Citi 2017 Basic Materials Conference

Nov 28, 2017

Slides

A. Thanks. Thank you, Dan. Thank you, Citi, for hosting. Thank you all for joining us today. We're going to try to accomplish three things rather quickly: first, to introduce the company for those of you that are new to us second, to very briefly cover recent performance and third, to talk about our plan to separate our two businesses into independent stand alone companies. We'll do it quickly to allow for Q and A. I'm going to start on Page four here, where you can see what platform is and what we've accomplished since our founding. We set out to build a diversified global specialty chemicals business focused on what we called asset light, high touch companies. And we did so through three through six acquisitions, three in what we call Performance Solutions and three in Agricultural Solutions. Today, they're about equal sized businesses, 1,800,000,000.0 in revenue each and in around $400,000,000 in EBITDA each. And we've accomplished quite a bit alongside both of those verticals since the acquisitions. On the agricultural side, we really combined three strong portfolios into one global portfolio and one global organization. We've accomplished we've realized about $80,000,000 of run rate synergies on the ag side and invested nicely in the pipeline, in the R and D pipeline for this business, growing it to a peak potential value of $1,300,000,000 On the performance side, we started that consolidation slightly later, but we are well along our way in integrating those businesses. We've achieved $50,000,000 in run rate synergies eighteen months after completing those acquisitions, integrated sales forces, integrated R and D organizations and really been able to drive revenue synergies through the combination of those three businesses. Today, Platform, I'm now on Page five, is a highly profitable, high cash flow business. We've gross margins in excess of 40% across the business, EBITDA north 20%, diversified across all major regions globally with exposure to very attractive, diverse end markets and fast growing at that. On Page six, you can see the next step in our evolution, which is to separate these two businesses into two stand alone public companies, each of which with great prospects. The ag business will be a leading stand alone independent global agricultural chemicals business, formulation driven, high margin with a great R and D pipeline, as I mentioned, growing mid single digits with high single digit adjusted EBITDA growth. Our target leverage for this business is about 3.5x, which we expect to accomplish within twelve months of separation. The Specialty Chemicals business, the Performance business is a diversified Industrial Chemicals business with exposure to both industrial end markets and electronics, growing low to mid single digits and also with high single digit adjusted EBITDA growth. We expect to grow that business inorganically through a measured acquisition approach focused on adjacencies and existing verticals where we have a presence, but there's a very compelling inorganic growth story there. Our target leverage for that business is four to 4.5 times debt to EBITDA within twelve to eighteen months from separation. On Page seven, you can see more highlights for this ag business. It's really a unique global formulation based ag chem business focused on specialty crops, specialty applications and niche segments of the market. It's got great growth prospects based on its leading positions in very attractive niches like biosolutions and seed treatment. Also niche geographies like Africa, the Andean region in South America and parts of Asia. This is a business with industry leading cash flow margins given its ability to generate proprietary margin without the commensurate investment in basic research and manufacturing facilities. So we're able to generate a north of 20% EBITDA margin with less than 3% of sales and CapEx. And on Page eight, we have highlights for our Performance business, which is a market leader in five distinct segments: number one, number two market position in each of those segments. It's a very high touch business with extremely sticky sales and customers. And we've got a great opportunity to grow this business on the back of attractive end markets and cross selling from our recent acquisition activity. As I talked about earlier, we combined three businesses into one with more touch points in our customer supply chain than any of our competitors. And that's put us in a unique opportunity to drive organic growth, to grow our market share, which we've been doing this year. This is a business with a terrific margin profile and cash characteristics, EBITDA margin of 25%, CapEx of less than 2% of sales, industry leading return on invested capital. So very quickly on Page nine, as I mentioned, I was going to cover recent performance. In Q3, we announced results several weeks ago now, but we grew 2% on the top line from strength in the performance business, particularly our industrial business and the Alpha assembly materials business, which was offset by a slow start to the growing season in our Brazilian ag business, which is really driven by drought conditions there. Fortunately, it's raining, and so that season is now going on full bore. EBITDA grew 3% and margin expanded about 40 bps, which was driven more by mix in the ag side of the business. I'd be happy to talk more about Q3 in Q and A if you'd like. But for expediency, I think I'll skip to Slide 12 here. Let me do that, where we're just reconfirming our guidance range of $810,000,000 to $830,000,000 in EBITDA for the full year 2017, which is growth of 5% to 8% for the year. Our observations on this slide about end markets and currency are largely unchanged from Q3. So I don't think we can spend too much time on it. But again, happy to talk about it during Q and A. On Slide 13, just a quick update on how we're thinking about the separation of our businesses. I think the right place to start is with our objectives. So our objective is to separate these two businesses into two public companies by the 2018. That's our primary objective, time based objective, and we're making good progress against that objective already. Obviously, it's market dependent, but if the markets aren't there for us, we'll wait to access them, but we will not change our plan. Second objective is to accomplish this run rate cost neutral to Platform shareholders. By that, we mean we're going to have to add some cost in the stand alone ag business, and we expect to be able to offset that on a run rate basis from the platform business. And the third objective is to attain our leverage objectives within the targeted time frames. I went through those earlier in the presentation, 3.5 times for the ag business within twelve months of the separation and 4x to 4.5x for the performance business within twelve to eighteen months. When we talk about separation, there are really two critical work streams. The first is an operational separation, right? This is to separate the functions of the businesses so that they can breathe, eat, survive on a stand alone basis. And the second is the balance sheet separation. It's the capital markets activity. We've got a quantum of debt right now that's collateralized by both the Arista business and the Performance business. We need to separate that, bring in some equity to take leverage down across the system, backing the ag business. And so that's the second work stream. From an operational perspective, our goal is to have the fundamental operational separation complete by January 1. I can we call this table stakes operational separation, different bank accounts, independent org designs, basic functions to allow these companies to function separately. We expect to have the complete separation with very limited requirement for a TSA by the time we're done with the capital structure separations and by the time we've brought in that equity from backing Arista. On the balance sheet separation, you will have seen in the past couple of weeks, we refinanced our 10.75% notes with new 5.5% notes. And they had an added function, an added bell and whistle, which allows for the guarantee from the Arista business to fall away subject to certain leverage criteria. So this is a bond that can stay with RomainCo subsequent to the separation. And we see an opportunity to pursue similarly flexible securities in the debt capital markets in coming months. Our goal is to have most of the balance sheet separation done before or in conjunction with bringing in equity to support the ag business. Finally, our twenty seventeen priorities, we always end with these. We have built operating momentum, growing the business, realizing synergies, executing against our plan. And so our primary priority for the year has always been execution and to build on the momentum we built we developed in 2016. And obviously, that's the first priority. The second is to continue to focus on fast growing niches. And we've done that in the Ag business. We talked about our BioSolutions business, again, growing double digits this year. On the Performance Solutions side, our semiconductor business is growing really nicely. And there are other interesting attractive niches we've been investing behind and growing. The third is synergy realization and continuous cost improvement. We've realized all the synergies in the ag business. We are getting close to having a run rate of the full synergies from the performance businesses we combined. We have a continuous improvement objective in the ag business to take out even more cost, and we're delivering against that this year and obviously spending a lot of time focused on that. And last but not least, is to generate free cash flow and reduce leverage. Cash flow seasonality in our business driven by ag suggests or leads to most of our cash being generated in the back half of the year. And you saw that in Q3 and should expect to see that in Q4 even more so. I'd be remiss not to include on this page progress against our separation, which is obviously a critical priority for the business and something we're clearly focused on and working towards and believe that to be sort of a crucial path towards value creation for all of our shareholders. So I moved pretty quickly through quite a bit of content, but I'm very happy to open the floor to Q and A at this point. Thanks, Ben. So maybe we should just start a bit on the fourth quarter since we're a couple of months in. I think you mentioned this briefly, Brazil and how the Brazilian ag season evolves was probably the biggest variable in the bottom and top end of your guidance for the full year. So since the call, maybe any update on the ground in Brazil and how that's progressing? Yes, happy to answer that. Obviously, the driver in Q3 was that there have been drought conditions in Brazil, September into October, which delayed planting season, delayed sales. We have seen weather conditions improving in Brazil. So there's always a risk if the weather is really poor that you miss the sales, right? The growing season is missed and you don't really sell as much as you would have in normal course. We don't believe that to be the case this year given the improvement in weather. Is there a risk that some sales fall from Q4 into Q1? Yes, that's a potential. But we feel pretty good about the season occurring and a healthy season in Brazil this year. The primary month for sales in this business in Brazil is December. So there's still quite a bit of data to come in, but we feel like we're well positioned. Channel inventories are not an enemy to us. It's just a matter of if the sales come in December or January. Okay. And then on the performance business, if I recall year over year, you had some margin compression in the third quarter. I think part of that was mix, part of it was raw materials. Can you just frame the different buckets of what's going on in margins and performance? And how do you bridge that to maybe your outlook for the fourth quarter and into 2018? Yes. So we saw some gross margin compression in the performance business. And in Q3, that was driven more by mix. So we had some raw material cost inflation in Q2. We took actions to offset that in the course of Q3. We haven't seen the full benefit of that in a full quarter. We'll see that in Q4. But it was almost an it was a very anomalous situation in that in our three biggest businesses in the performance space, the electronics business, the industrial business and the Alpha business, gross margin improved in all three of them, except the Alpha business, which is the lowest gross margin business of the three, grew faster than the rest. And so that's why you saw gross margin compression despite gross margin expansion in each of those three businesses. That's anomalous from our perspective. And the reason for that is if you think about the secular trends driving each of those businesses, there should be more growth through the cycle in the electronics business and in the industrial business than in the Alpha business. And so as we look out over a period of a matter of years, we actually expect gross margin expansion across that business as opposed to the modest compression you saw in the quarter. So raw material so just to clarify, so raw material inflationary trends that were in the second quarter, have they gotten better or worse or kind of neutral since then? So we've been able to offset pressure from COGS increases in the performance business through price increases and through taking cost out of suppliers. That the full impact of that doesn't hit until Q4. You saw some of that in Q3. And then just one last one, we'll see if anyone else has questions. You hinted at this, fourth quarter is seasonally the biggest cash generation quarter for you. And if you go back historically on the operations side, you've definitely tried to improve cash generation from EBITDA on that conversion rate. So as we go into this fourth quarter, how much progress have you made compared to this time last year in terms of converting EBITDA dollars to cash from operation dollars? Yes. Clearly, it's been a huge priority for us to take working capital out of the ag business. And so our cash flow conversion, EBITDA to cash flow should be better this year than last year. You won't see that as much in Q4 as you will on the full year basis because we did some factoring, which made Q2 better, and you'll see that benefit over the course of the full year. But if you look quarter over quarter from a cash flow perspective, the cash flow conversion perspective, it's not going to be meaningfully better on a percentage basis. But over the course of the full 2017, EBITDA to cash flow will be much better, partially from working capital, partially from taking cost of debt down. We've had meaningful interest savings year over year. Those would be the two biggest drivers. Ben, just on the balance sheet, you mentioned the opportunity to pursue similar transactions. You have two other bonds. Could you comment on how those would need to change in order for the transaction to proceed? Sure. We try to follow the thesis that if you tell them where you're going, it gets more expensive to go that way. So what I'll say is we're going to be opportunistic and we want to create a situation where we have flexibility to pursue what the market serves up as most attractive. That having been said, it's evident that our current 66.5% bonds don't allow for the separation as constructed. So we will either need to go to our bondholders for a consent or retire those bonds, refinance those bonds. And we will do whichever is most attractive from a cost of capital perspective, flexibility perspective at the appropriate time. And in terms of the actual split into two public companies, how would that actually look? Would it be would you own how would proceeds come back to the RemainCo? Yes. So obviously, we're taking leverage out of the system. We've got a quantum of debt at the platform level that needs to be reduced in the context of RemainCo. So we will need to bring proceeds back. Clearly, some of that will come from a debt financing at the Arista level, some of it will come from equity we bring in to support Arista. The mechanism for that equity is something that we're discussing. The baseline plan is an IPO. And so that's the path we're marching down. And then there's also the remaining stake in the ag business that in the context of an IPO would be held by platform RemainCo and could be sold down over time to reduce leverage or pursue other alternatives or could be spun to shareholders if that's the right thing to do. Great. Thank you. Maybe just jump back into the ag business. So if I look at sort of the overall ecosystem, there has been some challenge with inventory levels in Brazil still, some uneven performance in Europe and North America with some companies doing better, some companies doing worse. Maybe just kind of taking a step back as we go into 2018, what are some of the key things that you're thinking about, for the sort of the Northern Hemisphere for first half twenty eighteen before any sort of spend would take place in terms of sales growth targets or inventory or working capital changes? Sure. So we haven't talked too much about 2018, but just to give you a sense for our positioning going into the year from a market perspective on the ag side. In North America, we took actions to clear the channel. We didn't have inventory channel inventory issues anywhere in the world other than in North America. And that was back in 2015, where we said, we're just going to sell in line with on the ground demand. And we're harvesting the fruits of that in Q4. Obviously, before we talk about twenty eighteen Q4, we need to deliver that, and we're very focused on that. But we expect to continue to see improvement in North America going into next year on the back of the channel inventory work we've done and some new products we're introducing in that market. The European business is it's a huge business, right? So that's a business that spans Western Europe, Eastern Europe, great presence in Central And Eastern Europe, and we're entering new markets in both Western And Eastern Europe and Africa, of course. We're lapping some change in our selling strategy in Africa, so we should see a benefit from that from a growth perspective. And our private market business in Africa selling to individual smallholders is growing really nicely, double digits, relatively small business, but growing nicely. Eastern Europe was a tough season for us this year on the back of weather conditions. It was cold. And so we should weather neutral, see some recovery there next year. And the fruits from our opening these new markets in Western Europe, we talked about opening UK as a market and Germany as a market, which are big industrialized markets where we were undersized should also continue to come through. So we feel from a market position perspective, good about the prospects for the first half of next year. And obviously, it's all weather dependent, but outside of that, the controllables, we feel well positioned for. On the performance side, you mentioned that you're still working on sort of the final stages of the restructuring and you hope to get the full run rate benefit relatively soon. Can you talk about the risk of trying to separate out that from the ag business at the same time you're trying to capture ongoing synergies? And maybe walk us through that a relatively quick turnaround of piecing together and pulling apart. So just walk us through maybe some examples of some of the things that are potential risks that we should be looking for. Yes. So that's really not a risk as we see it. These businesses function from a commercial and supply chain perspective completely independently. We don't need to separate out joint factories. We don't need to separate out joint sales forces or supply chains. The work that's left to do on the Performance Solutions side of the integration is on the facility side, where we're trying to reduce our facility footprint. And the folks working on that are not working on the separation, right? The separation requires separating the back office functions, right? So treasury and tax, accounting, IT, things like that. They're not commingled commercially. So we've done a really good job of quickly putting the businesses together, the commercial side of things, the operational side of things, the supply chain side of things, those aren't getting separated. What's being separated is the public company and governance functions, accounting functions. And that there's very little interface between the operational side of things and the back office side of things in terms of governance. When do you envision the leadership for AGCO being announced publicly? Yes. So we put in this deck here is that our goal is to have the operational separation complete January 1 or at least the table stakes things. And obviously, leadership is table stakes. And so we won't withhold that information unnecessarily from interested parties. And so you should expect to hear about that in the coming months. Let's keep going then. So on the electronics side, comps get tougher, going into fourth quarter and into 2018. Can you just walk us through clearly, you just said that it should grow faster than the Alpha business over time. But into 2018, maybe just walk us through some of the key end markets, what your expectations are on the electronics side? And then on the industrial side, obviously, you have exposure to the automotive cycle. So just maybe some thoughts on that as well. Yes. So the industrial side of the story is a really good one. About half of that business is automotive, mostly Western, meaning North America and Europe. But where we're really gaining share and growing nicely is in Asia. We were concerned when we put these businesses together that we were taking the two and the three in the market and combining them. And so there would be customers who were disappointed. But in reality, what we've heard from customers is you created a number two. There was no globally qualified competitor to AdaTech. And that's playing out in the numbers and in the field where we are gaining market share in Asia. We had customers in Europe who had facilities in Asia and they weren't considering McDermid or Enthone for business in Asia, and now they are. And so that business is growing really nicely. And so when people point to potential softness in The U. S. Automotive market, from our perspective, that's being offset and some in the Asian market. And you're seeing that in the results. Industrial grew really well year to date and continues to show that strength in Q4. The electronics side of the business, you're right, Dan. 2016 was a slow year for our electronics business and for the electronics market broadly until Q4 when it really inflected. And we saw a nice pickup from that. And momentum continued through the first half of the year, and we posted some great results in that business in the first half. And we're starting to face some tougher comps in Q4. That business still continues to do well. And we see a lot of opportunity just from unit growth and new device launches. And so we expect to see continued momentum next year. Obviously, the year over year numbers won't be as good as the comps become more challenging, but there's still plenty of growth opportunity there as we look at next year. And then with Brent at 63 plus today, at what point does the oil and gas business start to get some improved momentum? Yes. So the offshore business has inflected. But unfortunately, there are pretty long lead times before we see that in our results because the CapEx cycle for a new producing offshore oil well is pretty long. That having been said, over the past two years, the offshore producers have taken a ton of cost out and made much more attractive breakeven pricing for them. So if you look at the North Sea oil, they've taken like $20 out per barrel in breakeven costs. And so we are starting to see some wells coming online and starting to see some new investment. And so that's why we say with some confidence that we feel like we've inflected in that business. I'd note, however, it's a relatively small business in the context of platform or even in the Performance Solutions segment. And then just on the Packaging business, I think the last quarter was a little bit slower, but maybe that wasn't consistent across the different businesses. There's a you have a newspaper exposure. Can you just walk us through kind of the different challenges in that and how we should be thinking about that business? Yes. The packaging business is a really nice business, high margin, great cash flow characteristics. What we do there is we make flexographic printing plates. So these are printing plates that are consumables in production of flexible packaging, right? And that business really has two dynamics going on in it about it's about 150,000,000 in sales. And about 20% of that business, so $30,000,000 is in newspapers. And sort of like VHS Betamax, flexographic printing for newspapers lost. So that's a business that's in secular decline because newspaper printing is in decline and most folks are using offset, not flexographic. And so that's something that's just a shrinking pool, but we're managing it for cash and it's slowly declining. The rest of the business is for packaging. And there's a great secular growth trend behind packaging as emerging markets are seeing more packaged food product. We get new orders when labeling changes. So if it's regulatory or design changes and your multinationals need to change what's on their labels, they need to order something new from us. And so that business is growing really nicely, particularly in emerging markets as an end market as an industry. We had a company specific issue where which was a technical issue in 2016 with one of our customers. And so that's created a headwind for us, not for the end market. But we expect to have that resolved. We will have that resolved going into next year. And so we'll continue to see growth in that segment of the business, which will offset some of the decline in the newspaper business, which becomes less and less material as the rest of the business grows. So on the performance side, you've talked about kind of 3% to 5% growth over sort of the medium to long term. What are the incremental margins look like on that 3% to 5% organic growth? And if you could kind of rank order any of your sub businesses performance just to get a sense of where some of the margin opportunity could be as those markets grow? Yes. So what I would say is the incremental margins you saw in the first half of the year were exceptional and anomalous. And the incremental margins you saw in Q3 were poor and anomalous. The Alpha business grew fastest in Q3. We had some shrinking in some of the smaller businesses, which are higher margin. And so you would have seen that offsetting and making the incremental margins look worse than sort of normal course average would be. If you rack and stack margin gross margin across these segments, offshore is highest, electronics and printing are sort of second tier, the industrial is about average and the Alpha business is below average. And so that explains why in Q3, Alpha business grew really nicely and incremental margins look poor. Q1, you saw huge growth in electronics, which created sort of above average incremental margins. Incremental margins in this business are pretty compelling. And if you take a look at sort of through the cycle, our operating leverage, you can get a sense that this business has been trending with incremental margins in the 30s and 40s. And then in the Performance business, is the CapEx profile any different than the ag business? And is that 2% of sales, is that sustainable over a long period of time? Or is that now because you're just leaning out the business through all these restructurings? No, it really is. It really is. These both of these businesses really don't require plant to grow or to maintain their margins, right? They use formulation facilities, which are very simple blending facilities. They look more like warehouses than factories, right? So that 2% is what this business requires to grow to sustain and grow. The profile in the ag business is slightly different because we capitalize some of our R and D spend. So you'll get a tick above 3% in the ag business, but the actual physical PP and E is less than 2%, whereas in the Performance business, you see that same sort of less than 2%, which is just PP and E. But while the business is levered, it has not been capital constrained at all from an operational perspective. We have made all the investments that our businesses have asked us to make to support growth, to support margin and to achieve their plans. Just one question on taxes with what's being proposed by the GOP. Can just give us any thoughts in terms of impact on the company as a whole or its two pieces, whether it be on interest deductibility or CapEx or net net with the tax rate being lower? Is it a positive, negative? Yes. So we're not that capital intensive. So the CapEx dynamic, it's a modest positive, but not a material positive. And interest deductibility is not such a material negative because we don't have that much earnings in The U. S. And so our interest in The U. S, which is where most of our debt is and we have quite a bit of our corporate cost, our interest isn't creating a tax shield. So it's not a major needle mover from our perspective. Ultimately, however, a lower tax rate is good for us. And so we will we've got plenty of tax planning to do. Our tax rate is a little wonky right now. It's a major opportunity for us over the medium term, and a lower U. S. Tax rate is beneficial for Platform. Great. All right. If there's no more questions, thank you very much. Thanks to you guys.