Synthomer PLC

LSE:SYNT

Earnings Call Transcript 2020-Q3

[Operator]

Welcome to Synthomer plc Q3 Trading Update Call. [Operator Instructions] And just to remind you, this conference call is being recorded. Today, I'm pleased to present Calum MacLean, Chief Executive Officer; Stephen Bennett, Chief Financial Officer; and Tim Hughes, Head of Investor Relations. Please begin your meeting.

[Calum G. MacLean, CEO & Executive Director]

Thank you very much. Thanks, everyone, for joining us to the Q3 trading statement, which, as you're aware, we had to bring forward from the planned date to the 5th of November. So as the announcement said, it's Calum MacLean here, I've got Stephen Bennett with me and Tim Hughes. So I thought I'd just give you a quick view of the headlines and then we can put it into a Q&A session. The 3 main headlines, if you like, is number one, that we've clearly raised guidance by circa 10% for 2020. We have, number two, reinstated the interim dividend and the full year dividend also being reinstated in line with capital policy. And number three is we've given you our latest views on where leverage will be, come the end of the year 2020. So if I just sort of delve into those 3 a little bit. From a trading perspective and the important message here today is that all 3 divisions are on or above the same time last year and that's comparing on a like-for-like basis, excluding the acquisition of OMNOVA. If I just say 1 or 2 words about each of them. Performance Elastomers, that's benefited from the nitrile upside, particularly from the new capacity that we brought on. So I think everyone is aware, we have been making large investments in the past 2 to 3 years, and we brought on some major step change capacity at the beginning of '19, which we started to fill during '19. And then post-COVID, of course, demand has gone up, which has tightened that market, and it meant that that capacity is now running at 100%, and we benefited from the extra volume there as well as improving margins due to the demand within that sector. Also within Performance Elastomers, our SBR business has shown some good recovery as well. You will recall, we had a strong quarter 1 in SBR with stable margins and the business had definitely had a strong Q1 versus the 2019. We were impacted here during Q2 on the back of COVID, but we've seen that come back reasonably robustly now in quarter 3, and we see that our quarter 3 2020 results is above our quarter 3 2019 in the SBR. I'll make a few more comments on SBR because we are working on the consolidation side of that asset base, and I'll say something about that in just a moment. Functional Solutions, interesting area for us, of course. Here is where we have the biggest OMNOVA overlap, and I'll say a few words about that integration in a minute. But they have been very much focusing on that integration. But that aside -- and that's helped, of course, but that aside, I think the sort of area of Functional Solution has been very resilient throughout COVID and it also has come out reasonably strongly out of the COVID. And that means it's benefited very much from the diversified product range that we've got there. And in line with the discussions we had in August, we've seen strong recovery in our construction, in our coatings area and also in our adhesives area. And less so recovery, but certainly not back to the pre-COVID levels in our exposure to automotive, oil and gas, these sorts of areas. So -- but overall, the net-net-net is that Functional Solutions, again, is trading ahead of where it was in financial year 2019, and again, I would emphasize that's on a like-for-like basis comparing the businesses.Industrial Specialties, just a recovery story, really. What we're seeing is a stronger quarter 3 than we had in quarter 2, which was impacted by COVID and current trading is on or above because there's a number of areas here, so it's on or above where it was this time last year. Moving into some of the others, so just to sort of touch on them. As I said, guidance, we've put up 10% versus where we are in August. So in August, we confirmed a consensus of GBP 211 million. And today, we're coming out and saying that we expect that to be GBP 232 million, circa GBP 232 million EBITDA end of the year. That means, let's say, our pro forma leverage because we've also taken quite a lot of actions, as we talked about in August, particularly at the beginning of the coronavirus to preserve cash. And so with the combination of the higher EBITDA, the cash focus and also managing our working capital that we now expect our leverage to be circa 2x net debt-to-EBITDA by the end of the year 2020, which is ahead of the original schedule that we put on the table at the time of the acquisition. And certainly, that's coming through now on the bottom line with good cash flow of the business at this time. We did mention in August that we intended to reinstate the 2020 dividend. What we didn't commit to at that time was paying an interim dividend. So we're confirming today that we will pay an interim dividend, and we will reinstate the dividend -- the full year dividend in line with the capital policy as well. The OMNOVA integration clearly got a big part to play in the overall story at the moment because we upgraded the synergies to GBP 20 million run rate by the end of the year. We're confirming that again today. So that integration has happened as it's happened ahead of schedule and it's happened to a greater degree than what we originally planned when we announced the deal. So we're quite pleased with the way that is going. A couple of other just issues to mention that we have announced today that -- we're not going to announce today in our announcement, we've already previously announced it on site that we will close the Oulu site, which is part of our major SBR consolidation work that we're doing and that that will close now by the end of quarter 1 2021 following consultation being completed. We're still in consultation around what we're going to do on the Marl site and hopefully, more information on that by the -- before the end of the year. The last point really was on the NBR expansion, just to point out to people that that goes ahead as planned, and we're continuing to fund that debottlenecking, which will be completed by the beginning of quarter 4 2021. So CapEx, which wasn't specifically mentioned here, typically, CapEx for this year will be around GBP 55 million, which is our underlying SHE and sustenance plus spending on -- particularly on this expansion of our NBR, which is due to come online. So reduced significantly from the previous year, which we did, and we communicated at the time of the beginning of the COVID crisis.So that's the sort of summary. I think I'll put it to Q&A now, if that's okay.

[Operator]

[Operator Instructions] Our first question comes from the line of Geoff Haire from UBS.

[Geoffrey Robert Haire, Managing Director and Equity Research Analyst]

Calum and Stephen, Tim, just 2 quick questions for you. First of all, just on the closure of the Oulu site. Could you just sort of outline what costs might be that need to put against that, if possible? Then the second question is on the better demand that you're seeing in Q3, how concerned are you that some of this is stock building by customers and, therefore, you may not see -- you may see volumes sort of moderate somewhat as we go through in 2021?

[Stephen G. Bennett, CFO & Executive Director]

Geoff, Stephen here. So I'll take the first one and then hand it back to Calum. In terms of Oulu, now the consultation process has come to an end and the closure of the site has been decided upon. The estimate of the closure cost is about EUR 5 million, of which a couple of million is severing the people, the employment contracts about EUR 3 million is clearing the site. That will be taken as an exceptional cost this year, but the cash outflow will arrive next year.

[Calum G. MacLean, CEO & Executive Director]

Geoff, on the second question, the better demand in Q3. It's difficult to speak generally about that because the demand depends very much by the market sectors that we are in. So we have some areas and I mentioned particularly automotive, oil and gas, where demand is still quite depressed compared to where it was pre-COVID, and then we have other areas like nitriles, where demand is clearly high. High because we brought on new capacity and the demand is good in the market. So I don't think any of that is -- and then you look at things like Construction & Coatings where demand is quite high, and you can see that around a lot of companies who are reporting at the moment. I'm not particularly concerned that that's going to go away and that it's restocking at all. I mean it's been reasonably consistent. We saw it starting in sort of July, it's been consistent in August, September, and our current orders till the end of the year look pretty robust, hence, the reason why we are able to sort of up the guidance. I don't think any of it at this side is something that we would expect would drop away next year, but that's just our view.

[Operator]

Our next question comes from the line of Sebastian Bray from Berenberg Bank.

[Sebastian Christian Bray, Analyst]

I would have 2, please. The first thing, on the magnitude of change between the old guidance, let's say, I believe it was around GBP 216 million and the current guidance, which is the 10% upgrade. Which of the divisions most outperformed expectations relative to H1? Has it been that nitrile margins have increased more than expected or that the core business in Construction & Coatings has been firmer just as an ideal proportion? The second question is simply one on CapEx. Given, I think, some projects have been deferred from this year and the demand profile looks like it's picking up quite nicely, what would be a reasonable number for 2021 and 2022?

[Calum G. MacLean, CEO & Executive Director]

Thank you, Sebastian. I'll try and start that and then maybe Stephen will add something particularly at the end. But from the guidance and the upgrade that we've given today, I think the important thing here is that all businesses have recovered, and all businesses are sort of broadly, on average, across the portfolios within each of the 3 divisions, are trading ahead of the same period last year. So that's the important point. If you then want to delve down a little bit lower into which divisions have delivered more, well, clearly, the one that you would expect deliver more is the one where the extra capacity came online, which was the Performance Elastomers because we brought on additional capacity in nitriles, which we've been able to sell out. So the improvement is more skewed towards Performance Elastomers because of nitriles and the fact that SBR has recovered. And -- as well as being able to sell that volume in nitriles, clearly, the margins are stronger because they came from a weaker position same time last year after we -- after, as you know, the Koreans had just brought on some very large amount of capacity to a market which is quite tight.So yes, so more skewed towards Performance Elastomers, but really, it's not the whole story. The story is more a recovery around each division and also the OMNOVA synergies and the integration of that business, which has been ahead of schedule and is coming in now in a good way. So that would be my -- and Construction & Coatings is clearly one, which you mentioned there, which has also had a difficult April and May, but came back reasonably strongly, and it's well reported in the market that that demand is pretty good there at this moment in time. In terms of the CapEx, you're right, we did reduce from GBP 90 million to GBP 50 million at the beginning of the year. We took that very early decision as a management in order to preserve cash, whilst we didn't really know or nobody knew what was -- how this thing was going to roll out. We've continued to deliver against that new budget this year. Next year, clearly, we will increase CapEx. We're going through our budgeting process at the moment. And as you know, there's always about GBP 30 million to GBP 40 million, which is SHE and sustenance in a business like this, which is compliance, safety, health, environmental legislation type spend. And then up and above that, it's more discretionary. So we will decide how much more we want to spend out of that, and it is discretionary. But I would be anticipating that we'll be spending circa GBP 70 million to GBP 80 million order of magnitude next year. And then the year after, it will depend on how the key projects come forward because clearly, as you rightfully pointed out, demand in some sectors of our business is there. And we need to make sure that we are running ahead of the growth and have the capacity to be able to absorb that demand.

[Operator]

Our next question comes from the line of Kevin Fogarty from Numis Securities.

[Kevin Christopher Fogarty, Analyst]

Just 2 from my side. I just wondered if you could comment on nitrile pricing and if the supply outlook has changed materially in recent weeks or so, i.e., if you look out over the next kind of 12 months, obviously, you've got capacity coming on, but I just wondered if you see others coming on there as well. And just second question really on SBR. Just in terms of the improvement, I just wondered if you could give a bit more sort of granularity, particularly around the paper market, how that has performed, if you've seen the recovery there and if there's been a benefit from competitors taking capacity out of the market if that helps SBR as well.

[Calum G. MacLean, CEO & Executive Director]

Yes. Thanks, Kevin. Let's pick up nitriles, first. I think the unitary price of nitrile today is not particularly high compared to historic prices, and that is based on the fact that raw materials are quite low. So we're not seeing a very high market price, even though the underlying margins have improved somewhat. In terms of demand, I think what we're seeing is, clearly, and I mentioned it in my intro, that we can effectively sell all the capacity we can produce today because demand is extremely high. We do not expect that that will slow down. We've had some very impressive growth this year on the back of COVID, but that demand will stay in place as we have this increasing demand for health and hygiene and the use of the medical gloves, which are expanding their applications and expanding their geography in which they are selling into. So demand, in our view, will remain very robust, albeit the high growth rate of 2020 will probably drop back to something more like the traditional 8% to 10% per annum that we've seen historically. In terms of capacity coming online, there's not a lot of new capacity in the next 12 months. So we'll bring 60,000 tonnes on in quarter 4 and LG are bringing on some capacity as well towards the end of the year. And there's a few other little bits and pieces on elsewhere, but nothing material. And bearing in mind the growth there that we'd expect the supply-demand balance certainly for the next couple of years, and that's the sort of as far as you can see in this business at this moment, to remain fairly tight. Moving on to your SBR and improvements. I think we've chosen -- we've got a number of plants in Europe, and we've chosen to consolidate there and take capacity out to run the remaining plants at a much higher rate. And hence, the discussion around Oulu and some of the other capacities that we're looking to take out. We haven't seen a lot of other reduction in capacity from our competitors at the moment. But we'll manage internally our own portfolio, and that's what we'll do. So that capacity will come out in quarter 1, and then we'd expect to have improved economics, lower cost to produce from the remaining capacities as we load them up thereafter. Whether or not any of the other competitors do the same things because our understanding is they are running at quite low utilization rates as well, I couldn't tell you, to be honest.

[Operator]

[Operator Instructions] Our next question comes from the line of Sam Perry from Crédit Suisse.

[Samuel Perry, Research Analyst]

Just a couple from me. On the guidance, can you add some color around exit rates into the fourth quarter? Has this been sort of a more broad-based recovery since the last time you addressed the market in August or is it something that you've seen more abruptly in recent weeks? And does this assume no further lockdown measures as well? And then also on capacity additions. As you mentioned, it looks like nitriles are going to remain tight for at least the next few years and you guys can sell everything you make. How much of a priority is it for you to then add further capacity after your DKT next year?

[Calum G. MacLean, CEO & Executive Director]

Thanks, Sam. Good questions really in terms of now what are we -- first, I'll take the lockdown situation first because clearly, it is -- it remains uncertain. And as you can see, there's a lot of things going on in terms of further lockdowns and going back to those lockdown situations. I think the first thing I would say to you is that if you look at the first half year trading of Synthomer, we were fairly resilient and fairly robust. So despite having the full lockdown in April and May, we came in around 6% below the previous year. So the impact to this business was not nothing but it was relatively modest. So a further lockdown situation will have an impact on this business, if it goes back to where it was before. But it's not going to have a very material impact to this business. And I think, therefore, that's just based around where we sell and the resilience of the portfolio and the diversity, really. In terms of the exit rates for quarter 4, clearly, the margins have improved as we've gone across the quarter. Are they continuing to improve? I don't really think so. I think generally, if you look at SBR, that's been pretty stable margins throughout the year. Even when demand was low, margins stayed fairly stable. I think -- and it was the volume impact we saw. The same with Functional Solutions. We haven't seen a lot of volatility in margin. The margins have been fairly flat. The value add that we do in there tracking raw materials, margins fairly flat there. Same in Industrial Specialties, I think that's been fairly flat as well. The one area where margins have improved over the course of the year really but still a bit since the middle of the year were in nitriles. So the exit rate in quarter 4 is probably slightly -- it's higher, obviously, than the average rates of the year. And your second question was around nitriles and further capacity. Is that right?

[Samuel Perry, Research Analyst]

Yes.

[Calum G. MacLean, CEO & Executive Director]

Yes. Nitriles, further capacity. We've got, and we always had that planned anyway, the additional 60,000 tonnes, which is a fairly significant debottleneck of our existing facility in Malaysia. And obviously, that's adding on to the back of an existing facility. So it adds more capacity for small creep in fixed costs. So it improves our underlying cost base and our economics of producing that. So first target is to get that complete, and the team are busy on working on that at this moment in time. But clearly, with a market that's growing, let's just even take the average growth of 10% per annum and with us sitting there with about 25%, 26% share, market share, that if we want to retain that market share, we need to be thinking ahead in terms of when is our next capacity coming online. And sufficient to say, although we've not made any announcements yet, in due course, we will be looking to bring additional capacity on, whether it's from repurposing some existing assets that we may have elsewhere or whether it's from putting in a new reactor somewhere else. I think we'll announce in due course when that happens. I would say, however, and this is one of the fundamentals of this industry is that anything that we choose and announce to do today is probably going to take at least 2 years before it comes online in terms of actually making that investment to -- or announcing that investment to beneficial production, which is kind of the lead time that you see on any major investment, unless it's a sort of debottlenecking that you can do a little bit faster. So needless to say, we are looking at that and watch this space in terms of when our next announcement comes out.

[Operator]

[Operator Instructions] Our next question comes from the line of Chetan Udeshi from JPMorgan.

[Chetan Udeshi, Research Analyst]

Just one question really, which is, are you guys seeing a change in willingness from your customers in the nitrile market to commit to volumes beyond maybe 1 month typical horizon? So in other words, are you seeing them willing to commit for longer period volumes? And to commit to those volumes, are they prepaying you some deposits, et cetera? Or is that not really happening just now?

[Calum G. MacLean, CEO & Executive Director]

Chetan, yes, good question, really. I think it's a reality, right, that with COVID that demand in nitriles is very strong, and at this moment in time, the tightness of Nitrile latex that the customers want to secure volume long term. So the opportunity to put in longer-term contracts and even pre-sell some of the additional capacity that's coming online is clearly there, and that's also in our interest. I'd also say to you that, in this area, there's improving technology over time. So we have the new patented product coming through, which is improved efficiency, improved energy consumption. And so we're -- the customers are looking at that and how they can secure volumes of that as well. So I think in a short market, there's always opportunities to commit to longer-term contracts because securing the volumes is really important to the customers. So the answer to your question is, yes, there are opportunities to do that. And in some cases, we will do it.

[Operator]

Our next question comes from the line of Laurent Favre from Exane BNP Paribas.

[Laurent Guy Favre, Research Analyst]

I just have one question left, please, and that's really regarding your, I guess, M&A ambitions over the next couple of years. You mentioned that your leverage will end at this year. And I guess on a depressed EBITDA at around 2x, the OMNOVA acquisition is now, I guess, more or less fully integrated or you're on track towards full integration. So I'm just wondering, at what point in time would you want to look for further acquisitions?

[Calum G. MacLean, CEO & Executive Director]

Thanks for the question. Look, we were very clear with everybody when we acquired OMNOVA that our capital policy is to run leverage between 1 and 2x and in the case of a large acquisition, we'd go something approaching 3, and we felt the market took the advice at that time and we went to 2.5. And we said that we only do that in a scenario where we could see ourselves deleveraging pretty quickly over the next 12 to 24 months. And we've been able to do that. And we said quite clearly in August that until such time as we were comfortably below 2x leverage, that there would be no major acquisitions or M&A on the agenda. So because we've been able to accelerate deleveraging, and we expect to be below 2x or on 2x, circa 2x by the end of the year, clearly, it accelerates the point at which we would be able to come back and start to look at acquisitions. So could that be brought forward to, say, next year rather than the year after? Possibly. But I would also point you to some of the other questions that were on the call as well to say that we equally have got a lot on our plates at the moment in terms of integrating the OMNOVA acquisition. So we need to deliver that GBP 40 million of synergies, which we'd promised, and also there's internal organic investments that we're looking at as well. And Chetan asked the question there a minute ago around are you going to put new capacity on the ground for nitrile. So that's also competition for capital that we will have in the next 12 to 18 months as well. So it's a balance really. We've got to see where the best use of the capital is and the time and the resources. But obviously, getting leverage down sooner opens that door for doing M&A if the right thing came along at the right time.

[Operator]

Our next question comes from the line of Jarek Pominkiewicz from Jefferies.

[Jaroslaw Marek Pominkiewicz, Equity Analyst]

Just a quick technical question from me. Could you give us an idea of the benefits from closing the Oulu site in terms of reduced fixed cost?

[Stephen G. Bennett, CFO & Executive Director]

Yes. Jarek, so the answer is the fixed costs on the site are broadly EUR 4 million, EUR 5 million, and that fixed cost will obviously go away. Our intention is to continue to service the customers from our European assets. In the event that that supply chain becomes too stretched, then the base case is that it's a broadly neutral transaction for us. If we retain the volume, we'll do better. But the base case to me is that the -- that you shouldn't book in your model any benefits of the Oulu closure.

[Jaroslaw Marek Pominkiewicz, Equity Analyst]

You shouldn't book any benefits on the closure. Okay.

[Stephen G. Bennett, CFO & Executive Director]

No, no.

[Operator]

There are no further questions registered, so I hand back to the speakers.

[Calum G. MacLean, CEO & Executive Director]

Okay. Thank you very much. Look, I thank you, everyone, for coming on at short notice. Clearly, very happy to be in a stronger position and have come out of the COVID crisis quite well as a business across the portfolio, integration of OMNOVA going well. Hence, the ability to upgrade the guidance and start repaying the -- start paying the dividends again. So thank you again for your attendance and look forward to catching up with you all in due course. Thank you.

[Operator]

This now concludes our conference call. Thank you all very much for attending. You may now disconnect your lines.