Venator Materials PLC (NYSE:VNTR) Q2 2020 Results Earnings Conference Call August 4, 2020 8:00 AM ET
Jeffrey Schnell – IR Director
Simon Turner – President, CEO
Kurt Ogden – EVP & CFO
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Conference Call Participants
Tom Glinski – Goldman Sachs
David Begleiter – Deutsche Bank
Mike Leithead – Barclays
Adam Bubes – Jefferies
John McNulty – BMO Capital Market
Luke Washer – Bank of America
Matt Skowronski – UBS
Eric Petrie – Citi
Arun Viswanathan – RBC Capital Markets
Steve Haynes – Morgan Stanley
Hassan Ahmed – Alembic Global
Good morning, and welcome to the Venator Second Quarter 2020 Earnings Call. All participants are will be in listen-only mode. [Operator Instructions] Please note that this event is being recorded.
I would now like to turn the conference over to Jeffrey Schnell, Director of Investor Relations. Please go ahead.
Thank you, Chris. And good morning, everyone. I’m Jeffrey Schnell, Director of Investor Relations for Venator Materials. Welcome to Venator’s second quarter 2020 earnings call. Joining us on the call today are Simon Turner, President and CEO; and Kurt Ogden, Executive Vice President and CFO.
This morning, we released our earnings for the second quarter 2020 via press release and posted the release and accompanying slides to our website at venatorcorp.com.
During this call, we may make statements about our projections or expectations for the future. All such statements are forward-looking, and while they reflect our current expectations, they involve risks and uncertainties and are not guarantees of future performance. You should review our filings with the SEC for more information regarding the factors that could cause actual results to differ materially from these projections or expectations. We do not plan on publicly updating or revising any forward-looking statements during the quarter.
We will also refer to non-GAAP financial measures, such as EBITDA, adjusted EBITDA, adjusted net income, free cash flow and net debt. You can find reconciliations to the most directly comparable GAAP financial measures in our earnings release, which has been posted to our website.
It is now my pleasure to turn the call over to Simon.
Thanks, Jeff. And good morning, everyone. Before we begin, I’d like to express my gratitude on behalf of Venator to the individual and collective efforts of our associates over these past months. Because of these efforts, our corporate and business functions are running well, while our manufacturing activities continue to reliably serve our customers, and our safety performance continues to improve.
Let’s begin on Slide 3. Venator delivered $37 million of adjusted EBITDA in the second quarter, notwithstanding the significant challenges caused by COVID-19. Company-wide, our sales volumes declined 19% compared to the prior year period, primarily as a result of the pandemic, and we continue to deliver on our cost initiatives, which helped mitigate the headwinds from lower demand.
As I mentioned last quarter, we had some structural advantages against the impact of COVID-19, which helps insulate our exposure in the quarter, namely our higher contribution in plastics and food packaging applications and the resilience in our color pigments and timber treatment businesses. We also delivered $18 million of free cash flow in the quarter.
Turning to Slide 4. At the onset of COVID-19, we immediately focused on protecting the health and safety of our people and the reliability of our assets. We enacted a range of safety measures at our manufacturing sites and instructed most of our office-based employees to work from home. We created a COVID-19 steering group to manage all critical facets of our business and meaningfully enhanced communication and transparency throughout the organization.
We also took meaningful steps to improve our liquidity and made progress towards our target of returning to positive free cash flow. Specifically, we reduced our cash uses, including reducing our expected capital expenditures to approximately $60 million for 2020 compared to $115 million last year. And we maintained an aggressive stance towards managing our working capital with strict inventory controls.
We delivered $11 million of cost benefits in the quarter, consisting of approximately $7 million of our COVID-19 cost initiative and an incremental $4 million benefit from our business improvement program.
We reported $18 million of positive free cash flow due to careful working capital management, and we bolstered our liquidity, which at the end of the quarter stood in excess of $450 million.
We are encouraged by the phased reopening of economies across the globe and the cadence of sales trends throughout the quarter. That said, we remain cautiously optimistic on the pace of recovery and believe the path will be uneven.
From an operational stance, the close collaboration we have with our customers and suppliers and our modular multi-line production network gives us the flexibility to respond to prolonged uncertainty in the supply chain and economy.
We remain committed to improving our costs and delivering on our objectives. I believe our robust response, committed and experienced associates and clear strategy will withstand the unique challenges that COVID-19 has presented.
Turning to Slide 5 and our cost programs. Strengthening our business and improving our cash flow is our top financial priority of Venator. We remain on track with our priority of improving our cost competitiveness.
We delivered $7 million of cost benefits from our COVID-19 cost initiative and continue to expect to deliver more than $20 million for the full year compared to 2019, helping to mitigate the impact of the pandemic.
We delivered $4 million of benefit from our 2019 Business Improvement Program in the second quarter and approximately two thirds of our annual target of $13 million in the first half of 2020. And we have identified $10 million of cost and operational efficiencies within our color pigments business, which are incremental to savings from our 2019 Business Improvement Program.
While I am pleased with the execution thus far, we have an unrelenting focus on improving our cost competitiveness. We are currently developing other initiatives to improve our cost profile, which we expect to announce and implement as we complete the initiatives associated with our 2019 Business Improvement Program.
Turning to Slide 6 and our Titanium Dioxide segment. Titanium Dioxide volumes declined by 16% compared to the prior quarter, within the 15% to 20% range we provided on our first quarter earnings call.
TiO2 volumes declined by 21% compared to the prior year period. Our average TiO2 price remains stable sequentially for the sixth consecutive quarter, highlighting one of the benefits of our customer-tailored approach.
Looking at our business regionally. On a relative basis, Asia and North America were the most resilient regions in the quarter, followed by Europe, which is also our largest market for TiO2. Europe was impacted by the most restrictive policy responses to the pandemic, and therefore, the result was generally expected. Our average TiO2 price remained stable on a year-over-year and a sequential basis in all regions.
In the second quarter, we generated $35 million of adjusted EBITDA in our Titanium Dioxide segment compared to $55 million in 2Q ’19 and $46 million in the prior quarter. The impact on demand from COVID-19 was the largest driver of the decrease and was partially offset by our cost reduction initiatives.
Turning to the outlook. COVID-19 continues to create significant uncertainty. Yet we were encouraged by the cadence of sales volumes through July and our order book. In the third quarter, we expect sales volumes to be modestly better than the second quarter of 2020 and prices to remain stable.
Though demand for many applications has improved, we continue to see weakness in textile demand, impacting our specialty TiO2 business. This has a relatively limited impact on our total volume. However, the contribution margin is higher than our functional and differentiated TiO2 and, therefore, will adversely impact earnings in the third quarter.
Additionally, we have taken further action to manage our production network to better align with demand and control our inventories. In the third quarter, we will contend with margin pressures associated with reduced operating rates, albeit with a corresponding inventory reduction. We expect to partially offset these headwinds with the incremental benefit from our cost initiatives.
COVID-19 had a significant impact on the demand for our products in the second quarter. The timing and trajectory of the recovery remains uncertain. The actions we are taking now will better position Venator to benefit from what we believe are favorable long-term fundamentals for TiO2.
Turning to Slide 7 and Performance Additives. Revenues declined 15% compared to the prior year period. Sales volumes declined 16% compared to the prior year period and 11% sequentially, primarily due to lower demand related to COVID-19. The average price rose modestly in the quarter due to favorable product mix in our color pigments and timber treatment businesses.
Softer demand for automotive coatings and construction end-use applications led to lower volumes in our functional additives and color pigments businesses. We saw relative strength in demand for our timber treatment business as DIY trends in North America remained resilient. Pricing in color pigments improved as we improved our mix, and we saw higher demand for our coatings, plastics and specialty end-use applications compared to products used in nonresidential construction.
The Performance Additives segment generated $13 million of adjusted EBITDA in the second quarter, down $3 million compared to the prior year period. This was primarily a result of low demand due to COVID-19 and partially offset by our self-help initiatives, lower cost and the impact on price from favorable mix.
Notwithstanding COVID-19 in the first half of 2020, the Performance Additives segment delivered an improvement in EBITDA compared to 2019, primarily due to our self-help measures. We are taking meaningful steps in our Performance Additives segment to improve the profitability of the segment.
As I previously announced, we have identified $10 million of cost and operational efficiencies within our color pigments business, which are incremental to savings from our 2019 Business Improvement.
As in our TiO2 business, the ultimate trajectory, pace and timing of the recovery remains uncertain. In the third quarter, we expect demand and pricing for our Performance Additives segment to remain stable compared to the prior quarter with differences by product and application.
Additionally, we expect margin pressure from reduced operating rates, particularly in our functional additives business as we adjust our production and manage our inventories.
I will now pass the call over to Kurt to discuss our financials. I will then return to provide some additional comments. Kurt?
Thanks, Simon. Let’s turn to Slide 8. In the second quarter, total adjusted EBITDA declined $24 million compared to the prior year period and $20 million compared to the first quarter of 2020. The decline compared to both periods was primarily attributable to lower volumes as a result of lower demand due to the effects of COVID-19 and partially offset by lower costs and the benefits from our Business Improvement Program and our COVID-19 initiatives.
Turning to Slide 9 and our cash flow bridge. In the second quarter, we generated $18 million of positive free cash flow. This was primarily due to efficient working capital management as we aligned our production network to meet demand with a strict focus on inventories.
At the end of the second quarter, total liquidity was $453 million, consisting of $188 million in cash and $265 million of undrawn availability under our asset-based revolving lending facility. We do not have any significant long-term debt maturities until 2024.
On May 22, we successfully completed an offering of $225 million in aggregate principal amount of senior secured notes due in 2025. The proceeds of the offering were used to repay borrowings under our ABL facility and for enhancing our liquidity position. At the end of the second quarter, net debt totaled $769 million.
As Simon has stressed, improving our cash flow is a top priority for Venator. Let me address the individual line items provided on the slide. Our outlook for capital expenditures in 2020 remains $60 million, $46 million of which was spent in the first half of 2020. This is a reduction of nearly 50% compared to 2019.
We generated a modest source of cash from working capital in the second quarter and expect a modest source of cash for the full year 2020. This is subject to market conditions and other factors, but we are highly focused on managing our inventory levels.
Cash restructuring in 2020 is unchanged versus our prior estimate at $15 million to $20 million. Other cash uses in 2020 are expected to be approximately $75 million, primarily consisting of pension obligations, joint venture capital expenditures and legal fees.
In 2020, we expect cash taxes to be less than $5 million, and our adjusted effective tax rate to be 15% to 20% in the long term. Additionally, cash interest is expected to be $40 million to $45 million.
Our Pori-related expenses are expected to total approximately $15 million in 2020 and down from an outflow of $64 million in 2019. We recognize the importance of improving our cash flow and remain intensely focused on reducing our costs and minimizing our cash uses.
We continue to assess the impact of COVID-19 on our business and liquidity, and we’ll continue to further address our cash uses as appropriate. We believe we have ample liquidity to weather the pandemic and position Venator to deliver sustainable free cash flow.
With that, I’ll turn it back over to Simon.
Thank you, Kurt. Turning to Slide 10. Our second quarter results demonstrate the value of our customer-tailored approach and execution on our self-help measures. Our business performed well, notwithstanding unprecedented global economic conditions. In the third quarter, we expect volumes to be modestly better and price to remain stable.
We expect further benefits from our cost initiatives to be offset by lower fixed cost absorption and lower contribution from our specialty TiO2 business. Our focus is on servicing our customers, closely managing our production network and working capital, executing on our cost initiatives and protecting the safety of our employees and our assets.
Irrespective of COVID-19, our 5-pronged strategy remains as follows: we are committed to our customer-tailored approach in both our TiO2 and Performance Additives segments. This balance has the anticipated effect of reducing margin volatility and improving visibility for us and our customers. We are focused on strengthening our leadership position in specialty and differentiated TiO2 as well as improving the mix in our Performance Additives segment.
We are unwavering with our self-help actions, which are aimed at enhancing our competitive position in all our businesses. We took decisive actions with our COVID-19 initiatives and currently are in the latter stages of delivering on our 2019 Business Improvement Program. We will continuously assess the need for further cost initiatives to enhance our competitiveness, and we expect to have more to discuss on this front later this year.
We continue to have a relentless focus on reducing our cash uses and improving our free cash flow. As Kurt mentioned, we delivered positive free cash flow in the second quarter and our expected cash uses in 2020 will be significantly below that of 2019. We continue to target a further reduction in cash uses this year and beyond.
We are fully committed to maximizing shareholder value through active portfolio optimization. We plan to continue exploring a potential sale of the color pigments business. However, the process remains on pause due to COVID-19. In the interim, we remain committed to enhancing the profitability of this business.
The uncertainty created by COVID-19 has tested our resolve but has not deterred us from executing on our strategic priorities. I’m encouraged by the phased reopening of economies. We cannot predict the timing or shape of the recovery but expect it will be uneven regionally and by application.
Our focus is on delivering our cost actions to mitigate the impact of the pandemic and better position Venator to meet our customer needs and create long-term value for shareholders.
With that, we thank you for your continued interest in Venator and would now like to open the call for questions.
Thank you very much. [Operator Instructions] Our first question is from Bob Koort of Goldman Sachs. Please go ahead.
Thank you. Hi, everyone. This is Tom Glinski on for Bob. So first question, could you just touch on TiO2 demand across the North American, European and Asian markets? I guess what did demand look like across the second quarter? And how do you see that trending through July and into the third quarter?
Sure. I’ll pick up on that, and I will start with 2Q, as per your question. Firstly, I think I’d like to make the point that on our previous call, we forecasted 15% to 20% of compression. We came in at 16%. We had some visibility at that time, which is somewhat more challenging in the third quarter. I’ll come back to that.
But in the second quarter, we continue to see some signs of recovery in China, but weak domestic demand. And that’s something that was very clear in the second quarter. And across Asia, much of which was in lockdown, we saw a fairly sort of mixed and uneven recovery in the second quarter.
In the US, we saw weaker architectural coatings with fairly resilient plastics. And in Europe, we saw lower demand for coatings and paper with plastics holding up a little bit better.
So I think we made the point on prior calls that our diverse product slate and our segmentary mix gives us some sort of like protection, which we saw in the second quarter embodied in that negative 16% result.
So I think that further comments, we could say about the third quarter would be that, well, first off, we did see the cadence of sales improving in the second quarter. June was the best month in the quarter. And I will tell you that July has improved upon June.
We are a little bit cautious about the remainder of the third quarter. And the macro issues for us are, a, our biggest market is in Europe, where traditionally, of course, in August, we see a holiday period dip and some uncertainty around the September month, which is the traditional pattern, although that will be likely somewhat different this year.
In addition, for us, we continue to take on some stressed headwind in our textile segment of our specialty business. And that’s why we are saying that while we will see a better sales volume in the third quarter, it will — you should think about it as modest or incrementally better rather than a rapid bounce back.
I think we are seeing recovery, we are seeing the start to gradual recovery, but we shouldn’t forget that we did dip quite significantly within the second quarter. And obviously, our results, both on a year-on-year or sequential basis are driven mainly by that volume hole.
Maybe a few other comments of color in the third quarter. It’s true to say that we do see further recovery in China, but we should not forget, of course, that there is quite a bit of stock in the system, there will be some destocking. Prices dropped quite significantly in China. So there will be some attempts to rebuild them.
In the United States, in the third quarter, we expect to see stronger recovery in architectural coatings, although, and to my earlier point, Venator is not the largest in North America, and we expect to see demand improving as construction restarts. In Europe, we expect to see further architectural coating recovery as evidenced in July, and we expect to see plastics remain resilient.
That’s great. Thank you. And then second question, what are you seeing from a raw material standpoint in the TiO2 business across the regions? Have you seen any inflation in recent months or have conditions remained more or less stable? And how do you see that playing out into the second half? Thank you.
Yes. I think that the answer to the question isn’t predominantly driven by regions, although I will pick out from a geographic standpoint that we would acknowledge there have been some material sort of ilmenite-based increases within China.
We don’t buy that ilmenite, neither do we manufacture TiO2 in China, but we have seen prices tick up for ilmenite in China, and that has also stimulated further the need to get the local prices up within China.
That aside, my comments now reflects more global dynamics in TiO2 rather than any regional specifics. But firstly, we can confirm that outside of our feedstocks, we continue to see tailwinds in energy, in categories like caustic and sulfur and sulfuric acid and other non-ore material. That is continuing, and we expect that to continue through the second half.
I think as it relates to ores, the point’s been made a number of times over the years that the feedstock industry tends to lag the TiO2 industry by anything between 3 to 6 months depending on the feedstock family, when there is a downturn in demand for TiO2, we’ve seen this back in ’08, ’09.
We saw this somewhat in the back half of 2018. And certainly now, we’ve seen this big downdraft of demand for TiO2. So we would expect to see downward pressures on raw material type families gradually come in. Of course, current stock we have on hand has been subject to those headwinds of raw materials. So that’s why we’re agitating with our customers for – around our pricing and talking to our customers as our price structures.
But there’s no doubt we’d expect to see prices come off in the ores gradually over this next period. And we expect to see high-grade feedstocks come off less than low-grade feedstocks, and low-grade feedstocks are the ones that Venator is more aligned with. So hopefully, that’s a picture around the raw material.
Awesome. Appreciate it.
Thank you. The next question is from David Begleiter of Deutsche Bank. Please go ahead.
Hey, this is David Huang here for Dave. I guess, first, just given these cost actions and stable pricing you’re expecting, how should we think about the incremental margins in second half and ’21 as demand recovers?
Well, I think let’s first say that in our world, at the moment, ’21 feels a long way off. So I really don’t think it’s appropriate at this time to be addressing our commentary towards 2021. But clearly, we’ve gone through the midyear point of this year. We have seen a 25% destock in the second half of 2018 and a 20%, let’s call it, sort of downdraft in the second quarter of ’20.
So in the world of TiO2 demand destruction, there’s pretty big events in a very short period of time. We have kept our pricing stable these past 6 quarters, and we spoke in our prepared remarks around the likelihood of being able to retain stability in this third quarter we are now. And that would bring stability to 7 quarters.
And that is because we have been very clear with our customers about what they expect to take from us, us holding them to that, at what price point, and that’s only manufacturing products and strictly controlling inventories, and we have managed to bring inventories down in the second quarter and make sure that we always keep our inventory position in a good state for any uptick. So I think that, that’s the outlook in the third quarter for price. You can expect more price stability.
As it relates to raws, I’ve said that we expect some of the feedstock to come off, but they’re at different rates. And certainly, non-feedstock items to start coming down. So if you think about the contribution margin in this next period, it’s positive. But one shouldn’t forget, of course, that, for us, in Venator, we’ve got two factors that we’ve got to contend within the third quarter.
One is the fact we do see a sort of outsized pro-rata impact on our specialty business because of the weakness in textiles. We will continue to trim our inventories in the third quarter. We only moderated part of the quarter in the second quarter, and that will be more fulsome in the third quarter.
So there will be some fixed cost absorption issues we can – and as we further trim our inventories in the third quarter. So the contribution margin, that looks positive near term, but hold on to the fact that we do have some other pressures as well.
Okay. And then do you still expect the normal seasonality in both of the businesses this year?
Yes. Look, that’s a great question. I mean, seasonality, how does that bear on this year against other years? I mean it’s a pretty well-known seasonal sort of pattern in TiO2, that over the years, 2Q has been better than 3Q, which has been better than 1Q, which has been better than 4Q and that most years is how it plays out.
In our Additives segment, we can say that half 1 is greater than half 2. It has been the traditional pattern and slightly more seasonal, if you like, than even the TiO2. So those have been the patterns. I think that we could expect to see in Performance Additives that pattern in the second half, we’re going to see some stable volumes and prices in the third quarter.
But in TiO2, I think where the heart of your question is, we would expect to see for — the first time for some time, an increased volume in the third quarter as against the second quarter. So that would buck the seasonal trend.
At this point, it is very hard to comment on the fourth quarter. So I should refrain from doing so because it is such an unusual area in any flare-up or choppiness in COVID and lockdowns or regional localized lockdowns but could distort the picture. So I think those might be the comments I’m prepared to volunteer.
Thank you very much. The next question is from Mike Leithead of Barclays. Please go ahead.
Thanks, guys. Good morning.
First question on TiO2. I think your very helpful color in terms of talking about 3Q volumes, modestly better than 2Q and kind of calling out some of the mix headwinds from textiles, so I mean, I guess, when you kind of add these up, would – do you think TiO2 sequentially should be up flat or down versus the second quarter as we sit here today?
At the earnings level?
Yes. EBITDA, yes.
Yes. I mean, look, I think that ordinary, of course, with some modest volumetric increase, we’d hope it to be up. But realistically, I think that despite the good efforts of further cost initiatives and the further delivery of our existing cost initiatives, I should say, the impact on the specialty because of the margin impact for textiles, combined with – we’ve got a bit of softness in autos and our Additives segment, combined with really the fixed cost absorption issue are going to sort of outweigh and pull that down.
Got it. Fair enough. And then I just want to clarify. I think you said in the prepared remarks that there will be lower operating rates or fixed – higher fixed cost absorption that will sequentially hit margins. Is that correct?
That’s correct. Yes. And let’s be clear, it’s lower fixed cost absorption, right? So more of the costs flowing through the P&L.
Yes. Sorry. I guess just a bit confused by that because I would have thought 2Q would have been the max pain point in terms of utilization rates. So I mean was there some inventory mismatch in the second quarter or can you just kind of help triangulate that for me?
Sure. I mean, there is two factors that really drive that. The first is that, as you know, the pandemic and the lockdowns and so forth didn’t all occur overnight in all geographies at the same point. So this situation evolved. And these are big, heavy industrial assets that need to be planned and prepared to be moderated. We don’t — we can’t do that on a sort of like with a very short notice.
So there’s a sort of setup phase, which means that the moderation of our asset circuit within the second quarter did not occur for all months in the quarter. More of it occurred in sort of the May or June period than did in the April period, for instance.
Given the fact that we’ve got this ongoing weakness in our textile segment for specialty and given we’ve also got the ongoing weakness in auto for our functional additives, we’ve had – you should think about the third quarter as being more like a full quarter’s impact of moderation plus a bit more extension of the moderation to cope with the specialty challenge, and we will further trim our inventories as a result. So we will lose on the SG&A side of the ledger, but we will gain on the cash side of the ledger, and we will position ourselves well as well.
So that’s the way I characterize. It’s a little bit counterintuitive. I wholly understand your point. And while we expect improvement in the third quarter, don’t forget that the second quarter dipped quite significantly, and that third quarter improvement isn’t – hasn’t taken us back up to those levels. So utilization rates are still lower than we’d like them to be.
Got it. Thank you.
Thank you. The next question is from Laurence Alexander of Jefferies. Please go ahead.
Hi. This is Adam Bubes on for Laurence Alexander today. So my first question just around cost improvement initiatives. There’s quite a few in place: the $40 million improvement program, the savings target and color pigments and then the coronavirus-related savings. If you could provide any color into what the more sustainable cost cuts have targeted here?
Sure. Look, the – to your point, around the range of initiatives. We have 3 distinct buckets that we’ve called out in the published materials and which we talked about.
Let’s start with the $40 million Business Improvement Program, the 2019 BIP, B-I-P. The activities that we have been reporting back on every quarter this past 18 months will continue and close as we close 2019, and that will give us the full run rate of sustainable benefits in 2021. So we expect the full $40 million run rate in 2021.
In terms of the color pigments business, we will not be achieving the $10 million we spoke about in 2020. Those will kick in from 2021. But those, we see sustainable business benefits. So think about the $40 million plus the $10 million as sustainable ongoing business benefits, think about the COVID savings, which we’ve described as greater than $20 million on the chart materials.
You will have noted that we delivered $7 million of that in the second quarter. We have been quite careful to position this $20 million to think about it when we first shared it with you as a sort of onetime type of benefit.
However, in line with many other companies, as we look at the effect of the pandemic, both near and far, and we are trying to see how much of that $20 million we can convert from a sort of onetime benefit into an ongoing sustainable benefit. And there will be an amount of that $20 million that we believe will carry forward and will be repeatable into next year.
Now we’re not prepared to dimension this at this time. But what we have said is when we come back later this year with sort of like our assessments and announcements on the further activities that we will look to improve in our company or our cost structures then at that time.
We will confirm how much of that sort of $20 million is going to be sustainable and how that fits into our broader program, recognizing that the 2019 programs coming to an end at the end of this year. So hopefully, that helps sort of like you through that question.
No, that’s very helpful. And then so my question — second question is on pricing. Wondering in the current pricing cycle, what the proper way to think about the interaction between raw materials and prices are, all else equal?
So if there is a tailwind in raw materials, for example, do you expect to keep that? And sort of what is the timing around raws and when they impact pricing?
Yes. So we’ve got to be a bit careful about speculation about raws with specifics, but I can give some remarks to that. I mean, look, in the second half, in the third quarter, we’ve spoken about keeping prices stable for TiO2. We expect some further tailwinds. So there will be some opening up of the contribution margin within the third quarter.
But you shouldn’t, of course, forget that the net margin level, shouldn’t forget that we have these fixed cost absorption and specialty challenges, which will eat into our third quarter earnings.
But you’re quite right, directionally, of course, one would hope to hold on to any margin opening with customers we plan to because we have onboarded over these past two years significant headwinds into our inventories, and we expect in our communications and dialogue with our customers to be rewarded for that in our price. So that’s the nature of the dynamic, which your question points at.
Okay. Thank you very much.
Thank you. The next question is from John McNulty of BMO Capital Market.
Yeah. Thanks for taking my question. So I think earlier in the call, you spoke to inventories in Asia being a little bit on the lofty side and needing to get worked down. Can you give us some color as to how you see the inventory in the other two major regions in Europe and the US?
Yes. I mean, look, I think from our point of view, we’re better positioned to focus on inventory levels in the U.S. and Europe because we’ve got a much larger position in those geographies collectively than we do have in China where we only send in some tens – nominal tens of thousands of specialty and differentiated materials.
But clearly, there has been a lot of weakness in demand in China. There has been sort of more stock built, so we expect to see China destocking through the third quarter. And I think that’s the sort of important calibration point. Outside of China, though, and as we look in Europe and North America, I mean we know from our own perspective, and of course, we can only talk on behalf of Venator.
But we have been very, very focused on ensuring that our inventories would always be at a point where should any meaningful demand improvement eventuate, stock would not be freely available. We believe in dialogue with our customers, of which there is a lot, that in fact, they are not carrying excess inventory.
I think in North America and in Europe, they’re probably carrying inventories that are sort of down the middle of a fairway. But in some cases, anecdotal, we’ve heard of some customers actually undercarrying inventory, and in fact, needing a bit more product than they expected to have from us.
And if we listen carefully to some of the comments made by the larger coatings enterprises, both within the United States and in Europe, we have reason for encouragement here in the early third quarter that stocks are more at a sort of like normalized level than at any high level, which is somewhat different to China.
Got it. No, that’s hugely helpful. And then on the color pigments, $10 million kind of incremental savings program, how much have you gotten year-to-date? Like — and — because it sounds like you expect to get the bulk of the benefit of the run rate in 2021. So how much are you actually seeing at this point?
Yeah. So there is none of the $10 million in the 2020 results, and let’s to be clear about that. However, there were some color pigment-based activities, nominal number in the 40 that was a part of the Business Improvement Program, but it’s a very nominal amount.
Got it. And the $10 million that you get starting in 2021, I guess, when do you kind of flip the switch and actually – and it actually starts to really roll through? How should we be thinking about that? Is it kind of January 1 type thing or – because it does seem like it’s on the come, but it’s just – it’s not crossing the finish line yet. So just curious how and when we see that really start to kick in?
Yes, that’s going to gradually build up in the 24 months after January 1. It’s not going to be a sort of flick-switch type of one big project there it goes. It’s a number of smaller initiatives. You’re going to see that building up, and as we have been doing these past – ever since we’ve been public, we will break out and share with you the fruits of our cost initiative labors at each and every turn to make sure that you have a clear view of that. But that’s the way I would think about that.
Got it. Thanks very much for the color.
Thank you. The next question is from Steve Byrne of Bank of America. Please go ahead.
Hi. This is Luke Washer on for Steve. I wanted to talk about kind of the Chinese market and kind of where you’re seeing product. I know you talked about domestic demand was weak in the second quarter and has improved a bit similar to prices. But we started to see some of the TiO2 exports into Europe.
So I was just curious kind of where your TiO2 exports from China going into Europe and how that’s going to impact the European market? Or if that slows down a bit as China demand improves?
Yes. Look, I mean, there is no question that we have seen exports in the first quarter of this year tick up quite considerably from China based on the fact that local demand conditions have been very, very weak. And I think we saw something like over 30% increase in exports in the first quarter.
But that has come off significantly in the second quarter, unsurprisingly, which means now on a year-to-date base, I think that it’s — the number is more like 15%. So it’s come down significantly in the second quarter.
The pattern of those exports has been largely the same as we’ve seen now for some time, i.e., emerging economies, Latin America, parts of broader Asia, some into the Middle East, et cetera. And the pattern has been more limited amounts of those products flowing into both Europe and North America.
So we don’t really see at this point a fundamental difference with the exports into Europe and North America, and we’ve been managing these past 5 or 6 years. It’s entirely manageable. Yes, there are exports. We’re certainly not getting overrun with them. Yes, there’s a little bit more chloride now.
But as demand recovers in China and as lockdown recoveries more broadly in Asia kick in, we’d expect to see that pressure subside a little bit. There’s still going to be exports into – out of China, but probably normalize more around the 1 million ton mark.
Thank you. And looking into 3Q, you mentioned that your Ti02 volumes are looking to improve sequentially and prices will remain stable. Is this fairly consistent across regions? Or is there a disparity there, both on the price and volume side?
Yeah. I mean, I think on the pricing side, I think, there’s no real disparity. That’s — let’s say that. Certainly on the volumetric side, as we said in our prepared remarks, I mean, the US, we’re starting to see some real sort of like better sort of recoveries being generated in the US in the third quarter.
So we are – one of the smaller positions is in the United States. So we won’t benefit from that as much as some of our larger US competitors. However, we expect to see the encouraging recovery in Europe, continuing us to be the beneficiaries of that.
So I think that we see – definitely, we see some recovery in China. We definitely feel quite encouraged by what we see in North America. We spoke about architectural coating recovery and resilience plastics.
And in Asia and China, I think that there can be some slower recovery because the way that countries emerging out of lockdown or sort of having local flare-ups and going back in is a little bit more spotty. So we don’t see it – I’d pick that one out geographically as maybe not being quite as strong.
Got it. Thank you very much.
Thank you. The next question is from Josh Spector of UBS. Please go ahead.
Good morning. It’s Matt Skowronski on for Josh. Can you talk about the inventories in Performance Additives, the supply chains there? And if there was a recovery, would these inventories kind of be meaningful for demand recovery?
I think as a broad situation, our inventories in most parts of that business, the segments and different sub-businesses within Performance Additives, you should think about as sort of normalized. There are one or two differences.
And the one I would pick out is in our functional additives, which is made in Europe and a significant amount goes into automotive. We will – that is part of the moderation program in the third quarter. So that will be one where we do need to trim a bit more. But – and the rest, I should think about as normalized.
Thank you. And then you mentioned textile demand as a headwind for mix. If things were kind of to return to normal demand patterns, how meaningful would that be to bottom line? Or would we not notice it?
Well, what is normal? It’s a great question as that’s highly speculative. Look, I think the best thing we can say about that is this. We’ve had this range of challenges. We’ve seen in this industry now for these past 2 or 3 years.
All through this, we’ve been absolutely unswerving on the tailored approach with our customers, stable pricing and lower and more stable inventory levels. So that is a good thing that positions us well for any uptick.
We rapidly navigated the challenge of the pandemic by a whole range of measures on our temporary actions, our cash and working capital focus, our capital expenditure reductions and so forth. So we did the right things there to strengthen the business and navigate through it and position well.
But through all this, industry fundamentals remain intact. No one’s building any new capacity. Others, we believe, are moderating inventories and controlling inventories, and at the first sign of a proper demand recovery, I guess, we can debate what normal means, of course, we stand to benefit significantly from the upside leverage that, that would bring.
Thank you, sir. Next question is from PJ Juvekar of Citi. Please go ahead.
Hey, Simon, it’s Eric Petrie on for PJ.
Your TiO2 volumes were in line with guide, down 16% quarter-over-quarter. How does that split between your coatings, plastics and specialty grades?
Yes. So look, I think we’re not – we won’t be prepared to break that out numerically, but we can – we could probably give you a bit of color on that. I think from a specialty standpoint, I think we made the point in the second quarter already that we have been seeing some headwinds with our specialty business, notably in our textiles, and that’s going to continue in this for us. So I think it’s probably fair to say that of all those buckets you mentioned, that’s been the one that’s been the most challenging.
And I think broadly speaking, I would say where we are right now, year-to-date, let’s call it, third quarter, in terms of coatings and decorative coatings and plastics, I’m not sure there’s really that much difference in aggregate between the difference between the two.
Certainly, we saw in the first – earlier stages in the second quarter, plastics was a bit more resilient. But I think what we’re seeing now in the third quarter is architectural coatings coming back. And we have seen that more down in North America and Europe.
Helpful. And then secondly, a few questions on Pori. Of the $60 million CapEx being spent, how much of that is related to the transfer of specialty and differentiated products?
And secondly, I believe you have roughly $100 million of project closure costs to be spent after this year. So how should we think about the cadence of spend?
Yeah. Eric, this is Kurt. As you know, we continue to try and look for ways to optimize the transfer or the remaining transfer of the specialty business out of Pori. And that includes tackling the remaining $100 million that we have out there.
And so as we look at the spend that we have this year, that does include a pretty good portion of the transfer of the business as well as wind down, and it is a mix of both of those costs. But we continue to look for ways to optimize that. And hopefully, we’ll begin – we’ll have the ability to whittle that total aggregate cost down here as we move forward.
Thank you. The next question is from Arun Viswanathan of RBC Capital Markets. Please go ahead.
Great. Thanks for taking my question. Just wanted to get your thoughts, I guess, on supply, demand, given that level of elevated inventories that you’re seeing maybe in Asia slightly. If there is any potential for pricing later in the year? And also, maybe you can put that in the context of the raw material outlook as well. Thanks.
Yes. Look, I mean, I think in China, we said that we do see inventories to build. We do see destocking through the third quarter. So potentially, that stock gets drawn down during the third quarter. And there is already some dialoguing there with customers around the need for higher prices. Prices have fallen quite significantly within China. And there has even been some price discussions outside in broader Asia.
I think it’s a tough question right now of all times because as we earlier said on the call, we’re sort of counter-seasonal in the 3Q against 2Q. It’s sort of swapped the normal way around as the other way around.
And frankly, the fourth quarter, at this point, you’d have to be pretty brave person to sort of have a confident definitive view on it. So I think you back down to this point of – we’re very well poised with our inventories. Yes, we’re going to get a little bit of relief on raw materials, but we’ve onboarded it for 2 years, and we still are discussing the need for higher prices with our customers.
So it really comes down to at the first sort of like sensible point of sustainable demand recovery that we are back on that price discussion. That’s probably about the most we could say at this point. I think the rest is too speculative, frankly.
Chris, we can move to the next question, please.
I’m sorry. Sir, my line just disconnected. I’m reconnected now. Next question is from Vincent Andrews of Morgan Stanley. Please go ahead.
Hi. This is Steve Haynes on for Vincent. Thanks for taking my question. Just wanted to ask a quick one on the year-over-year EBITDA bridge. There’s a $17 million benefit, I think, from cost of goods sold. You may be just bucket that out, how much of that is raws? Just any additional color there would be helpful.
Sure. This is Kurt. So as Simon had mentioned, we had $7 million of COVID initiative savings in the quarter, and that really compares to the prior year, but a good portion of that also compares to the prior quarter. And you see that manifest both in that COGS stack of $17 million as well as in the SG&A. So it really manifests itself a couple of different places on the bridge.
We haven’t traditionally broken out detail beyond ores and or raws and other movements. But it certainly — as you can imagine with the benefits of lower energy, that is showing up in that COGS stack as well as some of these other raw materials that we have that Simon alluded to earlier.
Okay. Thank you.
Thank you very much. The next question is from Hassan Ahmed of Alembic Global. Please go ahead.
Morning, Simon and Kurt.
Good morning, Hassan.
Question around volumes, TiO2 volumes. Overall, obviously, sequentially, you guys talked about volumes being down 16%, which seems pretty consistent with what some of your sort of global competitors reported as well.
What I’m trying to figure out is that as I look at that volume figure regionally, and even by end markets, did you guys see any material sort of market share shifts, like I said, be it by region or be it by end market?
Yes. I mean, look, Hassan, obviously, we would not want to lose position in our markets, of course, definitely, as Venator. But I think you can see that our priority has been unswerving on this stabilizing of price and managing our inventories. And that really speaks to stability more than anything. Those sort of like numbers don’t happen if you’re sort of out there gaining or losing share or moving it around.
So really from our standpoint, we’ve really been focused on our marketing plan, on our customer-tailored approach there to deliver the benefits. I think the only thing we would say, we sort of like went in very clearly at the end of our first quarter to say what we thought it would be for the second quarter. We didn’t see that much difference by geography.
What I would say though is, clearly, we were disappointed with some of our specialty volumes in the second quarter because that’s I call the textiles one out. So certainly, other sectors held up well. Plastics held up better in the beginning, but now coatings is coming back more.
So really, I think that from Venator’s standpoint, we’ve just been very disciplined on sort of holding our position but making sure we more importantly that our pricing and our inventory mix is balanced, is very well struck.
Understood. Understood. And as a follow-up, on the ore side of things, it seems like a very, very different sort of environment relative to, I guess, the run-up to the COVID lockdowns and the like. I mean it seemed that pricing was gaining momentum through the course of 2019, maybe even into the sort of January, February 2020 time period.
And again, in talking to a variety of sort of industry players, it seems that even ore availability, particularly on the high-end side of it, was an issue. And now clearly, with the lockdown, volumes coming down on TiO2, you clearly mentioned the lag effect as well. The environment seems to be quite different.
So the question is that, I mean, with all of those puts and takes, I mean, is it fair to assume that inventory levels for ore may be actually quite bloated, and we may actually see a fairly meaningful destock over there?
Look, I think in the aggregate, very high level, the picture you paint there, Hassan, is about spot on because already these sort of price moves are running out of steam in the front end of 2020. As demand drops and operators like ourselves, moderate assets and underlift or don’t lift the sort of like historical volumes of feedstock that we would, then, of course, the supply of the vendor of those materials experiences that as a downdraft in demand destruction.
Of course, minerals enterprises find it quite difficult to shed fixed costs or moderate in the same way that we do in our chemical industry. So they do face those pressures. And I think as a result of that, we tend to see this lag where prices then start softening off after — sometime after the drop in demand for TiO2 occurs. And that typically relates to sort of contract negotiation discussion 3 to 6 months.
I think that – I don’t think there’s much different here this time around. The only thing I would say is, of course, the picture per feedstock family is somewhat different. We’ve seen this somewhat localized push for pricing on ilmenite in China. So we’d pick that out. I mean, we still have a fairly broad array of lower-grade choices. And of course, there’s a relatively narrow range of high-grade choices.
But those products still need to be purchased and made. And so I think your point is well made. That’s what we expect to see. That’s what will play out, but it might be slightly different in the different feedstock groups.
Very helpful, Simon. Thanks so much.
Ladies and gentlemen, we have reached the end of our question-and-answer session. I would like to hand the conference back to Simon Turner for any closing remarks.
Okay. Thank you, operator. And thank you to everyone for your interest in Venator. We look forward to speaking to many of you throughout the quarter. In the interim, please reach out to Jeff in a normal way with any additional questions you might have, and we’ll be as responsive as we can to meet your needs there. Thank you. Thank you once again, everyone.
Thank you very much, sir. Ladies and gentlemen, that did conclude this conference call. Thank you for joining today’s presentation. And you may now disconnect.