Stepan Co

NYSE:SCL

Earnings Call Analysis

Company Forecasts Earnings Growth in 2024

In the pursuit of streamlined operations and improved cash flow, the company is executing a cost reduction plan, aiming to deliver $50 million in pre-tax savings in 2024, mainly from enhanced workforce productivity and operational performance. Capital spending is expected to decrease in the fourth quarter of 2023 and align with historical norms in 2024. The new alkoxylation facility in Pasadena is projected to be operational by mid-2024, with the underlying business already showing robust double-digit volume growth. Efforts are also underway to increase North American production of ether sulfates that comply with new regulatory limits on 1,4 dioxane, with both existing and new capacities poised to support the growth of the sulfonation business. Despite near-term challenges, such as destocking in agriculture and seasonal trends in Rigid Polyols, the company anticipates an upturn in volumes and margins in 2024 due to demand recovery, new business in surfactants, lower raw materials costs, and improved agricultural volumes. These factors, combined with strategic execution, are expected to drive earnings growth and positive free cash flow in the coming year.

Adjustments in Net Income and EBITDA Reflect Market Challenges

Stepan Company endured a challenging quarter with adjusted net income plunging to $14.7 million, a stark contrast to the preceding year's $46.3 million. This dramatic fall was a result of a 9% drop in sales volume as the company grappled with soft demand and inventory destocking. Factors such as unfavorable product mixes and pricing pressures in Latin America further exacerbated the situation, particularly within the surfactant unit which saw margins shrink. Concurrently, specialty product unit margins faced blowback due to aggressive import competition. Nonetheless, the organization took active measures to control headcount and discretionary expenses, and it further reduced inventory levels by a substantial $55 million.

Segment Performance: Diverse Impacts Across Portfolio

The surfactant segment, which improved modestly from the previous quarter, reported operating income of $15.4 million. This was triggered by a small 2% rise in volume, thanks to contracts in personal care and slight upticks in laundry and cleaning. The polymer segment achieved $21.8 million in operating income, maintaining a steady trajectory of growth quarter-over-quarter largely propelled by the global rigid polyols market. However, the specialty products struggled, bringing in operating income of merely $2.4 million compared to $3.8 million in the preceding quarter, reflecting the challenges of heightened competition and import pressures.

Dividends Increase Despite Economic Headwinds

In a demonstration of confidence, Stepan Company declared a dividend of $0.375 per share, up by 3% and marking the 56th consecutive year of dividend growth. Notwithstanding the economic climate and reduced earnings, the company steadfastly holds onto its long-term strategy to reward shareholder loyalty. Also notable is the company's prudent decision not to execute stock buybacks during the first nine months of the year, conserving a $125 million allowance for future repurchases and reflecting a responsive approach to market conditions.

Cash Management Efforts Bear Fruit Amidst Lower Taxes and Restructuring

Stepan's operational acumen was evident as it generated $70 million in cash from operations and secured a positive free cash flow of $16.4 million. These were strategic achievements, most notably given the significant investments and financial obligations undertaken during the quarter. A planned reduction of another $25 million in inventory by the fourth quarter signals ongoing efforts to strengthen the financial position. Adding to the financial dynamics was an after-tax business restructuring of $4.3 million, largely owing to a voluntary early retirement scheme. Meanwhile, a more favorable effective tax rate of 20.5% for the year—down from 24%—provided some relief to the bottom line.

Resilient Cost-Control Amidst Inflationary Pressures

Through a disciplined approach to cash expenses, Stepan Company aims to maintain or even reduce its full-year cash expenses compared to the prior year. This strategy defies the considerable headwinds afflicting many industries due to widespread cost inflation. The commitment to cost-effectiveness alongside operational efficiency positions the company to navigate current market turbulences and any future volatility.

Earnings Call Transcript 2023-Q3

[Operator]

Good day, and welcome to the Stepan Company Third Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. [Operator's Instructions]Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Luis Rojo, Chief Financial Officer. Please go ahead.

[Luis Rojo, executive]

Good morning, and thank you for joining Stepan Company's Third Quarter 2023 Financial Review. Before we begin, please note that information in this conference call contains forward-looking statements, which are not historical facts. These statements involve risks and uncertainties that could cause actual results to differ materially, including, but not limited, process for our foreign operations, global and regional economic conditions and factors detailed in our Securities and Exchange Commission filings. Whether you are joining also online or over the phone, we encourage you to review the investor slide presentation, which we have made available at www.stepan.com under the Investor section of our website. We make these slides available at approximately the same time as when the earnings release is issued, and we hope that you find the information and perspectives helpful. With that, I would like to turn the call over to Mr. Scott Behrens, our President and Chief Executive Officer.

[Scott Behrens, executive]

Good morning, and thank you all for joining us today to discuss our third quarter results. I plan to share highlights from our third quarter performance, and we'll also share updates on our key strategic priorities while Luis will provide additional details on our financial results. The company reported third quarter adjusted net income of $14.7 million. Earnings were significantly impacted by a 9% decline in sales volume versus the record prior year third quarter due to continued demand softness across most of our markets and continued inventory destocking in certain market channels. In the third quarter, surfactant unit margins were lower versus the prior year due to less favorable product mix, high cost raw material inventory carryover and pricing pressure in Latin America from imported products. Volumes in Latin America grew by high single digits compared to the second quarter. Specialty product unit margins were significantly lower due to high-cost inventory and pricing pressure related to increased MCT import activity. Expenses were slightly lower versus prior year due to proactive headcount and discretionary expense controls implemented earlier in the year and lower incentive-based compensation accruals. We recorded a $4.1 million after-tax restructuring reserves for the transition of employees participating in our voluntary early retirement program. We continue to make significant progress on our cash objectives, reducing our inventory levels by $55 million. Finally, we completed our low 1, 4-dioxane capital investments and continued our Constellation project in Pasadena, which is expected to be operational in midyear 2024. For the quarter, adjusted EBITDA was $48 million versus $85 million in the prior year quarter, primarily driven by the decline in sales volume. Adjusted EBITDA in the third quarter of 2023 was slightly higher than the second quarter of 2023 adjusted EBITDA of $46 million. Surfactant operating income was $15.4 million versus $39 million in the prior year and $15.1 million in the second quarter of 2023. The decline versus prior year was primarily due to a 7% decline in global sales volume and lower unit margins in Latin America driven by competitive pressure from imports. Demand within the agricultural end market remained low due to continued customer and channel inventory destocking. Polymer operating income was $21.8 million versus $31.9 million in the prior year and $16.3 million in the second quarter of 2023. The decrease versus prior year was primarily due to a 12% decline in global sales volume driven by a 10% decline in Rigid Polyol. Unit margins for Global Polymers remain in line with previous year. Specialty Product operating income was $2.4 million versus a record $9.7 million in the prior year. This decrease was primarily attributable to lower sales volume and unit margins within the MCT product line due to pressure from imported products. Residual high-cost raw material inventories within our MCT business should be consumed in the fourth quarter, which should lead to better margins moving forward. During the third quarter of 2023, the company paid $8.2 million in dividends to shareholders and $24.5 million during the first 9 months of 2023. The company has not repurchased any company stock during the first 9 months of 2023 and has $125 million remaining under the share repurchase program authorized by its Board of Directors. Yesterday, our Board of Directors declared a quarterly cash dividend on Stepan's common stock of $0.375 per share, payable on December 15, 2023. This represents a 3% increase in our dividend and Stepan has paid an increased its dividend for 56 consecutive years. Despite the challenging current macro environment and our reduced third quarter earnings, we remain confident in the strength and diversity of our business and its ability to generate cash that will allow us to continue to invest in our business and return cash to our shareholders. Luis will now share some details about our third quarter results.

[Luis Rojo, executive]

Thank you, Scott. My comments will generally follow the slide presentation. Let's start with Slide 4 to recap the quarter. Adjusted net income was $14.7 million or $0.64 per diluted share versus a record $46.3 million or $2.01 per diluted share in the prior year. Because adjusted net income is a non-GAAP measure, we provide full reconciliations to the comparable GAAP measures. This can be found in Appendix 2 of the presentation and Table 2 of the press release. Specifically, the adjusted net income for the third quarter excludes deferred compensation income of $2.1 million versus $1 million of income in the prior year. It also excludes business restructuring of $4.3 million of after-tax expenses. This business restructuring reserve is driven by the company's voluntary early retirement program. The deferred compensation figures represent the net income related to the company's deferred compensation plan as well as cash are stock appreciation rights for our employees. Because these liabilities change with the movement in the stock price, we exclude this item from operational discussion. Slide 5 shows the total company net income bridge for the third quarter compared to last year's third quarter and breaks down the decrease in adjusted net income. Because this is net income, the figure is not here are on an after-tax basis. We will cover this segment in more detail, but to summarize, we experienced lower operating income in all segments versus prior year. The company's effective tax rate was 20.5% for the first 9 months of 2023 versus 24% for the first 9 months of 2022. This year-over-year decrease was primarily attributable to more favorable tax benefits derived from stock-based compensation awards exercised or distributed during the first 9 months of 2023. Slide 6 focus on the Surfactant segment results for the quarter. Operating income for surfactant was $15.4 million. The surfactant business improved slightly from the second quarter of 2023, driven by a volume increase of 2%. This volume increase was driven by double-digit volume growth in our personal care business due to new contracted volume as part of the low 1, 4 Dx transition. Our laundry and cleaning volumes were up mid-single digits. Our distribution, oil sales, institutional cleaning and Construction and Industrial Solutions businesses were generally flat versus the second quarter of 2023. Based on these results and customer engagements, we believe destocking has largely rolling first in these end markets. The agricultural chemical business was down a strong double digit versus the second quarter due to continued cost over and channel destocking. This is the main driver of surfactants not generating greater sequential operating income improvement in the third quarter. Now turning to Polymers on Slide 7. Operating income for polymers was $21.8 million. We continue delivering sequential growth quarter-on-quarter, driven by mid-single-digit volume growth. Volume increased 6% versus the second quarter of 2023, driven by high single-digit growth in global rigid polyols. This was partially offset by a 25% decline in our commodity PA business. Finally, Specialty Product operating income was $2.4 million, down versus the second quarter of 2023 and $3.8 million. This reduction was primarily due to order timing differences. Turning to Slide 8. We continue making significant progress on our cash position. We have increased our efforts to lower working capital and reduce capital spending to adapt to the current business environment. For the third quarter, cash from operations was $70 million and free cash flow was positive at $16.4 million. During the quarter, we deployed $95 million against CapEx investments, debt payments and dividends. Finally, inventories closed at $285 million, which is already below our initial end of the year goal. We are working to further reduce inventory by another $25 million in the fourth quarter. Now on Slide 9 and 10, as Scott will update you on our strategic priorities and capital investments.

[Scott Behrens, executive]

Thanks, Luis. I will focus my comments on our cost and cash management initiatives and on the progress of our major capital investments. In regard to 2023 cash expenses, we continue targeting to hold full year cash expenses flat or down versus prior year, despite the continued pressure from cost inflation and from our new investments in Pasadena and Low 1, 4 Dioxane. During the third quarter, we took actions to control costs and improve cash flow, including a voluntary really retirement program for eligible employees at our corporate headquarters and global technology center, which are both located in the Chicago area. We expect this program to deliver more than $8 million in pretax savings in 2024. Given the continued challenging market conditions, we are expanding our cost reduction activities, which when combined with the early retirement program, are expected to deliver $50 million in pretax savings in 2024, centered around workforce productivity and improved operational performance across our manufacturing network. Regarding capital investments, we are continuing with our efficient and disciplined approach to capital allocation. Capital spending was $53.7 million during the quarter and $216.3 million during the first 9 months of 2023. Capital spending in the fourth quarter of 2023 is expected to be in the range of $41 million to $46 million, down versus the first 3 quarters of 2023 as spending on the low 1, 4-dioxanes investments is now complete and lower remaining capital outlays are anticipated to complete the new alkoxylation facility in Pasadena. For the full year, capital expenditures are expected to be in the range of $255 million to $260 million. We will provide more details on our capital forecast for 2024 in our February call, but generally, we expect to return to historical levels. Moving to Slide 10. Construction on our new alkoxylation production facility in Pasadena, Texas is approximately 55% complete and has surpassed 900,000 construction hours. We expect the plant to be 75% complete by year-end and to start up in mid-2024. The underlining of talk a very attractive unit margins. As you know, we are increasing North American capability and capacity to produce either sulfates that meet new regulatory limits on 1,4-dioxane. The new assets in our mill sales facility are now mechanically complete and are undergoing commissioning. New contracted 1,4-dioxane volumes have already started shipping from the site and should grow as we advance the commissioning process to reach full installed capacity during the first quarter of 2024 and should drive additional volume growth in the future. Stepan now has the largest installed 1,4-dioxane production capacity serving the North American merchant market, which will enable Stepan to maintain and grow our North American sulfonation business in 2024 and beyond. Looking forward, we believe the fourth quarter of 2023 will face challenges similar to those experienced during the first 9 months, including continued destocking within the agricultural end market and the normal low seasonal demand for rigid polyols in the fourth quarter. We expect to reduce inventory levels further by year-end, and we are nearing the end of our high capital spending phase. As we look forward to 2024, we believe volumes and margins will improve due to continued recovery in rigid polyol demand, growth in surfactant volume driven by new contracted business, lower raw material costs and the anticipated sequential year-on-year recovery of agricultural volumes. In closing, a combination of anticipated market recovery, the continued execution of our strategic initiatives and the aforementioned cost reduction activities should position us to deliver earnings growth and positive free cash flow in 2024. We remain confident in our long-term growth and innovation initiatives. This concludes our prepared remarks. At this time, we would like to turn the call over for questions. Abby, please review the instructions for the question portion of today's call.

[Operator]

At this time, we'll conduct the question-and-answer session. [Operator's Instructions]Our first question comes from Vincent Anderson with Stifel.

[Vincent Anderson, analyst]

So I wanted to start just kind of picking apart the surfactants margins. I respect that you don't adjust out things like start-up costs on Pasadena, but if you're willing, I would love to get an idea of the explicit impact and maybe the cadence of that as we work towards the mid-2024 start-up and then maybe just leave the back half of '24 for when we actually see the plant running.

[Luis Rojo, executive]

Luis, let me provide first, the context of what we said for this year. So we have in our cost of structure this year, $10 million of extra expenses between Pasadena and low 1,4 right? This is the guidance that we have provided. If you look at 2024, Pasadena is going to start up in the middle of the year, but we're going to have almost 90% of the cost during the year, right? I mean we are already hiring. We are already executing all our activities to be ready for midyear. And we're going to see only the benefit of savings and productivity improvements in the back half of 2024. So if you look at that, it's a $7 million to $10 million extra headwind that we have in 2024. When you think about all the extra costs and all the savings for in-sourcing and all of that in the second half. So $7 million to $10 million is what you could model for 2024.

[Vincent Anderson, analyst]

And then you probably don't want to give specifics on this, but I get the sense that the mix impact from agriculture this quarter was pretty severe. Is there anything just directionally you would want to add to that just under the assumption that we get some form of restocking or normalization in 2024 to reverse that out?

[Scott Behrens, executive]

Yes. I think, Vincent, we shared in our materials, a double-digit decline in volumes in agricultural chemicals this quarter, which did have an impact on obviously the recovery of the Surfactants earnings in Q3. We're able to show sequential volume growth of 2% in surfactants, but the adjusted EBITDA and/or income did not benefit from the decline in agricultural volumes. So I think that's all I'll say on the impact of AGG.

[Luis Rojo, executive]

And Vincent, we talked publicly -- I mean we had a good Q1 in 2023. A was still strong in Q1, and we delivered good operating income in Q1 surface...

[Vincent Anderson, analyst]

If I could shift over to polymers. I was kind of looking to just get your thoughts on where you are with some of the opportunities in polyols, maybe a bit longer term, but thinking about spray foam products and then maybe any progress towards converting a former INVISTA asset to run PA. Just curious if you've been able to push those a little bit harder in this weaker demand environment or if that's saying that we should return to maybe next year?

[Scott Behrens, executive]

Yes, Vincent, I would say our activities with our prospective customers and spray foam continue at a very robust pace. I do think that market has been impacted by the overall market conditions, but that has not stopped our pursuit of new customer approvals and that business and the outlook is still positive from our perspective. With regards to PA, there are no plans or intentions to put PA into the INVISTA assets. Millsdale is our PA production site, and that will remain our only PA production site going forward.

[Vincent Anderson, analyst]

I apologize if I was unclear. I was referring to using your Millsdale PA as a feedstock into one of the INVISTA plants.

[Scott Behrens, executive]

We did the integration of the business in '21, Vincent. So whatever raw material and operational synergies that we've gotten, we're taking care of in 2021.

[Operator]

Our next question comes from Dave Storms with Stonegate.

[David Joseph Storms, analyst]

Just would love to start, if you could talk a little more about the $50 million in savings that you're expecting over 2024. I know you broke out that there's maybe roughly $8 million in reductions from the restructuring costs. What does that other like 42 look like on a ground level?

[Scott Behrens, executive]

Yes. So I think as we put in our materials, we're centered around operational benefits and continuing to reduce the inefficiencies we have across our global operational network. So you can envision everything from logistics, even procurement, inventory management, waste, that's going to be the big bucket that's going to get us to the $50 million. And we have a lot of resources that are putting those plans together and we'll have more to report in our fourth quarter earnings call on our progress. There will be additional workforce productivity activities that we will look to engage in Q4 and also have more to report on that in our February call.

[David Joseph Storms, analyst]

And then just thinking about customer acquisitions and if you're able to break it down between what you're seeing among getting new Tier 1 customers in the door versus new Tier 2 and 3 customers in the door? Is there any updates there?

[Scott Behrens, executive]

So I think, generally, in our materials, we shared our contracted on that low 1,4-dioxane volumes are starting to ramp up as we complete the investments. That's going to benefit all of our customers across all tiers. And then Tier 2, Tier 3 has obviously been a big part of our growth strategy over the last 2 or 3 years, and we've been sharing in our materials, the acquisition of new customers, and that continues at a very robust pace. The issue right now is the market demand and all the destocking that's happened in 2023 is offsetting a lot of the continued positive momentum we have in new customer acquisition.

[Operator]

Our next question comes from David Silver with CL King & Associates.

[David Silver, analyst]

I'll stipulate here. I did have to step away for a couple of minutes during your remarks, so I apologize if I may apologize in advance if I make you repeat yourself. I did want to maybe just start with the polyols segment. And in particular, I did want to talk about -- ask you about the improvement in a couple of areas. So the per unit margins, I guess. So sequentially -- on a sequential basis, you had higher operating income. And I think kind of flattish or slightly better shipment volumes? And then I did pick up on the comment about improvement from China and assuming that these products are mainly used in the construction area. I was kind of scratching my head. I'm wondering if you could provide a little color. I mean I wasn't aware that the construction segment in China in general was especially robust now. So just a couple of comments there would be helpful.

[Scott Behrens, executive]

Regarding unit margins in polymers. So we have been reporting in the last couple of quarters, we've had a significant raw material headwind. And as we continue to work through those raw material headwinds, matching our pricing structure, our margins, we believe, are now stabilized, and you can see the sequential volume growth between Q1 to Q2 and now Q2 to Q3. We do believe that destocking has run its course, and we're back on a positive trajectory towards more normal market demand in the polymer space. As it relates to China, since that asset was fully commissioned 3, 4 years ago, we've been on a diversification strategy of unused markets and applications. And I think what we're seeing is the result of our team's efforts in building a much broader diversification of markets and product technologies to that site.

[Luis Rojo, executive]

Yes. Remember, we use that site. It's a different end market. When you think about colstorage and all of that is not typical insulation that we do here in the U.S. or Europe. And on top of that, the team has done fantastically diversify into other businesses. And using the assets in different end markets, and that is what is driving a very strong double-digit growth in Q3.

[David Silver, analyst]

Very good. And I did just want to pick up on Scott's comment about destocking being largely completed, I guess, on the polymers area. But I think if I mesh that with the comments in the press release, I mean, you are still pointing to inventory liquidation and destocking into the fourth quarter, I believe. And I guess that would make maybe at least 4, maybe 5 quarters where destocking has been in effect. And from a big picture perspective, should the fourth quarter be I don't know, the bulk of having the destocking behind us. And I did notice there's customer destocking and then there's our own inventory drawdowns. I was just wondering if you might be able to draw a contrast between the 2. I mean, are the customers largely through it, but maybe there's going to be a big reduction at the company level? Or how would you just characterize the overall progress in draining, I guess, the overall supply chain of excess product may be built up during the pandemic and during some concerns over supply chain reliability.

[Luis Rojo, executive]

David, so what Scott was mentioning was destocking is almost done in the polymers business. There is a pocket in the West Coast due to rain and other activities where not only the construction activities were able to be executed. So there is a small piece there remaining, but most of the destocking in polymers is already flushed through. What you see in Q4 in polymers is the normal seasonality of the business. But if you go back 5, 10, 20 years, Q4 is our lowest quarter in terms of demand because, of course, a lot of winter state and don't execute a lot of reroofing activities during the winter. So that's only seasonality. And then when you look at surfactants, we have -- what we are seeing is destocking is mostly done in all the cleaning, personal care market and what is remaining is Agg. We believe Agg will continue the destocking in Q4, and we will have more perspective in February, how we see Q1 and Q2.

[Scott Behrens, executive]

In the agg destocking lagged the consumer polymer destocking activities by almost 2 quarters, Luis mentioned earlier, we had a record Q1 in ag in 2023 and then Q2 is when we saw the destocking start in agriculture. So it's not probably another quarter at least to what for it's worth.

[David Silver, analyst]

Last question, maybe for this round. I did want to ask maybe a couple of -- just to try to get a cash flow for next year, not so much this year. But if you could remind me, I mean, I do think CapEx is going to tail off quite a bit. But could you just point out where your absolute kind of bedrock sustainable level of CapEx spending might be thinking ahead to 2024? And then if I look at the trend in DD&A, I mean, should we continue to see a rise maybe to the $120 million, million $20 million level for full year 2024. Would those be kind of maybe some rough numbers to start with, that would be helpful.

[Luis Rojo, executive]

Great question, David. What I would say is that we are very proud of the free cash flow and the cash from operations that we are delivering this year, right? I mean if you think about the first 9 months of 2023, our cash from operations is up 41% versus last year. Last year was a record year in net income, right, and EBITDA. This year, we have lowball our efforts on working capital and inventory and cash management and our cash from operations is up 41% as a result of all these excellent work done by the organization, okay? We will continue that effort in 2024. It's not only the $50 million that Scott mentioned it, but it's also cash management into next year. And as you know, things like Pasadena will provide a lot of help on cash because you don't -- you apply bonds depreciation and you don't -- your taxes goes lower on a cash basis. So that -- those are the benefits that we're going to see in terms of cash in 2024. And we put a footnote in the slides. I know you just got the slides a few hours ago, but we are estimating depreciation for next year between $130 million to $132 million is in the slide in the guidance that we provide is a bullet point there. So you can use that for your modeling in 2024.

[David Silver, analyst]

Yes. On that last point, I apologize. I literally just saw it here on Slide 13. So apologies there.

[Operator]

Our next question comes from Dave Storms with Stonegate.

[David Joseph Storms, analyst]

Earlier that capacity plant is expecting 90% of the cost for the year are not expected to be up and running until the middle of next year. Should we expect that to be running at full capacity? Or should we expect there to be a couple of quarters worth of ramp-up as passing fully operational?

[Scott Behrens, executive]

Yes. Dave, the latter statement is more accurate. So when you think about starting up an asset of this size, there's a lot of unit operations that have to go through commissioning and more importantly, the product mix that we will be putting through there. Some of it is highly specialized and there's customer qualification periods and protocols that we have to follow. So it will be a ramp-up in the second half of the year, for sure.

[David Joseph Storms, analyst]

And that's more just based on the logistics, though it's not a question of getting contracts in the door. The demand is there. The contracts are there is just the nature of the business.

[Scott Behrens, executive]

So when we... Starting up new assets, there's a customer qualification protocol that has to be followed to get customers to approve production from these sites.

[Operator]

Our next question comes from David Silver with CL King & Associates.

[David Silver, analyst]

Yes. This question would be just for Scott, and I'd just like to ask him to reflect if you could, Scott, on your long experience in the surfactants industry? And what, if anything, would you call out right about now that maybe deviates from, I think, the 3 decades that you have been managing that business and now the whole company here. But I don't know. This is my opinion, not yours. But for a long time, I would say surfactants was not one of the more volatile or trickier subsectors within the chemical industry. And I would contrast that maybe with the past 3.5, 4 years, where first to me, there was the very unusual demand boost from the pandemic, the issues surrounding supply chain reliability and maybe some of your new product development and customer development efforts. But as you stand here right now, you've come off a few consecutive record years and then this year, maybe some -- a pullback. But as you look ahead, I mean, do you think that the next year or 2 are going to be a reversion to the mean something of a catch-up for demand that might have been deferred or delayed this year. We might see it come back over the next 12 months or something. But from your perspective, managing this business over a very long period of time, what speaks out to you as maybe the the transitional points versus the secular growth points that you might care to call out?

[Scott Behrens, executive]

Thanks for the question, David. Let me say that I think what's not just the surfactant industry, but what the chemical industry has experienced in the last 18 months has been unprecedented in my career within the industry to see volume reductions of 10% to 20% in a calendar year is, I think, unprecedented definitely in the surfactant market. It was really driven in my opinion by the supply chain constraints and the or according of the material in 2022 as economies opened up around the world after the pandemic and the supply chain constraints caused a really strong year of demand in 2022, and we're paying the price for it this year as there's a lot of inventory reconciliation happening. Combine that with the fact that Stefan is finishing the end of our largest historical investment cycle in CapEx. So over the last 3 years, those 2 things don't marry up too well together, and you can see it in our P&L right now. But the outlook and the prospects we have long term in our business and the investments we're making are absolutely the right investments to continue to grow value for our shareholders. It's just, I think, a unique point in time right now when we got clouding our historical heavy spend cycle and we've seen an unprecedented downturn driven by inflation and the impact on the consumer. You can tell that the consumer is impacted with the 6-plus quarters of record inflation that we've seen at least here in the U.S. So that would be my thoughts right now, David.

[Operator]

[Operator's Instructions]. Our next question comes from Robert Court with WAM.

[Robert Court, analyst]

I hope you might be able to help me. I was interested in sort of what you guys are thinking about on your gross margin cadence and price cost. I noticed your -- you had businesses that were up high single, mid-double-digit pricing in the first quarter and now that's reversed. -- presumably because you're passing through those lower costs. And I guess, if I think about your cost structure, that might imply your raw materials are down 20% or 25% in the quarter you reported. So am I thinking about that right? And you've mentioned destocking and some slower volumes. Does that mean your purchases today are actually meaningfully better than that even? And then maybe if you could just help me out, I know you have pass-through arrangements on a good amount of the portfolio, but how is that going to change the cadence of that gross margin going forward? Because I think you're in the 12%, 13% range and at times, your company has had margins that are 50% above that. So any help you could provide there would be great.

[Luis Rojo, executive]

Look, great question. But as we have been talking in the last few quarters, there is always a lag with all these pricing and raw materials activities, right? So what we saw last year, of course, we were taking a lot of pricing because raw materials were going up. But at the end, you had also lower raw material prices in your P&L because you had inventory, right? So you get that benefit. In the way down, that's the lag that you see as well. I mean we -- as you mentioned, we have pass-through contracts in our business, noting 100% of the business, of course, just a portion of the Surfactant business and the rest moves with the market. But of course, with lower raw material prices, things get more competitive, and we need to adjust our prices. And we have been very clear that that, for example, Latin America, NCP, the Specialty Products business and a little bit in Europe is where we have seen a lot of pricing pressure from imports from Asia. So there is a lag. What I will say is most of the high raw material prices are wash out, we are expecting a Q4 for polymers and surfaces where our standards are in line with the market prices, right? And the only remaining piece that we have is in the MCT business, you are going to see still an impact in Q4 because of -- I mean, Fadi asset prices went down 70%. So we are still consuming the old one. So -- and then we'll see what happens in 2024, but Q4 should be pretty keen at the MCT business.

[Robert Court, analyst]

And if I could just follow up, it's very helpful. Can you tell me beyond the fatty acids, I mean I know you have a big broad back, but are there a handful of more significant raw materials for you? Or -- and I guess, should we be concerned now that oil is rolling, you might have to deal with inflation again next year?

[Scott Behrens, executive]

Yes. No, I think generally, other than what Luis mentioned, we feel we're in good shape now with where our raw material costs are versus related to market pricing. So I think we're going to see a more stabilization going forward. Too early to tell what's going to happen with raw materials, there's too much volatility in the markets right now that don't give us a real clear picture.

[Luis Rojo, executive]

We have proved historically that we can make money in the way up and in the way down with the respective lag, there is always a lag. But we have a business model that allow us to price also up when things are go.

[Operator]

Thank you. That concludes the question-and-answer session. At this time, I would like to turn the call back to Scott Behrens for closing remarks.

[Scott Behrens, executive]

Thank you very much for joining us on today's call. We appreciate your interest and ownership in Stepan Company, and please have a great day.

[Operator]

Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.