Good morning, and welcome to Olin Corporation's third quarter 2020 earnings conference call. All participants will be in a listen-only mode. Should you need assistance please signal our conference specialist by pressing the star key followed by zero. Following today brief opening comment there would be opportunity to ask a question, to ask a question you may press star then one on your touch-tone phone. To withdraw your question please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Steve Keenan, Olin's Director of Investor Relations. Please go ahead, Steve.
Thank you, Grant. Good morning, everyone, and thank you for joining us today. Before we begin, let me remind you that this discussion, along with the associated slides and the question and answer session that follows, will include statements regarding estimates or expectations of future performance. Please note that these are forward-looking statements and that the actual results could differ materially from those projected. Some of the factors that could cause actual results to differ from our projections are described without limitations in the risk factors section of our most recent Form 10-K, the Q3 2020 Form 10-Q, and in yesterday's third quarter earnings press release. A copy of today's transcript and slides will be available on our website in the Investors section under Past Events. The earnings press release and other financial data and information are available under Press Releases.
With me this morning are Scott Sutton, Olin's President and Chief Executive Officer, Pat Dawson, Executive Vice President and President of Epoxy and International, Jim Varilek, Executive Vice President and Chief Operating Officer, and Todd Slater, Vice President and Chief Financial Officer. We will begin with brief remarks, and thereafter, we will be happy to take your questions. I'll now turn the call over to Scott Sutton.
Yeah. Thanks, Steve, and hello to everybody. I've been Olin's CEO for a couple of months now, and I can tell you that I'm just plain lucky to be here in this great company and working with this passionate team. In fact, I'd ask you to watch carefully what this team is going to do with this company, as it will surely be exciting. My role is to lock arms with this team and win our way back to a much higher equity value. Let me start my comments with slide number three in the presentation and an update on market and business fundamentals. Look, I would say the summary is that global industry fundamentals are still intact, though currently pressured by COVID-19. In our chemicals business, the supply-demand balance is expected to push back toward demand as only limited meaningful supply additions are foreseen on the horizon.
In fact, 80%-ish effective industry utilization rates with a sophisticated player is a really good place to be as long as that player is focused on driving value. We are that player. We're going to be that leader. For example, competing in a way that represents the value we bring to the market, as we will discuss further today. In our Winchester business, demand in the U.S. far outstrips supply because of long-term positive demand attributes. Sporting participation, new firearms owners, and self-defense readiness is way up. Military programs have multi-year growth needs under long-term commitments. We are the absolute small-caliber ammunition leader. In fact, I'd say that under John Fischer's leadership, Olin has built undisputable number one global leadership positions in every single business, chlor-alkali, Epoxy, and Winchester.
When you break down the businesses into specific sources of value, the list of number ones expands to numerous product and geographic positions. John and the team did that. The necessary spending to complete that building process of approximately $1.4 billion for IT, ethylene payments, and transition cost is done. It's finished. What is next for Olin? Well, we are leaping from building to leading in terms of value. Building to leading. I'm moving to slide number four now. The next step in that evolution takes off today. Our value is not determined by industry trade indices or other items like asset utilizations and changes in input cost. Those may well be influencers, but they will not be main drivers of Olin's value. We are more eager to talk about and implement our own Olin initiatives to create main drivers.
We're committed to showing outcomes from those initiatives too. That means financial outcomes as well. We are accelerating the implementation of an Olin-unique winning model. All of our initiatives will evolve principally around two foundational elements. Number one is exercising and getting value from our undisputable leadership positions as Olin is critical in this world. Number two is driving and prioritizing productivity from a large, motivated, and engaged employee base. Some new things that you should look for from our winning model, particularly from the number one foundational element of exercising our leadership include that we will start talking about how Olin can increase the value of the ECUs it sells, and we will measure that through an Olin ECU Profit Contribution Index. This type of ECU metric is the best indicator of our success. It's really the number one indicator of our success.
That's what Olin does, increases returns on ECUs, and we are the clear global leader. Merchant caustic soda is only one element of our business, maybe up to 25% by sales, thinking prospectively. In fact, really as a side note, caustic is certainly not a singular driver. There are no independent caustic dynamics. If the caustic market quality is exceptionally poor, we might back down caustic and change our trading and inventory mix, resulting in slowing chlorine chain sales in order to maximize the Olin ECU value as we proactively manage our landscape. We will be sharing that ECU Profit Contribution Index with you quarterly. In fact, take a look at slide number five now.
It will represent the unit contribution value of chlorine and caustic soda through our complete and broad derivative chain, even including Epoxy, and of course, including merchant sales of chlorine and caustic too. Our index will be used to set an ever-rising floor on the unit ECU profit we will accept. It is the number one marker of us resetting business value and exercising our leadership, and it covers about 75% of this company's total business. A companion discussion is that unfortunately, some industry trade indices have come to be thought of as leading indicators of our business. We plan to make them a trailing indicator only as we control our own destiny. We will do this by shifting more of our business to be based on a freely negotiated basis and negotiating directly with customers for our value.
We just don't feel the industry trade indices represent the full value we will transact at. Our view of a timely example of this is the miss of the North American chlorine pricing by an index here over the last month. This unwinding from some industry trade indices gives us more ability to positively control the Olin ECU Profit Contribution Index. As a point of reference, in Q3, we sold some rail car chlorine at the highest price since 2003, we lifted some spot EDC pricing by more than 10 times the Q2 low price. In early Q4, we just asked for and received the largest Winchester commercial ammunition price increase in many years. This comes on the heels of two other successful commercial price increases this year. What's the expected outcome from our new unique winning model? Well, this is on slide number six.
Of course, we're thinking in terms of multiples of our current equity value. In terms of 2021, you should expect us to target an EBITDA margin roughly in the mid-teens composed of the following elements. One is an expected $100 million of improvement from confirmed items. That is our Lake City Army ammunition contract and operation and a new VCM deal. Another expected $100 million of improvement over 2020 from not repeating the second quarter COVID shutdown. Additionally, we expect up to $100 million of net, and that is net, productivity savings as our gross actions more than offset inflation pressures. The big one is up to $200 million expected from our acceleration of leadership activities, as I just previously described.
Our levered free cash flow, that's after all of our capital spending, it's expected to be quite positive, somewhere between $2 and $3 a share. I'd say at today's stock price, it's a huge return. We mean for every business to deliver in 2021, and every business is positioned to do so. With that introduction, I look forward to your questions on these next steps and how we will be controlling our own destiny and how we will significantly lift our equity value. That completes the opening comments.
We will now begin the question and answer session. To ask a question you may press star then one on your touch-tone phone. If you are using a speaker phone please pick up your handset before pressing the keys. To withdraw your question please press star then two. This time we will pause momentarily to assemble our roster. Our first question will come from Hassan Ahmed with Alembic Global. Please go ahead.
Morning, Scott, and congratulations on the new job.
Thanks, Hassan.
Question around strategy. Appreciate some of the color that you gave in your earlier remarks. Can't help but sort of think about your past life and your time at Celanese and the sort of similarities between the acetyls chain and the chlorovinyls chain in terms of oligopolistic nature and the like. As I sort of sit there and think about the evolution of the acetyls chain, there was a step change in profitability over there, call it from 2011, 2012 onwards. If one thinks about some of the strategic changes that were implemented, I broadly think about four silos. There was utilization rate management that was exercised, doing more with the network, as you guys used to call it, feedstock optionality and commercial flexibility. It seems all of those things are pretty applicable to chlorovinyls, and it seems that that's the direction you guys are headed in.
Is it fair to assume that each and every one of those things can be hit and this $50 million-$200 million number that you're talking about in terms of exercising your leadership position, over the long run, actually could be far greater than that?
Thanks, Hassan. I guess what I would say is, look, we're going to go out and lead with this winning model, right? You described some parts. The main feature of it is we're going to exercise our number one positions. How are we going to do that, right? We're going to be interacting with global supply demand. We're going to be impacting our own global supply demand, and that means we're going to be surging inventory when it's appropriate, releasing inventory when it's appropriate. We're likely to do more trading as we reach into pockets of global liquidity that are already out there. We're not going to be selling into poor quality markets. When we do that, we're going to be overlaying a price increase, and that lets us open and close arbitrage windows.
That's the main elements of how we're going to go out and manage our landscape. Hassan, underneath all that, we'll certainly have rigorous commerce. We use the terms edgy commerce in here to make sure we get the next or the best price that we can get and get the best deal in place at every customer. Overlaying all this in the future, you'll hear us talk about using forward intelligence. You can think of it as AI almost to predict the best point that we should run at. Where are we going to set our ECU knob and know that three months in advance. It really contains a number of elements, right? You've got that umbrella of where to set our ECU knob, how we manage our landscape, and then our edgy commerce activities. That's what it sets up for. In the future, Hassan, I expect it to bring more than the numbers we've quoted.
Very helpful, Scott. As a follow-up on the near-term side of things, obviously you touched on the chlorine price hike that has been announced. Question is that how sustainable do you think in the near term that price hike is, keeping in mind some facilities in the U.S. coming back online and then chatter about a Brazilian facility on the chlor-alkali side coming back online as well? Part and parcel with that, as we're talking about some of the pricing moves on the raw side of things, how are you guys thinking about the recent move up that we've seen in natural gas prices?
Yeah. From our side and for our business, right, I think the sustainability and materialization of that chlorine price increase are good. If you looked at our portfolio, certainly in our small amount of spot business, we've achieved it, both price increases and more. Where we have contracts that negotiate every month, I would say that we've generally achieved it as well. Some customers have not picked up all the volume they normally do. I would say even further evidence of that, Hassan, is that where we have contract business on an index and we have caps on the amount we have to supply, we're actually able to get some premiums up on volumes above those caps. For us, it's really sustainable. As far as your second part of that, where does natural gas take us?
Out of all the inputs, this is the one that we have to go out and recover, and I think this model lets us be able to do that.
Very helpful, Scott. Thank you so much.
Sure.
Our next question will come from Mike Sison with Wells Fargo. Please go ahead. Mike, your line may be muted on your end.
Yeah. Sorry, guys. I apologize about that. Scott, welcome back, and look forward to working with you. In terms of exercising your leadership position and correlating that with the ECU contribution index, how do we think your variables or your actions will change depending on where that index sort of lies?
Yeah. Well, thanks, Mike. Of course, our intention is to steadily move that index up over time. Yeah, there could be some quarters where it flattens a bit. The reason it's the number one indicator of our business, it represents value per unit more than anything else. Clearly, there's multiple things that go into our value equation. You have the unit contribution, which this index represents. You have our volume, and you have our fixed cost, right? We can talk about what we're doing on fixed cost and productivity in a bit. Jim will comment on a question on that later. We'll be watching volume carefully. Once you lose unit contribution across something that represents such a large part of your company, it can take you months and years to recover it. Here's what you should expect us to do, Mike.
If some part of our whole ECU value chain, whether it's on chlorine derivative side or the caustic side, is showing bad quality out there in the marketplace, we're very likely to withdraw, right? Slow down inserting material into such a bad quality market for us. Therefore, the repercussions of that will be that it'll likely shorten us on the other side, and we'll have to decide what derivatives we're going to put it in, and we're going to put it into the derivatives with the best opportunities for Olin. That's one way that it'll guide us.
Got it. When you think about that $50 million-$200 million, those are drivers for 2021, right? What do you think that potential is over a cycle over the next five- six years? It doesn't seem like there's any major capacity coming on. Maybe your thoughts there over the next several years?
Yeah. Here's what I would say to that, Mike. First of all, global dynamics only get better, right? Demand is going to continue to increase. There's no meaningful supply coming online. Therefore, the application of our unique model only gets better as well. As far as where we're going, I would just refer back to our investor day at the start of 2019, where we said we had a couple clear milestones being $1 billion of EBITDA, $1.5 billion of EBITDA, and then $2 billion of EBITDA that we will pass within the timeframe that you asked about.
Great. Thank you.
Sure.
Our next question will come from Kevin McCarthy with Vertical Research Partners. Please go ahead.
Yes, good morning. Scott, I was wondering if you could address your go-to-market strategy around the ECU in some practical terms. For example, would the mix of contract versus spot business change? To the extent that you have contracts, would the percentage link to benchmark assessments go down? Finally, what do you think, or what are your initial thoughts about price protection? It seems that convention in the industry has been that many large buyers enjoy quarterly price protection. What do you think about quarterly versus monthly versus spot?
Thanks a lot for the question, Kevin. What I would say that, those three things that you asked about, they will absolutely all evolve to being much more open and much more freely negotiated. In order to be effective to run this kind of model, we've got to have knobs that we can turn that are totally under our control every day, right? It's an essential component of that. Today, we're much too heavily weighted toward having contracts that are tied to perhaps an external indices. We're going to be working to reduce that, right? We're going to try to even pull forward some of that work because we have the ability to trade getting control over that knob today for giving customers security of supply out in the future.
That allows us to open up contracts that you might think that we couldn't otherwise open up. As far as our sort of go-to-market strategy and view, I'd just like to point out that this is not just a commercial business strategy, by the way. It engages the whole company. You may have heard me during the first Q&A that we had talk about all those activities it takes to effectively manage our landscape and interact with global supply-demand in a positive way. It takes every support team in this company to be coordinated on that. The real business that we're running here is lifting peoples and teams and connecting them to this winning model.
That's very helpful. Secondly, if I may, would you comment broadly on your expectations in the fourth quarter as it relates to seasonality against the current market backdrop of many supply dislocations across the industry. How do you think volumes will play out relative to a normal seasonal pattern?
Yeah. I would echo a little bit about what we put in our press release. We're going to see a little bit of that. That's not honestly a real big factor. I think the bigger volume factor is that we're choosing not to participate in a poor quality market there, certainly for caustic or participate as much as we normally might would. That's going to be the bigger volume hit to us than probably the inventory reductions are at end of year. It's not bad in the fourth quarter in terms of supply and demand.
Mm-hmm. Okay, thanks so much.
Yeah.
Our next question will come from Frank Mitsch with Fermium Research. Please go ahead.
Yes. Good morning, Scott, and let me echo the congratulations on the new role and the chance to reconnect.
Thanks, Frank.
Yeah. Clearly, fairly traumatic changes with respect to how chlorine is treated at Olin. I was wondering if you could update us on your ability to flex between captive and merchant on chlorine. With respect to merchant, some of it is railcar, some of it is pipeline, and I'd assume that on the pipeline side might have more price protection. Is there any way that you can kind of quantify some of these metrics here so we can understand how some of the new changes on chlorine pricing actually will flow through for Olin?
Sure. I'll start, and Todd might want to join in here a little bit. For chlorine, we're heavily weighted today on contracts that are tied to an index, and we have a good bit of business that goes into pipeline. I think we've shared before that if you think about merchant chlorine, it's around 1/5 of our total chlorine. On the large part that is railcar chlorine, which by the way, rail capacity is certainly a limiting factor right now out there in the marketplace. We have and are gaining every day more flexibility. If the merchant world doesn't look good to us, we have the ability to push that back through a number of derivatives all the way out to the end of our Epoxy chain. I'll let Todd comment now.
Scott, I would echo the comment about chlorine by rail is very tight in our system, and you can see that by lead times that we've implemented over the last month and a half, and the requirements related to that. I'd say chlorine by rail is especially tight, Frank.
Got you. Understood. Just coming back to the upside here in the third quarter that you announced. We'd imagine that some of these indices that you've talked about are showing caustic having declined in the third quarter and an expectation that'll actually happen here in the fourth quarter as well. Your contracts are with a lag. Any way to quantify the benefit in terms of the lag that you saw in the third quarter and kind of what your expectations are for caustic price realizations in the fourth quarter in the Olin system relative to the third quarter?
Yeah. I don't know that I have a specific number for the benefit. You're right. We do get a little bit of lag there. There's some level of benefit. I would also, speaking about the fourth quarter, I would just refer back to our earlier discussion a little bit there that it's not about a singular product. Almost don't care. It doesn't matter because we're going to run our model just like in the fourth quarter, such that we have a lot of places to get value from. One of the ways we generate value is not selling into a poor quality market. The more the quality decreases, the more we're going to turn that knob. It's not significant.
Got you. All right. Thank you. Thank you so much.
Sure.
Our next question will come from Vincent Anderson with Stifel. Please go ahead.
Yeah, thanks. Good morning, everyone. When I think about the $50 million-$200 million target, how are you thinking about the near term balance between maybe some additional SG&A for those direct negotiations, incremental capital for inventory management infrastructure, fixed cost coverage things like that, kind of relative to what you see as easy wins in the near term?
Yeah, sure. Jim's going to answer the bulk of this question. I would just say that we have broad opportunities across all those buckets for productivity, and it's many small things that are going to add up to a big thing, right? Internally, I like to say we're masters of the small on this, but I'll let Jim answer this.
Sure. Yeah, I would say that your comment on adding SGA to have these capabilities and so forth, and quite honestly, we'd probably be working at getting more efficient rather than adding and still being able to cover what we need. From a productivity standpoint, we actually have very well-established programs here at Olin. Every division, every function, every site has productivity goals and objectives for not only the coming year, but has had the past years. In fact, just a point of reference, we actually have 1,127 active projects across the company all geared towards driving productivity and getting our fixed costs and our costs down to be able to make sure that we can pull that lever and deliver on that $50 million-$100 million net productivity objective that we have. We do have momentum on productivity.
Things like you've heard about our vinylidene chloride asset closure, the chlorine closure that we announced about a year ago or so, epoxy novolac plant that's closing as well. We have a number of projects and so forth that'll deliver momentum as we head into 2021. Some are large, some are small, but they all add up at the end of the day. We feel confident about that $50 million-$100 million.
Thanks, Jim. That actually answered my next question, so I'll try a different one here. When you think about your position in kind of globally traded EDC volumes, I'm just curious to see, do you see that as a particularly attractive near-term opportunity to maybe smooth out that volatility through your commercialization changes? Do you have a house view on non-integrated PVC expansions that would largely solve some of that volatility through higher demand?
Yeah. I guess as an umbrella statement, right, because we're doing broad portfolio management under a unique model, generally speaking, any volatility up or down is going to be good for Olin, right? We're going to be able to take advantage of that. Specifically for EDC being the largest merchant player there, yes, we are able to provide a number of activations out there to get the right value. We are getting value from that, and we expect to continue to get some more value from that. What I will say, you brought up sort of the PVC demand versus caustic and so forth. If you think about our configuration right now, we're not participating in an optimal configuration, right? PVC is exceptionally strong, which of course is spitting out a lot of caustic, and we are a smaller participant in the chain to PVC.
I guess the reason I point that out is because it's a real testament to how we're starting to run the company and how we're running our model right now today, because we're doing okay even in that dynamic, which isn't our best dynamic. We're able to do things with EDC. We had the discussion earlier on chlorine, and there are some strong parts there in other thermosets and thermoplastics that it goes into, and the inorganics as well. Yeah, that's how our model's got to work.
I appreciate the detail. Thanks again.
Sure.
Our next question will come from Eric Petrie with Citi. Please go ahead.
Hi, Scott. Good morning.
Hi, Eric.
Olin acquired the Dow Chlorine Products business to expand their chlorine envelope. Where are you thinking that value could be uplisted and captured from those downstream products? What currently now is, in your view, poor quality or low economic return?
Yeah. I would say that it's going to be across the entire portfolio, right? There's been a lot of effort and money and sweat by so many people to put this company together that we don't have to go out and build anymore, right? We don't have to pump a lot more money into that building process. We have a game plan to start leading using what's already been built, and that's going to be our game plan until that ECU Profit Contribution Index gets to whatever, 1.5 or two. We've got to get up in that range to match what we said we'd do at Investor Day, and we're going to do it. As far as areas that we're lifting merchant chlorine is fundamental to this company. You see us out there doing that. That's going to push along and drive many things.
In fact, all the way through our Epoxy business, which I'm going to ask Pat to comment on here in just a minute. Our Epoxy business is one of our downstream businesses that is subject to this chlor-alkali ECU winning model, and also has its own similar landscape management model built in around epichlorohydrin and Epoxy. Epoxy, to your question, is one area that we can absolutely lift margins on. I'll ask Pat, will you comment a little bit on that?
Sure, Scott. Can you hear me?
Yes.
Like you were saying, just a little bit of the lead in around epichlorohydrin. We're the only producer of epichlorohydrin now in North America, and of course, we have a major leadership position on EPI in Europe as well. EPI is really critical to strategically what we're trying to do with our Epoxy portfolio, and then how we monetize that EPI in the form of liquid epoxy resin, solid epoxy resin, and other ways we can sell those epoxy resin equivalents into the downstream. Back to the plot here of not selling into low return segments applies to Epoxy just like it does in the rest of the portfolio.
Driving productivity, Jim mentioned we just made the announcement to shut down a Novolac plant in North America, which wasn't productive, and we have other ways to still participate in that market, but in a more productive way with our asset capabilities in Europe. I think through EPI and how we monetize that EPI into various channels where we select having a sharper edge on where we sell the EPI and the liquid epoxy resin is exactly what we're going to do.
Thanks, Pat.
Great. Thank you. My follow-up question is on the leadership position bucket of $50 million-$200 million. It's quite a bit of a range. What is your view on industry conditions in the ECU? Chlorine is beginning to increase in price, which leads recoveries, and then caustic soda typically bottoms within a quarter to two. Consultancies still expect price degradation in caustic soda into next year. What is your view and do you agree with consultants or do you take a different stance?
Well, yeah, thanks for the question. My view is that our ECU value is going to go up, right? No matter what. That's how we're going to run our model. Look, I'll certainly acknowledge that we need to continue to give our model more tools and more degrees of freedom. That takes just a little bit of time to get in place. Even with the degrees of freedom that we have today, right, I'm confident that we can make ECU values move up. I think the proof will be in the pudding in our ECU Profit Contribution Index, which is that measure of all variable margin for all our products that use chlorine or caustic divided by our total volume of ECUs.
I think to some extent, we're having to prove that a little bit here in the fourth quarter, because I acknowledge that caustic is moving down in the public indexes, and we haven't built a plan for next year that's only based on caustic flattening or going back up, right? We built a plan that's based on a model of portfolio management, where we can work through any situation and make some of those valleys much higher than they otherwise would have been, and make some of those peaks much higher than they otherwise would have been, and also sort of shorten the distance between valleys and peaks as well.
Thank you.
Yep, sure.
Our next question will come from Mike Leithead with Barclays. Please go ahead.
Great. Thanks. Good morning. Scott, welcome.
Thanks, Mike.
I do want to go back to the chlorine conversation and the pricing dynamic. I guess my understanding is, call it roughly a third of your chlorine goes to Dow, which I assume there's not really much pricing flexibility there. Another third goes into what I would call more pure global commodities like EDC or liquid epoxy resin, where I think pricing power is probably a bit challenging on your own. The remaining third, potentially you can drive more value, whether it's merchant chlorine, EPI that you mentioned earlier, or chlorinated organics. Am I kind of thinking about that bucket of opportunity correctly, or kind of where among that chlorine envelope do you think you can drive the most value, per se?
Yeah, Mike, that's not too bad, but I would just add a little bit to that. While it's not a whole third. Right. It's not far off that goes to one single consumer that is more cost-based. We've sort of taken that out of the equation. It's not even represented in our ECU Profit Contribution Index. It's basically the only thing that's not really represented there. You get to the other, call it at least 70%. We've recently proven that we're able to materialize price increases there. In many cases, we've gotten both of our price increases. We had announced $80 a ton, and we followed it up by $100 a ton. That's on the business that is open. It works. The other part, a little bit to your point, is that we're priced on index contractually, right?
Unfortunately, that index completely missed the run in chlorine here that's going to continue. That goes back to some of my opening comments, and yeah, that limits us today, right? We're going to be working to make sure that that misrepresentation no longer takes place.
Got it. That's super helpful. A question for Todd. A bit of a technical question, but I think important. Could you maybe clarify how you're treating or accounting for the delta between what you believe Oxy contractually owes you under your chlorine arrangement and what you've been getting paid? I know you won't comment on the litigation, but I guess, has that amount been fully included in adjusted EBITDA? Have you taken any bad debt allowance on that?
We would not comment on the amount other than to say we think we've recorded the dispute between Olin and Oxy appropriately. Obviously, any resolution associated with that dispute could only be positive from a cash flow perspective as we go forward.
I guess just from an adjusted EBITDA perspective, that $80 million last year, was that included or was that not included?
From an adjusted EBITDA perspective, I'm not sure where $80 million would come from. I think directionally, the annual dispute is in the $50 million range.
Mike, just to make sure it's clear. We recorded that where we think it should be, I guess is the thing we would say. I do want to clarify, I think Todd said exactly the right thing. Win or lose that, it's only cash positive for us. Win or lose that, it's only cash positive for us, just to give some perspective around it. We haven't said much more than that about it.
Right. That's what. Thanks you, Scott.
Sure.
Our next question will come from John Roberts with UBS. Please go ahead.
Thank you, congrats, Scott, and welcome back to the public company quarterly earnings call.
Yeah, thanks, John.
It was unclear to me if the ECU profit contribution includes variable margin on ethylene, since your contracts are based on cost, not market price of ethylene. Obviously the margin on ethylene is going to go up and down with energy prices?
Yeah. John, it includes the variable margin of any product that we sell that uses or starts with chlorine or caustic. Let's take EDC as the example. It's the one that uses most of the ethylene. You look at the sales revenue of EDC less all the variable cost of which ethylene is one component of that. That is the total variable profit that goes into the index.
Yeah. I guess I'll go through it a little bit more offline as well. Secondly, if you look backwards to the second quarter where this variable margin index dropped to 92.7, do you have in mind a pro forma level that the new approach might have held it to? What might you have done back in the second quarter to not drop down to 92.7?
John, it's a little bit of a hypothetical question. I would say, just look at third quarter as an example. We were able to move it back up. The other way I would try to address your question is that until that ECU Profit Contribution Index gets up to around 1.5 or 2, we're not running this business at a place that represents reinvestment economics. Our model has a lot of potential to really pull that up. That's pretty substantial, John. If you think about raising it to 1.5, it being 75% of the company's business, that means we have to increase our variable margin by effectively 50% to get it there across all those products. I don't know that I'm answering your question or not.
No, that's helpful. Thank you very much.
Okay.
Our next question will come from Aleksey Yefremov with KeyBanc. Please go ahead.
Yes, thank you. Good morning, Scott, congratulations and good luck. Just to come back to your 2021 EBITDA drivers slide, you show $50 million-$200 million opportunity for exercising leadership positions. How do you think about caustic soda scenarios in that bucket, roughly? Something similar to the price level that we see today, improvement or potentially further deterioration? I know you think of it as a system, caustic has pretty high sensitivity to your numbers?
Yeah. Thanks for the question. I'll answer your question specifically, first I'll sort of say, I don't know, it doesn't matter almost. Caustic could end up in a number of places within reason, because we're going to thrive on that volatility and lead with this winning model of exercising our number one positions across our whole portfolio, that we'll come out with a good outcome. I guess to be more specific on your question, if it stayed where it was to today, clearly we're in great shape. We've just started really implementing this model and practicing it a little bit. In September there, it was a great month for us, and I'm really proud of the team, not just the commercial team, like I said before, but the whole company for really attaching to it.
I would say we have miles and miles of runway to get better at this. I'm just trying to put it in perspective. If caustic just stopped where it is today, I'd say we're golden, right? Do we expect a little more decline? Yeah, there's going to be some decline here in the near term.
Thank you for that. Coming back to chlorine, can you give us some sense what percent of your merchant chlorine business is tied to the indexes, and how long it might take to get away from that? Are we looking for maybe one year, a couple of years, or something longer?
Yeah. I probably won't give you an exact number, but maybe you can hypothesize what it is from that. My answer is way too much, okay, is tied to the index. As far as how long it's going to take us to work our way out of that, we are working on it hard today, and I expect as we go through 2021, we're going to get a chunk unwound, and we'll still have part of it tied to an index in 2022.
Thank you.
Okay.
Our next question will come from Steve Byrne with Bank of America. Please go ahead.
Hi, morning. It's Matt DeYoe on for Steve. Operating rates in the U.S. aren't actually tight for much of these products. PVC maybe aside. You bust up the contracts and you're no longer on index, and you start moving price where you can. How do you expect competition to respond to this? I would imagine they're not going to sit back idly and kind of let you get away on the margin end. I realize a lot of chlorine can be a local market, and so there's a lot of the commentary relating to just the merchant opportunity and turning leverage where you can, where you don't have much competition, because given so much of its kind of pipeline in a very competitive Gulf Coast, I would think there'd be kind of natural buffers with competition?
Yeah. Thanks for the question. I won't comment on what competition might do. I would just sort of put up a few points here. Number one is we're the leader in chlorine and derivatives, and we're critical to the world. It doesn't matter what the operating rate is, we're critical to the world. That's the first point, I would say. The second point I would offer is that effective utilization rates are quite different than nameplate utilization rates. And when you have assets and maybe others face the same that haven't necessarily been fully invested in or certainly don't meet reinvestment economics, that that effective utilization rate really becomes the nameplate operating rate. I would just contend a little bit that ECU operating rates are a bit tighter than you might think. Again, demand is okay there.
In organics, if you think of titanium dioxide and bromine, it's all okay. Polyurethanes and epoxies as well. That's how I'd respond.
Understood. If I were to think about maybe three- four big opportunities you think you have in your back pocket to drive growth, I know you mentioned Epoxy being one, or, sorry, EPI being one, but perhaps other things that we're not thinking about as it relates to what can be kickers on EBITDA over the next two years?
Well, in the next two years, it's all about growth in ECU contribution profit, right? We have some opportunities for volume growth, it's not about volume growth, right? We lead in volume. We can get volume any day that we want to get it, right? It's all about growth in unit profitability, because that's the number one thing we need to be the value player and be the value leader, right? Some of those things that are certainly solid growth in volume is Epoxy and Pat spoke to that earlier, you look at some of the applications we sell into, right? Like turbine blades, right? Blades on the power generation windmills, right? We're probably the Epoxy in one of every three of those that's in the world, that's definitely a growing segment for us as an example.
I would say some of our chlorinated organics that go into next generation refrigerants are a good source of growth for us. Perhaps the number one source of growth for us is in small caliber ammunition. There's great positive fundamentals there on both the military side and the consumer side as well, as participation is way up. Just as an example of that, more people are now doing shooting sports and target shooting than they're fishing, than they're camping, than they're golfing, whatever the case is. That's a long-term fundamental that's driving demand right now, and it's where we have our biggest backlog in the company by far.
All right. I'll leave it there. Thank you.
Okay. Sure.
Our next question will come from Matthew Blair with Tudor, Pickering, Holt. Please go ahead.
Hey, good morning, Scott. I had a question on the new model here. It definitely sounds a lot more nimble. I think you make a good case that there's more upside down the road, but it also seems like there's a potential for just a lot more volatility in your bottom line results. Is that fair? Would you agree with that? If so, is that something that you're comfortable living with, or do you expect to take specific actions to keep things pretty stable?
Yeah, thanks. That's a good question, right? I think you heard me say before that I actually think volatility up or down in the drivers for us now is a good thing because we get the opportunity to turn a number of knobs. You're right. In the near term, there could be some volatility because until the model is fully functioning and we have our optimal configuration in place, we may choose to hold value up on the ECU. To do that, we move a lot less volume through one particular quarter, right? If we do that, I would rest assured that it'll be a purposeful activity. As soon as we come out of that activity, apply the volume back to it, I think we'd be in pretty good shape.
Sounds good. My follow-up is on ECU cost in the fourth quarter here. We can all see natural gas prices are moving up. It looks like at the same time that electricity prices are coming down. Does that present any sort of an opportunity for Olin? If so, would you be able to capitalize on that?
Yeah. Maybe others will want to comment on this. We have a mix of electricity. Some is self-produced, some is purchased. I'm not seeing big swings in our purchase of electricity. We commented a little earlier on potential for gas to move up, which is really more a European driver for us right now than anything. Yeah, you're right. We've got to go out and capture any movements in this. This is the one thing that maybe is less pass-through than some of our other raw materials, some of the other hydrocarbons that we buy. We have a lot of pass-through activity on those. Go ahead, Todd.
Matthew, you do know we hedge gas and about 70% of our power comes from gas. Any increases you'll see or decreases you'll see through our system over time. Realistically, it's not that big of a near-term headwind into the fourth quarter for us. The other big area for power is hydropower, so you won't necessarily see the swings in cost that you're talking about associated with that.
Got it. Thank you.
Our next question will come from Travis Edwards with Goldman Sachs. Please go ahead.
Hey, thanks for the time and thanks for the detail this morning. We're brief as we're getting to the end of the call, but just one on capital allocation. In the last few quarters, your team has gotten questions just on the high-coupon debt and capital allocation priorities. I think, as an extension of that question, it feels like that sentiment has sort of shifted from a full refi, obviously, of the high-coupon debt to more paying down with incremental free cash flow generation. Just curious how you're thinking about cadence of debt paydown as well as priorities across high-coupon debt that's still left outstanding versus no more near-term maturities? Thanks.
Travis, this is Todd. Obviously, with the action that we did in the middle of October by taking $100 million of cash and reducing the 9.7% acquisition bond, that's the model you should continue to expect from Olin. Obviously, as we generate free cash flow, you'll see us fund the dividends and pay down debt. As opposed to a rate arbitrage, we would expect to de-lever the balance sheet with excess cash flow. We have, as you saw on one of the slides in the back, minimal cash requirements over the next three years for debt repayment. The biggest one would be $200 million in 2022. That gives us a lot of opportunity to use our excess cash flow to take out high-cost debt.
Got it. Then can you just remind us what, I guess, you would consider excess free cash flow or excess cash?
I think, yeah.
What level?
For next year, it's $2-$3 a share. That's lever free cash flow. It's after interest, after all capital, all fixed capital, all working capital. That $2-$3 a share is available to do exactly what Todd said. Of course, we're going to pay the rock-solid dividend, and then we're going to use the rest to pay down some high-cost debt.
Got it. Appreciate the time and c ongrats on the new seat, Scott. Thanks.
Thanks.
Next question will come from Arun Viswanathan with RBC Capital Markets. Please go ahead.
Great. Thanks for taking my question. Good morning. Congrats on the new role and success over there, Scott.
Thanks.
I guess my question is first off, I'd start by on the leadership strategy. It sounds like there's maybe two things in this strategy, which is detaching from the contracts and then only selling in higher value parts of the chain. It does a little bit remind me of Celanese's options to move [acetic] into VAM. I guess, in other parts, is that somewhat of a fair characterization? Then maybe you can just offer your thoughts on what changed within the company for you to affect this strategy. I'm just curious because historically, these opportunities have been there maybe over the last couple of years. Is it just the tying to the contracts that you want to move away from? Is it the opportunities that you can sell more of the chlorine, you have more outlets for the chlorine, or a combination of all that? Thanks.
Yeah. Thanks. The way I would characterize this, it's really Olin unique. It's our own winning model. It's a much more sophisticated model than you might have seen in other places in the industry because, if you think about it, we have multiple sets of supply-demand characteristics that are all somewhat tied together. The smartest player is going to win in that, and the player that can connect everybody in the company to that model, because it really is like a 3D game of chess. That's what you have to envision with this model, and it's doing many things. Some of those things that I named earlier, and it's doing them all at the same time, putting those activations or activities in place all at the same time that we draw up in a war room every day and play out every week. Okay.
I just want to say that it's quite an Olin unique situation. As far as why are we doing this now? The team has been incredibly occupied with trying to build to the point that we could do this. This was always the next step in the evolution, and we're just here. I arrived and everybody's carrying me on their back for what they intended to do. Like I said, I'm just glad to lock arms and be able to do that. That's it.
Okay. Appreciate that. The last question is just on the portfolio itself. Given what you just said, are there any areas of the portfolio that you feel like you need to potentially exit? Have they consistently been low-value contributors? Yeah, thanks. That's it.
Yeah, sure. I would say everything's going to contribute at a lot higher value. Of course, we'll always do what delivers the best return to shareholders. Knowing our future outlook, no one's going to pay the multiple that they're worth right now. Okay.
Thanks.
Okay.
This will conclude our question and answer session. I would like to turn the conference back over to Scott Sutton for closing comments.
Yeah. Thanks a lot. With that, I would just say that Olin will meet the expectation that's been set for us. We're going to lead, we're going to be productive, we're going to be very engaged, and we're going to win our way back to a much higher equity value. I would just say thanks to everybody for joining us today.
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