Good day, ladies and gentlemen. Welcome to the Huntsman Corporation third quarter 2016 earnings conference call. My name is Janeda. I will be your operator for today. At this time, all participants are in listen-only mode. Later, we will be conducting a question and answer session. If at any time you require operator assistance, please press star followed by zero. We will be happy to assist you. As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to Kurt Ogden, Vice President, Investor Relations and Finance. Please proceed.
Thank you, Janeda. Good morning, everyone. Welcome to our third quarter 2016 earnings call. Joining us on the call today are Jon Huntsman, our Founder and Executive Chairman, Peter Huntsman, President and CEO, and Kimo Esplin, Executive Vice President and CFO. This morning before the market opened, we released our earnings for the third quarter 2016 via press release. We posted it on our website, huntsman.com. We also posted a set of slides on our website, which we will use on the call this morning in the discussion of our results. During this call, we may make statements about our projections or expectations for the future. All such statements are forward-looking statements. While they reflect our current expectations, they involve risks and uncertainties and are not guarantees of future performance.
You should review our filings with the Securities and Exchange Commission for more information regarding the factors that could cause actual results to differ materially from these projections or expectations. We do not plan on publicly updating or revising any forward-looking statements during the quarter. In addition, we will also refer to non-GAAP financial measures such as adjusted EBITDA, adjusted net income or loss, and free cash flow. You can find reconciliations to the most directly comparable GAAP financial measures in our earnings release, which has been posted on our website. In our earnings release this morning, we reported third quarter 2016 revenue of $2,363 million, adjusted EBITDA of $272 million, and adjusted earnings per share of $0.38 per diluted share. I will now turn the call over to Peter Huntsman, our President and CEO.
Thank you, Kurt. Good morning, everyone. Thanks for taking the time to join us. Let's turn to slide number three. Adjusted EBITDA for our Polyurethanes division in the third quarter was $137 million. MDI urethanes delivered impressive earnings growth with a third-quarter EBITDA of $138 million. This represents an improvement of $17 million compared to the prior year period. MDI volume growth was strong for the quarter at 5% globally, driven by strong growth in Europe and North America. Growth in Europe was across the board. In particular, we saw a strong double-digit growth within our downstream specialty MDI product range into our adhesives, composites, elastomers, as well as automotive and furniture business units. North American growth was driven by commercial insulation as we continue to see a recovery in this large market combined with the ongoing trend of MDI system substitution of alternative insulating materials.
Asian growth was relatively flat. We grew our differentiated portfolio by 10% while deselecting our lower-margin component business. Asian profitability increased substantially compared to the prior year period as tightness in the Chinese market led to significantly improved margins. Our MTBE business recorded an EBITDA loss of $1 million in the third quarter. The average C factor, which is an industry proxy for MTBE contribution margins, declined by 50% compared to the prior year period, from $1.45 per gallon to $0.73 per gallon. The decrease in C factors was primarily attributable to higher gasoline inventories and lower refined margins. The C factors remain low today, and we expect this to have an adverse impact on MTBE earnings in the fourth quarter.
During the third quarter, we experienced a negative EBITDA impact of approximately $15 million to Polyurethanes earnings from weather-related and other production outages, we expect a $10 million negative EBITDA impact during the fourth quarter. All the affected facilities are now back operating. We continue to strengthen our innovation capabilities as we drive for higher differentiated growth in downstream markets. These efforts were recognized earlier this month when our Polyurethanes division won a prestigious supplier innovation award from BMW for developing a technology which dramatically reduces emissions from high-performance polyurethane seating foam used in its vehicles. The innovative chemistry developed by Huntsman enables BMW to reduce total emissions from its seating foams by a factor of 10 without compromising comfort or quality.
Huntsman is the only supplier able to meet BMW's ambitious requirements, the award reinforces the importance of collaborative partnerships with key customers to develop innovative solutions that enhance product performance and ultimately business competitiveness. Let's turn to slide number four. In the third quarter, our Performance Products division recorded adjusted EBITDA of $70 million. During the quarter, we saw soft demand in China, particularly in the wind market, and soft demand globally for oilfield products. In addition, volume in this business were impacted by weather-related and other production outages during the quarter, which had a $10 million negative impact. We expect to see another $10 million negative impact from these production outages during the fourth quarter. Similar to our Polyurethanes operations located along the U.S. Gulf Coast, the impacted facilities are also now back and operational.
During the quarter, we announced that Innospec had committed to purchase our European surfactants business at an enterprise value of $225 million. This business represents approximately $24 million of annual EBITDA, we expect closing to occur by the end of this year. As a reminder, we have postponed our planned maintenance of our ethylene oxide and ethylene glycol units in Port Neches, Texas, until the second half of 2017. This maintenance occurs once every four years and will last approximately two months, with a cash cost of less than $50 million. The EBITDA impact will depend on economics at that time, but we currently estimate it to be approximately $15 million. We continue to make progress with the self-help measures we are undertaking in this business to improve earnings. We expect minimal restructuring costs as we are focused on business optimization, not capacity rationalization.
While these measures won't be fully implemented until the end of 2017, we are already seeing a benefit. While this business will be affected in the fourth quarter by typical seasonality and the production outages which extended into the quarter, we expect that their impacts will be offset by the benefit of the self-help measures that have been put into place. As a result, we expect to see similar sequential earnings in this division in the fourth quarter. Let's turn to slide number five. In the third quarter, our Advanced Materials division recorded adjusted EBITDA of $55 million with an EBITDA margin of 22%. Sales volumes decreased primarily due to soft demand for lower value resins in our coatings and construction markets. In addition, slowing demand for wind in China and competitive pressures in North America resulted in lower sales in our wind market.
This was partially offset by continued strong growth in our high-value aerospace and electrical markets. EBITDA was lower in our coatings and construction and wind markets but improved in our aerospace and electrical markets. Continued focus on our higher value markets, such as aerospace, resulted in overall improvement of 200 basis points in EBITDA margin. In the fourth quarter, we expect to see a normal seasonal slowdown in demand, however, improved earnings compared to the prior year. Turning to slide number six. Our Textile Effects division reported adjusted EBITDA of $17 million in the third quarter, an increase of $7 million over the prior year period. Sales volumes grew 5% compared to the prior year period. We target key markets such as China, India, and Bangladesh to grow our business.
These efforts continue to be successful for us as sales volumes in key markets grew 11% compared to the third quarter of the prior year, primarily due to strong demand in Bangladesh and India, while demand was nearly unchanged in China. The combination of our continued focus on higher value product ranges, lower raw material costs, and lower selling, general, and administrative costs led to increased EBITDA margins of 9% compared to 5% in the prior year's period. The return on net assets for the last 12 months for this business is 13%, a significant improvement from where this business was not long ago. We expect the fourth quarter adjusted EBITDA in Textile Effects to be similar to what it has been in the third quarter. Let's turn to slide number seven.
In our Pigments and Additives division, we earned $38 million of adjusted EBITDA in the third quarter, an improvement of $33 million versus the prior year period, predominantly in our TiO2 business. Our TiO2 business earned $22 million of adjusted EBITDA during the quarter, while the additives portion of our business earned $16 million. Average selling prices for the division were up 3% sequentially on a local currency basis. We were particularly encouraged to see the average selling price for functional TiO2 improve 5% compared to the second quarter. We've implemented two price increases through the end of the third quarter of this year and are implementing a third increase during the fourth quarter. In addition, earlier this week, we announced another price increase for implementation in the first quarter of 2017.
These necessary price increases, along with the benefits from our restructuring efforts, position this division for success in delivering a long-term sustainable and profitable business. Compared to the third quarter of last year, sales volumes were essentially flat for the division. However, TiO2 sales volumes increased 5% compared to the prior year period, with notable growth in Europe. In the fourth quarter, we expect to see the typical seasonal slowdown in demand and would therefore expect earnings to decrease on a sequential basis. Before sharing some concluding thoughts, I'd like to turn a few minutes over to Kimo Esplin, our Chief Financial Officer.
Thanks, Peter. Let's go to slide eight. Our adjusted EBITDA decreased to $272 million in the third quarter of 2016 from $311 million in the prior year period. During the quarter, adjusted EBITDA was impacted by approximately $25 million from weather-related and other production outages in our Performance Products and Polyurethanes businesses. Sales volumes were essentially flat, excluding the effect of the outages. Overall margins decreased by $36 million, primarily in MTBE, where the C factor was approximately half of what it was in the prior year and due to competitive market conditions in our Performance Products division. We continue to see strong EBITDA growth in our MDI business and margin expansion in TiO2 as a result of the previously announced price increases. Compared to the prior quarter, our adjusted EBITDA decreased to $272 million from $325 million in the second quarter.
Overall sales prices increased by 2% sequentially, primarily due to higher MDI and TiO2 prices. Sales volume and contribution margins combined decreased $52 million. Slide nine. This year, we set a goal to generate more than $350 million in free cash flow. As of the end of the third quarter, we have exceeded that goal by producing $569 million of free cash flow year to date. It's worth noting that in the fourth quarter, we expect inventory build in some of our businesses, such as in European MDI, in preparation for a first-quarter scheduled maintenance of our Rotterdam facility, and as we replenish inventories from our unplanned outages in Performance Products and Polyurethanes. As we look forward to 2017, we expect to continue our strong free cash flow generation, most notably through growth in EBITDA, stable working capital, as well as lower capital expenditure and restructuring payments.
We expect pension payments to increase in 2017 due to changes in the discount rates, primarily in Europe. At the end of the quarter, we had liquidity of $1,247 million. This is an increase of $224 million from the end of 2015. On July 22nd and again on September 30th, we made early debt payments of $100 million, reducing our term loan B by $200 million during the third quarter. Through the third quarter year to date, we have spent $290 million on capital expenditures, and we have received approximately $28 million of capital reimbursements from our customers and joint venture partners. In 2016, we expect to spend approximately $450 million on capital expenditures before capital reimbursements from business partners, which are expected to be about $30 million.
We recently completed a capital planning review with senior managers of our business and have reduced our planned capital expenditures to approximately $400 million in 2017 and expect capital reimbursements of approximately $20 million. Our maintenance capital will be similar to that of 2016 or approximately $250 million. However, given the global economic backdrop, we have elected to trim certain discretionary growth projects. We expect our annual depreciation and amortization rate to be approximately $435 million in 2016 and approximately $450 million in 2017. During the third quarter this year, we recorded an income tax benefit of $1 million and paid $8 million in cash for income taxes. Our MTBE earnings are taxed at the U.S. statutory rate of 35%. Variability in our MTBE earnings has a meaningful impact on our adjusted effective tax rate.
The combination of significantly lower MTBE earnings, weather-related and other production outages in the U.S., and higher earnings in countries with valuation allowances resulted in an unusually low effective tax rate of 14% in the third quarter of 2016. We expect our 2016 and 2017 adjusted effective tax rate to be in the range of 25%-30%. We expect our long-term adjusted effective tax rate to be approximately 30%. Peter?
Thank you, Kimo. Earlier this year, I outlined three objectives for our company. The first was to build on our core differentiated businesses. I would summarize our third quarter operational performance as follows. We are seeing attractive earnings growth in MDI. Margins for key business lines and Performance Products have stabilized. Advanced Materials and Textile Effects continue to operate at a steady and modestly improving pace, and TiO2 prices are improving. We have had some headwinds, such as lower MTBE margins, as well as weather-related and other one-time production outages. Our second objective was the delivery of more than $350 million of pre-dividend free cash flow for the entire year of 2016. To this end, we are generating substantial amounts of free cash flow and are putting it to use by prepaying our debt.
To date, we have generated over $550 million of free cash flow, made debt payments of more than $250 million, including $200 million, which were early prepayments, and strengthened our balance sheet. Our third objective is the separation of our Pigments and Additives division. Let's turn to slide number 10. Earlier today, we filed an initial Form 10 registration statement with the U.S. Securities and Exchange Commission. The filing represents an important step in the progression towards the separation. The filing contains useful information and answers many questions that you have been asking. Additional information, such as the company name, capitalization, additional pro forma information, and other matters will be provided in subsequent amendments to the Form 10. Within the filing this morning, we indicated that we intend to spin the combination of our Pigments and Additives and Textile Effects businesses, which we refer to as SpinCo.
An overview of these businesses is provided in the filing, along with industry and market information, strengths of the business, and an outline of strategy. Historical carve-out financials are provided, although these are compliant with accounting requirements, to be candid, they don't provide the full insightful view of the business. In certain cases, our Pigments and Additives and Textile Effects businesses operated within legal entities, which include businesses that will not be part of SpinCo. While we have made an attempt to pro forma these legal entities' adjustments within the filing, there are additional pro forma adjustments that will be made in future amendments, such as corporate overhead costs and interest expense. SpinCo is incorporated in the U.S., and its principal executive offices are expected to be in the U.K. We plan to have SpinCo shares listed on the New York Stock Exchange.
We have previously indicated our intent to retain as much as 40% of the economic interest in SpinCo, in large part to capture the appreciation in value associated with an improving titanium dioxide cycle. We intend to use the monetization of our economic interest to repay debt. In order for this spin-off to be tax-free, we will not retain more than 19.9% of the voting power. We will determine our retained ownership following receipt of a private letter ruling sanctioning the tax-free nature of the spin-off. Certain board members and executive managers are also identified in the Form 10. Subject to market conditions, we plan to separate in the first half of 2017. Let's turn to slide number 11. We provided an update profile of what SpinCo and pro forma Huntsman will look like.
Both companies will be industry leaders in their respective areas of operation with a diversified geographic business footprint. I think we'll have two great companies that shareholders can invest in. Slide number 12. It's our belief that the cyclicality of titanium dioxide caused an undervaluation of Huntsman Corporation shares. We think the separation will allow equity markets to value our businesses more fairly and lead to higher independent valuation multiples of the different businesses. The separation creates two separate industry-leading businesses that will enable enhanced focus, resource allocation, and flexibility to pursue separate strategies and talent alignment. Our goal with the spin-off is to create a Huntsman-type company. We won't overburden it with debt or abnormal environmental liabilities or other items that may jeopardize shareholder value. Ultimately, we think both companies will represent attractive investments, and the separation will unlock shareholder value.
With that, I'll turn the call back over to Kurt.
Thanks, Peter. Janeda, will you explain the procedure for Q&A and then open the line for questions, please?
Thank you. Ladies and gentlemen, if you have a question, please press star, followed by one on your phone. If your question has been answered or you would like to withdraw your question, press star followed by two. Please press star one to begin. Your first question comes from the line of Laurence Alexander with Jefferies. Please proceed.
Good morning.
Morning.
I guess two questions. One, can you flesh out a little bit on how you see the pension costs possibly shifting in 2017, 2018? It sounds as if the pension will be retained at the Huntsman level. Is that correct?
You mean, Laurence, in terms of the spin?
Correct. Yes.
The spin companies carry with them the pensions associated with the businesses that are being spun. To your first question around where we think pension contributions will go, of course, we haven't got through the actuarial process yet, so we don't have specific numbers, but obviously interest rates have fallen in the last year in Europe where most of our liabilities sit. So we would expect that the required contribution would go up. This year, I think our pension contribution is about $90 million. My guess is that it'll be up significantly. It could be 30%, 40% increase.
Okay. For the volume swing in Polyurethanes, can you disaggregate that somewhat between the MDI component and the balance of the business?
When you say MDI components and the balance of the business.
Sorry. The Polyurethanes component within the pure Polyurethanes business within the Polyurethanes, as opposed to MTBE volumes or any other swings.
Okay. We'll have to look at that. If I just look at the MTBE in general, we did see a 5% growth over the prior year. Again, 8% of that growth was in the Americas, 6% of that was in Europe, and Asia was essentially flat. As we look within that number, we did see a slowdown in the appliances, but that was mostly because that's typically a lower margin for us. Our automotive composite wood and our construction insulation were all very strong year-over-year.
That was MDI, Peter was quoting.
Yes. Okay. Perfect. Okay, thank you.
Your next question comes from the line of Robert Koort with Goldman Sachs. Please proceed.
Thanks. Good morning.
Good morning, Bob.
I wanted to talk maybe sort of the strategy on the spin-outs. I guess I recognize the massive volatility in TiO2 maybe distracts from shareholders looking at the value of the core business, but you're still going to have the ethylene and MTBE components in there. Is there something you can do to moderate the cyclicality of those businesses so that it doesn't impair the valuation you might get on your higher performing businesses?
I think on the ethylene part, we're consuming over 1 billion pounds of ethylene as a company, in ethylene oxide and other ethylene derivatives. Of course, we consume a great deal of propylene as well, Bob. We are going to be subject to the cyclicality of those raw material costs one way or the other. The ethylene production that we have internally is about 400 million pounds of that 1 billion plus pounds of consumption that we have. It's low-cost production, ethane-fed production, and I think should that ever not be profitable to us, we certainly can shut that smaller unit down as we have in years past. While it continues to generate margin uplift and improvement for us, we'll continue to operate that facility. I don't see that really as a massive flywheel on the overall cyclicality and profitability of the company.
On the MTBE side, if there's some way that you could look at MTBE as just a standalone facility that was out from the rest of our portfolio, I think that we probably would have some more options there. Bob, as you know, that's a facility that produces MTBE as a byproduct of propylene oxide. I think we've tried to be, particularly starting about a year ago, as transparent as we could, educating investors as to what are the components of volatility there and what drives the MTBE markets. As tough as MTBE looks, as we look at this on a combined propylene oxide MTBE sort of a basis, I expect this year that our EBITDA margins in that PO MTBE combined business is going to be around somewhere in the mid-teens of an EBITDA to sales.
As we look at that, I would just remind you that when you look at MTBE, if you take that and you put it in with the propylene oxide, the downstream advantage that propylene oxide adds to the Polyurethanes business, I think it probably doesn't provide quite the volatility that it would appear when you break it out. Nevertheless, as you compare it to where we were a year ago, it is a volatile component of our earnings.
Peter, if I might follow up. I don't believe I heard on MDI, you talk about the opportunistic margins you might be making in the short run from some competitor problems. Is that just being diplomatic, or is that something you guys won't realize from a short-term basis?
I think that we've realized some short-term basis particularly on the Asian side of the business. As we said, most of our growth in earnings in Asia have come about through our downstream specialty side of the business. We're trying to take as much as a component, the more commoditized end of our Asian MDI business and shifting that over to the more specialty side of the business. I'm not sure that we've seen a huge uplift because of various outages that have occurred in the industry. I would expect some of those benefits to moderate perhaps in the fourth and first quarter over the course of the next couple of months here.
Bob, as it relates to an outage in Asia by one of our competitors, you remember that our Asian facility is running full out. When we look at year-over-year volumes in Asia, we were actually down a little bit. We weren't grabbing market share because of that outage. Certainly, polymeric MDI margins did rise year-over-year because of that outage and other reasons, but it wasn't a volume drill in Asia for us. We didn't grab market share.
Got it. Thanks very much.
Thank you, Bob.
Your next question comes from the line of John Roberts with UBS. Please proceed.
Thanks, congrats, Kurt, on the new CFO role.
Thanks, John. I look forward to working with the talented people of Pigments and Additives and Textile Effects more closely.
He's already harder to live with.
Peter, you're named on the board. Are you chairman of the SpinCo?
Subject to some final decisions and so forth. At this point, that is our plan going forward.
Okay. There's some language about being able to exchange the retained SpinCo stock for debt. Could you maybe elaborate a little bit on that?
That is just the, I think you've seen it, where there is an equity-for-debt exchange structure that can be used on a tax-free basis within a certain time period of the spin, and we will have the option to avail ourselves of that opportunity.
Okay. Thank you.
Your next question comes from the line of Frank Mitsch with Wells Fargo Securities. Please proceed.
Good morning, gentlemen. Let me also echo my congrats to Mr. Ogden. Also, in his new role, let me go ahead and ask a question. In the slides, you're looking at a normalized EBITDA level, I think of $500 million, of which 80% is going to be Pigments and Additives, so $400 million. What would be your estimation as to when you could reach normalized levels in that business? Obviously, TiO2 is trending upwards. I was just curious as to what sort of timeframe folks might want to think about there.
First of all, thanks, Frank, for the kind words. I think that as you have heard from us in the past, we won't put a timeline on when we expect to reach that normalization. Of course, there are a number of variables that will feed into our ability to hit that historical normalized profitability. That said, with the rise in TiO2 prices, that is going to be the primary driver which lifts this business to that. It'll be conditioned on the market environment that we find for particularly titanium dioxide. To the extent that that continues to be as strong as we have seen here over the last few quarters, then we would expect to get there sooner rather than later, but no specific time horizon.
If I can just add, as the old CFO, to those comments. What's interesting, Frank, and we've pointed it out over the quarters, that normalized EBITDA that we're showing is really based on an industry utilization rate of the mid-80s, which we're at right now. It isn't predicated on getting back to some sort of utilization rate threshold. We are already at that normalized utilization rate level today. It is really a question of how quickly will prices rebound over the next few years.
As the old CEO and perhaps the incoming chairman, again, I think that when we talk about that bridge as to where we are today and where we're going, if you just look at it on a functional TiO2 basis, if you assume that we're kind of running today on this annualized run rate of around $160 million. If you look at that uplift, you need about $500 a ton. I would just remind you that if we went back to first quarter of last year, which were pretty bad prices for TiO2 on average, globally, if we go back to where we were the first quarter of last year, you're halfway there from where we are today. We're trying to be very realistic here.
We're not saying that we need to go back to where we were a few years ago, anything close to what record peaks were. I do think that it's quite realistic. When you look at the pricing momentum that we've seen on average across the company over the last couple of quarters, we've seen a better than $200 per ton increase that we've realized just in the last two quarters.
All right. Terrific. That's very helpful, and I know that Kurt's going to say a lot more when he's just reporting to Simon, so I look forward to that. If I could just follow up on the MDI outage question. Peter, you mentioned that you're not seeing a ton of benefit in Q4, but is there a chance that as contracts reset in Q1, that that could be a source of upside for you or based on expectations of how long the outages will last on MDI?
You're talking about particularly in Asia?
Yeah, Asia and Europe. Yes.
Yeah. I would think that it might, but I'm not really counting on it. I'm counting more on the continued growth of our downstream differentiated, the 70% of our business, that drives on improvement of economics and margins, because of the value that it delivers to the customers. That's not to say that we're not going to push as aggressively as we can for margin expansion in the component side of the business. It is a smaller, volumetrically, it is a much smaller end of our business on the MDI side. Yes, we'll try to take as much as we possibly can.
All right. Terrific. Thank you.
Thank you.
Your next question comes from the line of James Sheehan with SunTrust Robinson Humphrey. Please proceed.
Morning. I want to talk about your very positive working capital performance. That's very impressive here. I'm just wondering if you could break that out between TiO2 versus Polyurethanes or Performance Products. How much of that is repeatable, with that sort of execution, especially after TiO2 is separated?
We continue to have initiatives in all areas of our business to reduce the supply chain. We will see incremental benefits, I think, over the next few years. I think we've made a pretty big step change here, and I wouldn't expect that in 2017 you'd see this sort of working capital improvement unless you see raw materials continue to fall. I would expect that we will have a fairly flat working capital view for 2017, again, assuming that energy prices stay at the levels they are today.
Okay, great. Peter, given your comments on polyurethane benefits you're seeing from outages maybe falling off over the next couple of months, what chance do you see of full year 2016 EBITDA getting back to 2015 levels, if any?
For MDI?
No, the entire business.
For the entire Polyurethanes business.
On your total Huntsman EBITDA, it looks like it may be falling short of 2015 levels at this rate. What is your view as to how much lower 2016 EBITDA will be versus 2015 right now?
I'd be giving a very specific number in the fourth quarter on guidance, given the volatility particularly around MTBE, I'd be reluctant to do that. I think that as we look at our fourth quarter, MTBE is a variable there. I think that we're expecting, as I tried to give division by division guidance of flat to perhaps seasonally down in some of the divisions and so forth. I think that on a relative basis on the typical seasonality of our MDI business, I think it's going to be stronger than we seasonally would see. Nevertheless, we will see a seasonal impact on most of our businesses.
Terrific. On TiO2 pricing, looks like you're continuing to push for more here. Given some of the comments of your downstream coatings producers, it looks like demand is fairly muted there. What are the prospects for getting a higher price in that type of environment?
I think we went over some of these same sort of concerns the last conference call when people were questioning if we'd be able to get any price increase, when some of the largest TiO2 consumers were saying that they weren't seeing price increases, nor were they accepting any price increases. I think we said last conference that every one of our customers were going to be going up. I think that as we see the needed economics in the TiO2 industry, the needed improvement of margins and cash flow generation, we also see the pressures of raw materials and ores that have gone up in the third, fourth quarter. I think that the environment is such that we are going to continue to push very hard to have margin recovery take place.
I'm quite pleased with what we've seen in the last two quarters of price increases. As I look at our average selling price globally in the third quarter, it's exactly where we were in the third quarter of last year, which were pretty tough, well very tough market conditions for us. Our business has improved on an annualized basis by nearly $130 million-$140 million, third quarter last year versus third quarter this year. A little bit of that's growth, a little bit of that's mix, but mostly all of that is due to the cost cutting that we've implemented. When we look at the selling price of TiO2 and the margin of TiO2, it still has quite a ways to go until we see any sort of margin that I think we would call anything close to normalized or even justifiable for reinvestment back in that industry.
Happy with where we've been, we've still got quite a ways to go.
Jim, maybe I can give you some near term guidance relative to TiO2 pricing. I think the coverage of coatings tends to be a little bit U.S.-centric.
The TiO2 price increases have been pushed off to the first quarter in the U.S. Non-U.S. prices will rise in the fourth quarter, and they will be substantial. Of course, with our mix of business, with a big European business, expect prices to rise sequentially third quarter to fourth quarter without a U.S. price increase.
Appreciate the help, guys. Thanks.
Thanks.
Your next question comes from the line of P.J. Juvekar with Citi. Please proceed.
Hi. Good morning. This is Eric Petrie for P.J.
Hello.
First question is on TiO2. Second, you commented that raw material or pricing pressure is occurring in third quarter and fourth quarter. Is that across the spectrum, or are you seeing more price inflation in chloride versus sulfate ore?
Our inventories right now, for Huntsman are, I would say that they're in the mid-40s, the number of days. The industry's probably in the mid-50s. When I say probably, there's no exact published data on that. Frankly, we don't track competitor inventories. I'm just assuming that that's pretty typical with demand and so forth. We are seeing across the board pressure taking place on the ore side. The volumetrically largest ore we buy, ilmenite. We've seen that go from $100 a ton and upwards of 120 to $140 a ton. On a contained basis, that ilmenite ore still is substantially more cost competitive to us than rutile or chloride slag or even sulfate slag.
I would also remind you that when we agree on a price, there's typically about a quarter, if not two quarters of time until we've accepted that price is the time that cost actually hits our bottom line. I think that we've got a pretty good supply chain of raw materials. I think we've got a very competitive supply chain of raw material, and we have time to be able to, I believe, implement price increases to offset those rising raw material pressures.
Just to put a dollar amount on that ilmenite increase. That 100 to whatever you said, Peter, $130 to $140 a ton ilmenite price. That's roughly a $10 million annualized increase in our ore costs.
Helpful. For my follow-up, do you expect overall MDI demand growth to slow following weakness noted by auto OEMs and appliance manufacturers, or are you tilting your portfolio to more specialty and consumer end markets to offset that?
As I look at our year-over-year improvement, a lot of what we're doing is the biggest area of growth that we're actually seeing globally in the automotive area for MDI is the biggest area of growth on a percentage basis is Asia. As you think of the Asian consumer buying a more quality-oriented car, a higher valued car, typically you're going to see a higher valued automobile, a better automobile, if you will, using MDI rather than TDI applications. We've seen double-digit demand growth in our Asian auto sector over the prior year. We've seen strong single-digit growth in Europe, and we've seen a decrease in the Americas. You're right. In the U.S., we are seeing a decline in demand from a year earlier, in the automotive area.
I think when you take the global picture of year-over-year automotive demand for MDI, we're up about 8% or so.
Thank you.
Your next question comes from the line of Hassan Ahmed with Alembic Global Advisors. Please proceed.
Hi. Good morning, Peter.
Good morning.
Peter, wanted to revisit the ilmenite ore sort of pricing dynamics. You obviously talked about pricing moving up to $130, $140 a ton from $100. As I sit there and look at some of the announcements coming out of China, in particular, the Chinese have come out and said that they're looking for aggressive sort of steel production cuts. In line with that, obviously, iron ore production is going to go down, which means magnetite production is going to go down. In theory, that should imply that one could see significant ilmenite production cuts as well. Is there a fear on your part that despite a $30, $40 a ton price hike, if these production cuts do take hold, ilmenite could move significantly up above and beyond the $30-$40 we've already seen?
I would think that there could be more upward pressure on ilmenite. As you think about ilmenite, it has about half the contained TiO2 raw material in it as some of the other slags and raw materials. When you talk about $130 per ton, you're talking like a $260 a ton competitive ore comparison to a 400, 450 sort of an ore. You're absolutely right. As you see demand for iron ore and the steel industry go down, you are going to see the amount of ilmenite ore, which is a by-product of the iron ore, you'll see that tighten as well. I would remind you that we source our ilmenite from Africa, from multiple continents and so forth. I think in comparison to the other ores ilmenite's going to continue to have a very much of a cost advantage to the other ores.
As I look at the inventory that is on hand, I look at the number of suppliers around the world of ilmenite ores versus chloride and various slags and so forth, I think that ilmenite's going to be the cost leader and the preferred raw material for some time to come.
Very good.
I think, Hassan, just if I could add, I think Ilmenite producers have been producing at below their marginal cost. It's been pretty tough market for them. So they're getting really back to kind of a break-even level. I don't think that this price pressure on ore is going to be unique to sulfate ilmenite ores. I think there is an expectation out there in the marketplace that higher grade ores for chloride will likely move up with TiO2 pricing.
Understood. Moving on to the TiO2 pricing side of things. You guys mentioned sequentially Q3 to Q4 you will see decent price gains in the non-U.S. markets. What should we expect as far as the U.S. market goes? Should we expect sequentially flattish pricing in the U.S.?
Yes.
Perfect. Thank you so much, guys.
Thank you.
Your next question comes from the line of Kevin McCarthy with Vertical Research Partners. Please proceed.
Yes. Good morning, gentlemen. Kimo, would you comment on any expected tax-related synergies or dyssynergies as you proceed with the spin domiciled in the U.K., please?
Sure. Welcome to the name, Kevin. It's good to have you back.
Good to be back. Thank you.
I think from a spin standpoint, notwithstanding a domicile that will be U.K.-based, we wouldn't expect any sort of inversion type benefits with that transaction from a tax standpoint. The taxes in aggregate for the two businesses will look an awful lot like they do on a consolidated basis. Now, of course, there are NOLs associated with the countries that TiO2 manufactures in. They will enjoy those benefits going forward just like they do today.
A second question, if I may, on cash flow. Looks like your CapEx is coming down, maybe pension comes up a bit. I recognize it's early to comment on 2017. As you look into the crystal ball, do you have reason to believe free cash flow would be materially better or worse, were it not for the spin-off, if I look at Huntsman standalone?
If you look at sort of Huntsman together as a consolidated entity relative to 2016, I think we're not going to have the same working capital benefits in 2017 that we had in 2016. I think generally you pick your EBITDA at $400 million of CapEx. I think we're going to have a lot less restructuring and a little bit more pension. I think we're still going to have substantial free cash flow, it won't be at the mid $500 million level that we're at today because of working capital.
Understood. Thank you very much.
Your next question comes from the line of Ivan Marcuse with KeyBanc Capital Markets. Please proceed.
Hi. Most of my questions have been answered. Just have a couple of quick ones. If I miss this, I apologize, where MTBE stands today, in the fourth quarter, what would be the year-over-year headwind?
I think that we'd see MTBE on a year-over-year basis would be south of where it was in the fourth quarter. I think on a sequential basis, again, if C factors remain where they are today, it would be a few million, singular million dollars worse in the fourth quarter than in the third quarter.
Ivan, the comparison period, fourth quarter 2015, MTBE made $5 million. Of course Peter's referencing that negative $1 million into the third quarter.
Okay, great. If you look in the performance of the business, say you sold the $24 million in EBITDA, is there any sort of seasonality to that or would that be pretty much flow through at a pretty equal level through the quarters? Will that be in discontinued operations in the fourth quarter?
No, it won't be discontinued. It's a fairly stable business, not lots of seasonality other than the typical European December that you usually see.
August and December.
Yeah.
Then with the 225, is there any tax leakage?
Little bit. We should net $200 million after taxes and transaction costs.
Okay, great. Thanks for taking my questions.
Operator, why don't we take one more question? I think we're coming up to the top of the hour.
Your next question comes from the line of Roger Spitz with Bank of America. Please proceed.
Thank you very much. Good morning. I know it's early days. Would SpinCo likely raise debt and give a dividend back to Huntsman Corp upon the spin? What might you think SpinCo leverage and ratings might be?
We're just going through that process now, Roger. In the Form 10, we really didn't discuss the capital structure. That will come in the coming weeks from an amendment to that Form 10. What we have said is that it will be modestly capitalized, and maybe the right way to think about it is roughly what Huntsman Corporation is today. If we're at three and a half times leverage, maybe that's the way you ought to think about SpinCo. There will be some modest amount of debt, bonds and bank, and Huntsman Corporation will receive that dividend back. In addition, as we've mentioned, Roger, we will have a retained interest, and we are asking the IRS for the opportunity to have a greater than a 20% retained interest in SpinCo upwards, as Peter said, of 40%.
The use of proceeds as we divest of that retained interest will be used to continue to pay down debt at Huntsman Corporation. There's really two means by which we will receive proceeds from SpinCo, both debt incurrence at SpinCo at the time of the spin and in subsequent sell down of our retained interest.
Thank you for that. Lastly, just the missing MTBE for Q2 2016 EBITDA.
Q2 2016 MTBE EBITDA is $19 million.
Perfect. Thank you very much.
Good talking to you, Roger.
Jeneda, this is Kurt. We want to thank everybody for joining us on the call this morning. To the extent that you have additional questions, please feel free to reach out to the investor relations team. Thanks again.
Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.