. For those either on the line or in the room that are maybe newer to the story, can you just give a brief synopsis of what these three projects are, how you're executing, and just the partnerships or customer arrangements that sort of help underpin this opportunity?
Sure. On the polyester side, as I think we all know, plastic waste is a huge issue with the world and where that waste issue needs to be managed. Climate is a huge issue, where we have to reduce our carbon footprint. For a lot of the brands, you know, both are big issues. Regulators and policymakers also very focused on both topics. As a result, regulation is being put already in place in Europe that creates a requirement for 30% recycled content to be put on the shelf in 2025, pay a tax for anything that doesn't have recycled content. That's not a, "I'm being a good company." It's now a regulatory requirement, right? States here are already passing versions of EPR bills that are like that in California and Washington, Colorado.
I think we're headed to some version of this in New York. The requirement isn't just brands having aggressive goals on sustainability for their consumers and their owners, but also policymakers mandating it. When it comes to polyester as part of that overall climate plastic legislation, Eastman's just in a very good position. We had a technology for a long time called methanolysis that we ran on behalf of Kodak to recover silver off of X-ray films for 30 years, you know, at 40 KMT, so at commercial scale. This is not a lab experiment. It's a technology that's run at scale for quite some time. I wanted to do this actually in 2010 in my prior job, I couldn't get customers to engage on this around paying the premium necessary.
You know, the straw up a turtle's nose and Blue Planet II, and we got a new world. People really focusing on waste and climate. These plants work really well because polyester is a polymer. It's easy to break the bond, we can just go back 1 step to the monomers with this technology. We take waste that cannot be mechanically recycled. This bottle we would not touch 'cause mechanically they can do that at a better carbon footprint. Like in Europe, only 17% of what they capture in recycling gets brought back to food grade. The rest of it ends up going into carpet, textiles, that's about 43%. 40% ends up in landfill. All that has very low value, and that's what we take, garbage.
We take it back to the methanolysis, unzip the polymer to the building blocks, purify it, which is the hard part, and then we make the polymer, and it's identical to that polymer, you know, made today, you know, what we call virgin PET. We can do it infinitely. There's no limit, where mechanical recycling degrades after about 5 laps. It truly is a partnership with mechanical to give plastic an infinite life. We can do this at a carbon footprint that's 50%-80% lower, great fossil fuel, you know, climate story being eliminated and about 94% less emissions in the local community. From an environmental justice point of view, it's also a great story. It's financially very attractive. The first plant we're building is in Tennessee. It'll be completed this summer.
That will go into our specialties that we make today with recycled content, and we're adding about 75,000 tons of more Tritan capacity to serve that demand we see for that plant. Very attractive, very profitable. We announced a second plant in France, that'll be, you know, also similar in size to sort of start managing this waste issue in France. That'll be sort of half specialty, half PET. We recently in October announced a third plant with PepsiCo as a base load that'll be in the U.S., that'll be focused on PET. When you put all three together, it's about $2.25 billion in capital that will produce about $450 million in EBITDA across the three plants when you're at full running in 2027.
A large portion of that's come from the first plant going into specialties, so that earnings will start showing up as earnings accretion in 2024 and 2025.
Great. Okay. I'll pause here if there's any questions in the room. I can chat with Mark for another hour. I know we've got three and a half minutes left, but if there's any questions in the room, happy to answer those. Okay, great. I get to chat with Mark for another three minutes. Maybe you can talk a little bit more just around the pros and cons versus mechanical recycling. I think.
Yeah.
Again, sometimes people try to figure out the differences or people aren't as in the weeds. Why is this so much more powerful? Maybe it's in conjunction with mechanical recycling.
First, I'd say it's in conjunction.
Yeah.
I don't wanna try and pretend either play a unique role. I think it's actually a necessary complementary role. Mechanical has been around for a long time. They basically collect bottles or other waste, you know, and then try and through mechanical technology separate it. They can identify a lot of very clean bottles. They can chop them up, wash it with baking soda, basically melt it, you know, into flake, and then they can make a new bottle. It's a very low energy footprint because, you know, there's a lot of acid intensity in what I just described. The problem is that there's a quality issue that gets worse over time.
Each lap, the bonds, if you're just warming the plastic up, sort of degrade and at some point, typically around five laps, no longer valid. There are some quality clarity issues that get with it, and there are huge yield issues, right? There's only so much of this they can get back into food grade quality and safely from an impurity point of view. The rest of it, as I said, gets downcycled or incinerated or landfilled. It's a great sort of core solution that needs to happen. Then all the material that they can't use, we can. We can then take that and chemically unzip it and bring it back to, you know, first-grade quality, including their degraded polymer. On their side, we can lap back and bring it back to first grade.
We can create the aluminum circularity within plastic at a very low carbon footprint and far lower than, you know, aluminum and glass in the bottle in the bottle application.
Great. Maybe lastly, you can talk a little bit more around the contracting side of things, because obviously you guys are investing a lot of capital. You're expecting fairly good high margin returns on that capital.
Yeah.
Maybe it's not a newer technology for you guys because you've been doing it a while, but it's a little bit of a newer growth angle, more broadly speaking. Maybe you can speak a little more to the contract nature with your customers on that and how you adds confidence to your returns there.
Absolutely. One of the key things when we started this whole program, you know, we were first focused on we had run out of DMT, which is the key intermediate we need for making our specialty polyesters. We had a choice to say, we have to add DMT with, you know, traditional fossil fuels or recycling. It was easy choice. We're gonna go with recycling with where the world's headed and we're break even at $70 oil, you know, on that choice. This is, you know, a good choice.
When you go beyond that and say, "Okay, how do I scale this up into its own business that has a big growth curve to it, that gets investors really excited beyond our core model on how we could accelerate the growth of the company and really create a whole new vector of growth for us?" You gotta get into bigger volume applications like PET or polyester textiles. I've been in that business, you know, in fact, you know, we were one of the original people who created the industry, and watched it then get economically destroyed by China competition. There was no way I was ever gonna get back into that.
We said, we're only gonna get back into this if we could take the Airgas model, where we have brands who really wanna solve their challenges on recycled content, as I described it earlier, and we can provide a conversion service of taking feedstock and energy and for an appropriate fee, basically convert that to rPET on their behalf. It's an Airgas model and how we're sort of structuring this in long-term contracts to have very stable margins that, you know, we know before we start construction, give us an acceptable return on capital. That, you know, and it's a long-term contract. That, you know, that for us was an important milestone. The Pepsi contract was a critical milestone on that contracting question.
The conversations with other brands is, you know, going well in the same kind of structure. That gives us the certainty to make these kind of very large capital investments.
Great. Well, we'll leave it there. Hopefully, we'll be sitting here February 2024, and we'll have even more data points to point to about-.
Well, we'll have a plant up and running. We'll have revenue from methanoly sis.
Exactly. I might need to move it from 30 minutes to 45.
Absolutely.
We're gonna have cellulosic, you know, cellulosic trays going into landfill. You know, it's gonna be awesome.
Exactly. Well, Mark, Greg, appreciate you guys being here. Thank you.
Thank you.