Ashland Inc. ( ASH) Ashland Analyst Day Call November 15, 2011 08:30 am ET Executives Dave Neuberger - Director, IR Jim O'Brien - Chairman & CEO John Panichella - SVP & President, Ashland Specialty Ingredients Paul Raymond - SVP, Ashland Inc., and President, Ashland Water Technologies Ted Harris - SVP, President, Ashland Performance Materials; and President, Global Supply Chain Sam Mitchell - SVP and President, Ashland Consumer Markets Lamar Chambers - SVP & CFO Analysts Dave Begleiter - Deutsche Bank John Roberts - Buckingham Research Mike Sison - KeyBanc Jeff Zekauskas - JPMorgan Dmitry Silversteyn - Longbow Research Peter Goodson - Eminence Capital Presentation Dave Neuberger
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Please turn to slide 4 for the agenda. Today we have a large number of Ashland senior management team here with us including Jim O’Brien, Chairman and Chief Executive Officer; Lamar Chambers Chief Financial Officer and each of our four commercial presidents; John Panichella of Ashland Specialty Ingredients; Paul Raymond of Ashland Water Technologies; Ted Harris of Ashland Performance Materials and Sam Mitchell of Ashland Consumer Markets.Our program will run until about 12:30. We will start with opening remarks from Jim O’Brien followed by a presentation from Specialty Ingredients and Water Technologies. After a short break, we will return with the presentations from Performance Materials and Consumer Markets. Lamar Chambers will provide a financial review and Jim O’Brien will offer some closing thoughts before lunch. There will be a short question-and-answer period after each commercial unit presentation along with time at the end for any remaining questions that are still outstanding. We will be taking questions from only those present in the room. Lunch will be provided immediately after the last Q&A session in the gathering room next door. Please turn the slide five. Our primary goal today is to review how Ashland is now positioned for growth. As we progress with the transformation of Ashland we’ve completed a number of significant steps and we will elaborate on this throughout the presentation. Perhaps more important, we will also define our 2014 performance expectations for each commercial unit and for Ashland overall. This is a clear departure from the June 2010 Analyst Day when longer-term expectations were built around the concept of the midcycle economic environment. Given the sale of Ashland distribution and the acquisition of International Specialty Products or ISP for short, Ashland has significantly reduced its exposure to cyclical markets and should enjoy stable, more predictable earnings growth. Our 2014 expectations come directly from our three-year operating plans and represent clear targets which we expect to be held accountable. We will also review our current and planned capital structure as well as our views regarding our cash flow expectations, overall capital redeployment and EPS growth.
Last, Jim will conclude the presentation with his closing thoughts. Please turn to slide 6 and I will turn the presentation over to Jim O'Brien.Jim O'Brien Thank you Dave and good morning everybody and thank you for your time this morning. Let’s start on slide 7 with a look at what Ashland looks like today. With pro forma sales of roughly $8 billion, Ashland is one of the world’s leading specialty chemical companies. We are characterized by four key attributes. First, is our strong market positions where we are generally number one or number two in the market. Today, we enjoy leadership positions in such high-margin, less cyclical end markets as pharmaceuticals and personal care. Second, is an overall focus on growth through innovation. Our technology-driven sales process and approach to markets enable us to develop solutions tailored to meet our customers’ needs. Third is our broad application expertise, where our people process deep industry knowledge of both our product and their applications. These insights enable us to create comprehensive solutions to solve our customers’ unique problems. Finally, our fourth key attribute is our significant global presence and increased scale in emerging markets. Today nearly half of our sales come outside the United States and approximately 20% of sales come from the rapidly growing Asia-Pacific and Latin America regions. Our growth in these markets is key to our long-term success and we will preferentially allocate resources to these areas. These four attributes have combined to position us for accelerated growth at margin expansion. You’ll hear about this over the course of our presentation today. So this is how we view Ashland and let’s go slide 8 to see how we got here. When we decided in 1998 to have a minority interest in the Marathon Ashland refining joint venture, Ashland’s transformation was set into motion. We had a number of different businesses at that time all built around refining the marketing core. We knew that once we contributed the core business to the JV, we would have to reinvent Ashland. Our corporate transformation then accelerated when we sold our stake in the joint venture in 2005.
In 2006, we divested the highly cyclical Ashland Paving and Construction subsidiary known as APAC. During this time, we essentially paid down all of our debt, bought back a third number of our shares and paid a substantial special dividend to our shareholders.In 2008, we took a pivotal step forward with the acquisition of Hercules. With this one transformational event, for the first time in our history, more than half of Ashland’s earnings came from the specialty chemicals. Then in March of this year, we sold the cyclical low margin Ashland Distribution business and just five months later acquired ISP. We do think cyclicality has been an overall theme for Ashland since becoming CEO. And this will continue as part of our ongoing strategy. Today, we have four strong businesses that we will invest in and grow. With our transformation now complete, the Ashland stock has moved from an event-based trading model to one more dependent on underlying earnings growth. Let’s go onto the next slide. As part of our Specialty Chemicals expansion strategy, we used a variety of filters shown here to select and target attractive opportunities. All potential acquisition candidates were viewed through this screen. This helped us target the acquisition of Hercules in 2008 as well as the recent acquisition of ISP. Let’s go on to slide 10. With the acquisition of ISP and on a pro forma basis, Specialty Chemicals contribute almost 80% of Ashland’s consolidated EBITDA. This compares with a baseline of 2004 where the majority of our earnings stem from cyclical businesses we chose to exit. At that time Specialty Chemicals made up only 15% of Ashland’s earnings. In addition to our broad business transformation our pro forma EBITDA has roughly doubled over this period going from $600 million to $1.2 billion. Let’s go to slide 7 to look at our geographic makeup over the same period. Geographically, we have become a much more global company. In 2004, the vast majority of our sales were within North America. At that time international markets was a limited focus. Today nearly half of our sales come from outside North America with roughly 20% coming from the higher growth Asia-Pacific and Latin America regions.
Slide 12 shows the tremendous improvement that we have made to Ashland’s overall EBITDA margins. Starting from the low of 3.9% in 2006 we have expanded the pro-forma margins by more than 1000 basis points, largely due to the strategic steps I described earlier. Each of these steps has moved us on and toward our goal of becoming a high performing specialty chemical company.Slide 13 describes the four strong businesses that make up Ashland today. We have three specialty chemical businesses; Specialty Ingredients, the number one cellulosic ethers producer and global leader in PVP; Water Technologies, the number one producer of specialty paper making chemicals; and Performance Materials, the global leader on unsaturated polyester and vinyl ester resins. We also operate in consumer markets of Valvoline business which is the second largest franchise quick-lube chain in the US and also holds the number two spot in passenger car motor oil. Slide 14 shows how these businesses contribute to Ashland’s pro-forma sales and EBITDA. Specialty Ingredients is a combination of our high performing functional ingredients business in the majority of ISP. This newly formed commercial unit is now our largest business contributing roughly 30% of Ashland’s pro-forma sales and more importantly generating more than half of our EBITDA. Specialty Ingredients is also our highest margin business and as we’ll hear from John, this commercial unit is geared for a significant growth. Now let's turn to Ashland’s historical performance on slide 15. This chart shows Ashland’s baseline EBITDA and EBITDA margins. For all periods we have included the results of certain acquisitions such as Hercules and ISP and adjusted for the change in pension accounting that Lamar will discuss later. We have also excluded the results of other transactions such Ashland Distribution. These adjustments provide a clear comparison across all periods and should be a better indication of our ongoing business.
As you can see, Ashland’s EBITDA has been growing steadily; after a very small dip during the recession. This performance was enabled by significant cost reductions, largely beginning in 2008 as well as significant pricing actions taken during the latter half of 2010 through 2011. During these last three years, Ashland’s consolidated baseline EBITDA margins have averaged around 15%. In 2011, this margin fell to 14.5% given significant cost pressures across each of our commercial units.Regarding price, our commercial units has had varied degrees of successes. Two businesses are ahead of costs, Specialty Ingredients and Performance Materials and two businesses had been behind, Consumer Markets and Water Technologies. However, we bring all four businesses together Ashland has kept up with raw material cost increases. As the lagging businesses recover their cost in 2012, we should expand our margins. Let’s go to slide 16 for a look at our 2014 expectations. From 2011 to 2104 we expect to expand EBITDA to $1.7 billion, a roughly $500 million increase over 2011. Shown here are our expectations for each commercial unit’s contribution to that total and the major steps required to hit these numbers. As Dave mentioned, at the outset, each of these targets is based on our internal three year planning process. Our budget and our incentive compensation will be based on these forecasts. This morning our commercial unit presence will describe a detailed plan for reaching these targets. Slide 17, gives you some perspective on where we focused our efforts during the past three years and where we will concentrate going forward. From 2009 until 2011, our activities have primarily revolved around optimizing the business mix. This included a number of divestitures, the acquisitions of Hercules and ISP as well as the formation of the ASK Chemicals joint venture. Now, we are shifting our emphasis from the broader transformation in business adjustment to focus growth in earnings expansion. I believe that we now have all the necessary elements in place to achieve our long term success.
During the next three years, our commercial units will be strongly focused on organic volume growth. This growth will come largely from earnings and regions and our internal product developments efforts. Based on our 2014 targets, our sales and EBITDA should grow at a compound annual growth rate of 7% and 14% respectively.Over the next couple of years, our excess cash will go to build liquidity to ultimately retire our higher interest rate debt. By 2014, these combined actions should lead to an EPS of roughly $9.50 to $10.50 per share. With that, I’ll turn the presentation over to John Panichella to describe Ashland’s Specialty Ingredients plans to achieve its 2014 targets. John? John Panichella Thanks Jim. Good morning everyone. Let’s turn to slide 19. With pro-forma sales of $2.5 billion and adjusted pro-forma EBITDA of $608 million, Specialty Ingredients is a world leader in water-soluble polymers. For fiscal 2011, our pro-forma EBITDA margin would have been nearly 24%. Roughly 40% of sales go into the high-growth, high-margin and largely non-cyclical personal care and pharmaceutical markets. The coatings market contributed 16% of pro-forma sales and generally consists of additives for use in water-based paints. Representing 15% of sales, the industrial market includes the construction and energy segments. Our remaining sales go into the specialty performance market, which covers a wide variety of markets and applications. This includes our entire solvents and intermediates product line. Environmentally-friendly cellulose represents our largest product category. These green chemistries are based upon renewable inputs, such as wood pulp and cotton linter. This is truly a global business with better than two-thirds of our sales coming from outside North America. The high growth Asia-Pacific and Latin America regions now make up more than a quarter of our sales. Let’s go to slide 20. We recently formed the Ashland Specialty Ingredients commercial unit from the combination of Ashland Aqualon Functional Ingredients and the vast majority of ISP. These two strong businesses have numerous similarities, sharing markets and customers and each with a driving focus on innovation.
The ISP elastomers business is being integrated into the Ashland Performance Materials commercial units. Elastomers had significant sales in to transportation market, as well as the position in specialty adhesives, both of which complement Performance Materials. To give you an idea of the size for fiscal 2011, elastomers accounted for $410 million of ISP’s $1.9 billion of sales.Let’s go to slide 21 for an overview of the ISP business before we bought it. ISP is a high volume margin global business with EBITDA margins of approximately 21% to 22%. It sells into a number of high growth markets including personal care and pharmaceutical and has a history of robust top-line performance. ISP’s technology is protected by a combination of trade secrets and patented chemistries. At close, ISP had more than 400 active patents in place covering a variety of products and end-markets. ISP employed approximately 2,700 people, including 275 scientist physicians throughout the world. This technical presence helps support ISP’s worldwide commercial offerings and nearly 60% of its sales came from outside North America. The combination of these attributes enables extensive relationships with leading consumer product and multinational pharmaceutical companies. Many of these same customers are also supported by Functional Ingredients. Let’s go to slide 22 for some more details on ISP. ISP has a number of special dynamics which very similar to Ashland Functional Ingredients business. First and foremost, ISP creates highly specialized products to meet customers’ unique specifications. Due to the regulated nature of many of these applications, ISP’s products go through a battery of customer testing protocols in order to assure suitability before initial sale. Next, ISP’s products typically represent a small fraction of customers overall costs but provide very high functionality and value. In addition, ISP’s broad technology portfolio is protected by the patents and trade secrets I described on the previous slide as well as our deep manufacturing know-how.
Lastly ISP enjoys an outstanding manufacturing capability and is largely backward integrated through key inputs. To replicate this capability, a fairly sizeable capital investment would be required. Slide 23 details ISP’s historical results. The data shown here excluded the Elastomers business that was transferred to Performance Materials as well as small amounts of corporate expense that would have historically been captured in our unallocated and other line item within segment reporting.Since ISP’s sales have grown approximately -- since 2009, ISP’s sales have grown approximately 30%. Over that period, EBITDA margins have been steadily increasing, primarily due to strong volume growth and better fixed costs absorptions. For 2011, ISP achieved EBITDA margins of 24% of sales. As I mentioned, ISP is largely backward integrated and as such is a sizeable purchaser of fairly basic raw materials. From 2010 to 2011, ISP, similar to Ashland, faced significant cost inflation and took pricing action throughout the year. As a result of these actions, ISP achieved roughly $100 million of pricing. While this captured the raw material cost increase in total, a number of product lines were still behind. Of late, ISP’s strongest performance by far has been at intermediate and solvent business. Sales in this business increased more than 40% over 2010. Stronger pricing and better fixed cost absorption also led to significant increases in gross profit margins. We do not expect that trend to continue and as you see later, we’ve assumed some reduction in these products as a part of our 2014 targets. Read the rest of this transcript for free on seekingalpha.com