Olin Corp (OLN) 2018 Q2 法說會逐字稿

Good morning, and welcome to the Olin Corporation Second Quarter 2018 Earnings Conference Call. (Operator Instructions) Please note that this event is being recorded.

I would now like to turn the conference over to Larry Kromidas, Olin's Director of Investor Relations. Please go ahead, sir.

Thank you, Cole. Good morning, everyone, and thank you for joining us on our second quarter earnings call.

Before we begin this morning, I want to remind everyone that this presentation, along with the associated slides and the question-and-answer session following our prepared remarks, will include statements regarding estimates of future performance. Please note that these are forward-looking statements and that actual results could differ materially from those projected. Some of the factors that could cause actual results to differ from our projections are described without limitations in the Risk Factors section of our most recent Form 10-K and in yesterday's earnings press release. A copy of today's transcript and slides will be available on our website in the Investors section under Calendar of Events. The earnings press release and other financial data and information are available under Press Releases.

With me this morning are John Fischer, Olin's Chairman, President and Chief Executive Officer; Pat Dawson, Executive Vice President and President, Epoxy and International; John McIntosh, Executive Vice President, Synergies & Systems; Jim Varilek, Executive Vice President and President, Chlor Alkali Products and Vinyls and Services; and Todd Slater, Vice President and Chief Financial Officer.

Now I'd like to turn the call over to John Fischer. John?

Thank you, Larry. Good morning, and thank you for joining us today. During this morning's call, I will begin by describing the 4 key highlights of Olin's second quarter performance, followed by a more detailed discussion of each of our business segments.

So let's turn to Slide 3. In the second quarter of 2018, Olin generated the highest level of quarterly adjusted EBITDA since the acquisition of the DowDuPont chlorine products assets.

After the strong performance in the second quarter by our Chlor Alkali Products and Vinyls and Epoxy businesses, we are raising our adjusted EBITDA guidance for 2018 by $50 million to $1.3 billion, with upside opportunities and downside risks of approximately 4%.

This year's major turnarounds in our Chlor Alkali Products and Vinyls and Epoxy businesses have been completed on schedule and on budget. Maintenance turnaround costs during the second half of this year will be approximately $135 million lower than in the first half of the year. This is consistent with the normal seasonal pattern of our planned maintenance outages.

The maintenance turnaround costs are expected to be approximately $195 million in 2018, which would be approximately $25 million lower than 2017 turnaround costs. We are forecasting 2019 planned maintenance turnaround costs to be approximately $30 million to $40 million lower than our expected 2018 levels.

The Epoxy business earned approximately $50 million of adjusted EBITDA during the second quarter, a quarter which was impacted by $21 million of planned maintenance turnaround costs. The overall supply and demand environment for Epoxy resins has continued to be favorable. With the significant maintenance turnaround successfully completed, we expect improved volumes and improved results in the second half of 2018. However, a word of caution: higher raw material costs, primarily benzene and propylene, are expected to dampen the second half improvement.

Caustic soda prices in Olin's system increased approximately 5% in the second quarter of 2018 compared to the first quarter, which followed a 10% sequential increase in the first quarter. We are expecting our domestic caustic soda prices to increase further in the third quarter. Domestic contract caustic soda price indices have been essentially flat for the last 3 months, reflecting a more balanced supply and demand environment during the seasonally stronger period of chlorine demand.

In the second quarter, we saw some modest weakness in the export caustic soda market. The decrease in export spot caustic soda pricing has not impacted the domestic caustic soda contract prices, with North America caustic soda demand remaining strong. We will discuss the caustic soda market in more detail in a couple of slides, but we are confident that a positive caustic soda cycle remains intact and expect continued long-term caustic soda pricing improvement.

Now turning to the business segments, beginning with Chlor Alkali Products and Vinyls, which is summarized on Slide 4.

Second quarter 2018 Chlor Alkali Products and Vinyls adjusted EBITDA of $290.3 million improved 82% compared to the second quarter of 2017. The increased earnings were primarily due to higher pricing for caustic soda, chlorine and other chlorine derivatives.

We also experienced higher volumes in the second quarter compared to last year, with Olin setting quarterly records for both bleach and chlorinated organic shipments.

Ethylene dichloride prices in Olin's system increased approximately 40% in the second quarter of 2018 compared to the first quarter, which followed the 25% sequential increase in the first quarter.

We are expecting ethylene dichloride prices to increase further in the third quarter. We've experienced increased demand from Europe and improved pricing in Asia throughout 2018. We believe the improved pricing in Asia reflects strong PVC demand, higher naphtha-based ethylene costs and lower caustic soda prices in China. We now expect full year 2018 ethylene dichloride pricing to improve compared to 2017.

During the second quarter, we experienced sequential pricing improvement in chlorine, hydrochloric acid, bleach and several chlorinated organic products.

The Chlor Alkali Products and Vinyls business is expected to improve in the second half of 2018 from the first half, driven by higher pricing, increased volumes and lower maintenance turnaround costs.

Olin continues to maintain its positive long-term view of caustic soda pricing. This is summarized on Slide 5. In 2018, we expect caustic soda export volumes from North America to once again reach record levels.

As I previously mentioned, we've seen some recent weakness in the export caustic soda market. The U.S. Gulf Coast export spot index decreased $48 per metric ton in the second quarter of 2018, but was flat in July after increasing approximately $260 per metric ton in 2017.

A key point of consideration for Olin: during the first half of 2018, approximately 1% of Olin's caustic soda sales were spot sales. Since the acquisition, we have moved to a caustic soda sales model that is virtually all contract-based. We would also observe that the volumes associated with recent lower-priced spot export trades have been very minimal.

For the U.S. Gulf Coast, export pricing has been under pressure the last few months due to regional conditions in Asia, China, Brazil and Europe, influencing global supply and demand dynamics. We are convinced that these regional factors are short term. The capacity additions that have been announced recently will not impact the market for approximately 3 years and are small in relation to the expected growth in caustic soda demand.

Strong global and U.S. GDP growth continues to drive key caustic soda market growth in pulp and paper, water treatment, organic and inorganic chemicals, and aluminum. As a result, we believe the favorable long-term global caustic soda market dynamics that have been experienced over the past 2 years remain in place.

Let us now move on to the performance of our Epoxy segment, which is summarized on Slide 6. Second quarter 2018 Epoxy adjusted EBITDA of $49.9 million was approximately $35 million higher than the second quarter 2017 results. This significant earnings improvement was driven by higher product pricing, partially offset by higher raw material costs and lower volumes. The lower volumes were primarily due to a cooler-than-normal spring in North America, which delayed industrial coatings customers demand.

We are forecasting improved Epoxy resin sales in the third quarter of 2018 compared to both the second quarter of 2018 and the third quarter of last year.

During the first half of 2018, propylene costs increased approximately 23% compared to 2017 levels, and we expect third quarter raw material costs to increase approximately $20 million to $25 million sequentially from third -- excuse me, from second quarter levels. These higher raw material costs represent a potential offset to the sequential benefit from lower maintenance turnaround costs and improved volumes.

We are encouraged by the second quarter results in the Epoxy business and the overall supply and demand dynamics present in the market. With the significant maintenance turnaround successfully completed, we expect improved volumes and improved results in the second half of 2018 and into 2019, with the risk of higher raw material costs, primarily benzene and propylene, a potential negative.

On Slide 7, we show liquid epoxy resin pricing over the past 2.5 years for the United States, Europe and Asia. Resin pricing has improved in each region since the beginning of 2016. A portion of these increases has been necessary to recover the higher raw material costs, principally benzene and propylene. Tighter market conditions for liquid epoxy resin have added to the price momentum, and these dynamics are expected to continue.

The current forecasted demand growth for our products over the next several years, depending on the geographic location and the application, is between 3% and 5% annually.

Pricing dynamics have been different by region. In Asian -- Asia, resin prices increased dramatically in the latter part of 2017 into 2018 and lately have moderated. In North America and Europe, prices increased late in the fourth quarter and through the beginning of the second quarter with less moderation. We have announced additional resin price increases in North America and Europe to be effective September 1.

Moving on to Winchester on Slide 8. Second quarter 2018 Winchester adjusted EBITDA was $16.7 million, a decrease of $6.8 million from the second quarter of 2017. The decline in year-over-year adjusted EBITDA was mainly the result of higher commodity and other material costs, which increased $6.5 million in the second quarter of 2018 compared to the same period in 2017.

For the full year 2018, we expect commodity and other material costs to increase approximately $20 million from 2017 levels. During the second quarter, lower commercial ammunition sales were partially offset by higher sales to the military and law enforcement agencies.

We've seen commercial ammunition demand decline by approximately 8% during the first half of 2018, which followed a 17% decline in commercial demand in 2017. However, we do expect commercial demand to improve sequentially in the third quarter of 2018 from the second quarter level due to normal seasonal demand. As a result, we expect Winchester's results to improve in the third quarter compared to the second quarter due to higher commercial sales.

Throughout the first half of 2018, our efforts to recover higher commodity metal prices through higher selling prices have met with limited success.

Before I conclude, I would like to emphasize that our outlook for the chemical businesses is positive. We remain confident that we're in a multiyear up-cycle in caustic soda. We're also experiencing favorable volume and price trends in chlorine, ethylene dichloride and other chlorine derivative products.

In the Epoxy business, we've also experienced improved volume and increased pricing. Our expectations of seasonally stronger second half of 2018 will provide the basis for further improvement as we move into 2019.

Now I'd like to turn the call over to Todd Slater. Todd?

Thanks, John. Let's turn to our 2018 cash flow forecast, which is on Slide 9.

We expect to generate approximately $500 million of free cash flow. Our top priority for free cash flow remains debt reduction, and our expectation is that by the end of 2018, the combination of debt reduction and EBITDA growth will reduce the net debt to EBITDA leverage ratio to the 2.5x range. During the first half of the year, we prepaid approximately $80 million of debt.

Starting with the midpoint of our full year adjusted EBITDA forecast of $1.3 billion on the far left of the waterfall chart. We deduct $50 million in estimated tax payments, which primary reflect income tax payments made to foreign jurisdictions in 2018. We are forecasting our cash tax rate will be in the 10% to 15% range for the year. Since 2015, Olin has not been a U.S. federal taxpayer because of the utilization of net operating loss carryforwards, primarily arising out of costs associated with the acquisition in 2015. Because of this, we do not expect to be a U.S. federal taxpayer in 2018.

While we are continuing to analyze the full impact of the Tax Cuts and Jobs Act of 2017, the cash tax benefit to Olin of the changes in the tax law is minimal in 2018 due to the tax credit carryforwards. We do expect the new law to provide cash tax benefits to Olin beginning in 2019. The new law is currently estimated to reduce our cash tax rate for 2019 and beyond to the 15% to 20% range. This translates into an estimated annual reduction in cash taxes of approximately $75 million.

Column 3 reflects the midpoint of our current forecast for capital spending of $400 million, which includes annual maintenance capital spending of between $225 million and $275 million and the investment associated with our multiyear information technology project of approximately $100 million.

As we have previously discussed, in 2017, we began a multiyear project to implement new enterprise resource planning, manufacturing and engineering systems across the heritage Olin and the acquired Dow chlorine products businesses. The projects include required information technology infrastructure.

Now turning to the fourth column. We're expecting working capital to be use of cash in 2018 of approximately $50 million. The estimated increase in working capital is primarily due to higher selling prices and inventory costs associated with hydrocarbons in 2018. We currently expect revenue for 2018 to increase approximately 15% compared to 2017 levels.

In the next column, onetime items of approximately $60 million include integration, cash restructuring costs, the first quarter's $8 million business interruption, insurance recovery and the approximately $50 million for the expense portion of the multiyear IT project that I just spoke about.

The next column represents the estimate of interest expense. We have approximately 20% of our debt at variable interest rates after the debt refinancing that we completed in January. We are forecasting 2018 interest rates to be higher than those we experienced in 2017.

We are forecasting to generate $500 million of free cash flow in 2018. We are targeting a minimum debt reduction of approximately $300 million this year while paying our normal quarterly dividend totaling approximately $134 million.

While debt reduction remains our top priority for free cash flow generation, we began to opportunistically repurchase shares in the second quarter with the goal of offsetting dilution, and to date, we have repurchased approximately 300,000 shares.

Finally, on Thursday, July 26, Olin's Board of Directors declared a dividend of $0.20 on each share of Olin common stock. The dividend is payable on September 10, 2018, to shareholders of record at the close of business on August 10, 2018. This is the 367th consecutive quarterly dividend to be paid by the company.

Operator, we are now ready to take questions.

(Operator Instructions) And our first question comes from Don Carson from Susquehanna.

So John, where do you think we are in the Chlor Alkali cycle? You talked in the past about mid-cycle earnings of EBITDA of $1.5 billion. Do you think you -- we can get there by next year? And as you look, you expressed confidence that caustic pricing will continue to increase. What's sort of the magnitude versus what you show on Slide 5 in terms of what we've seen over the last year?

Your first question, I think, from the standpoint of achieving mid-cycle of $1.5 billion, I think that is a 2019 or 2020 event for us. I think from the standpoint of where we are in the cycle, I would say we're at, worst case, halfway through the cycle. I think what we're going to see though is that the level or the degree of price increases are going to be slower as we go forward than we've seen in the past. We obviously saw a significant jump last year, but I think it will be more steady increases, and I think we'll see occasionally things -- some dislocations around events and production in certain areas that will cause slowing down of those increases, which is some of what we've seen right now -- recently.

And then a follow-up on Epoxy. So how would you characterize -- what's your view on what your average margins will be this year versus last year? And can you help us out at all with any sort of idea of operating leverage per -- related to changes in, say, a $0.01 margin per pound?

I'm not really sure, from a competitive standpoint, we want to answer either of those questions. I would tell you that if you look at the -- if you go back to the investor presentation we made in February of 2016, we showed a chart that suggested that EBITDA could reach $250 million to $300 million. And I would say, based on where we are today, we're making very good progress towards achieving that.

And our next question comes from Neel Kumar from Morgan Stanley.

What does your new $1.3 billion EBITDA guidance assume in regards to caustic, EDC and epoxy prices? Is it as of July levels?

Neel, this is Todd. It assumes the pricing for caustic that was in effect at the end of July. And for EDC, it assumes our outlook for the full year on EDC being higher priced in '18 than it was in '17. That is an improvement over what we've talked about in the prior 2 earnings calls. And on epoxy, I think we haven't talked about pricing other than the improvement that you saw on the slide. And then there's a September 1 price announcement out there. But on epoxy, as we were clear, there is $20 million to $25 million of higher hydrocarbons that are coming through in the third quarter compared to the second quarter.

That's helpful. And then you also guided to maintenance costs climbing an additional $30 million to $40 million in 2019. Do you believe that will be a good run rate level for maintenance going forward? Or can costs come down even further?

I think we guided to they would be $30 million to $40 million lower in 2019 than they were in 2018.

Right. Yes, so maybe you heard me wrong, but that's what I was saying. Is that basically a new run rate 2019 levels? Or do you think they can come down even more in 2020 going forward?

I think if you looked at -- there are -- we've talked about there are large turnarounds in 3 different assets, the epoxy assets, which are done every 5 to 6 years, which have now been done; and the VCM asset, which is done every 3 years, that was done in 2017. So I would say, if you looked at it on balance, '19 is probably near the low end of what we would see.

Okay. Great. And then last question, in Epoxy, where are you in your longer-term initiatives to drive costs out of that business and then upgrade your portfolio and cost mix?

Yes, Neel, this is Pat Dawson. We have announced that we've been -- we're going to drive out $100 million of cost over the next 5 years. I would say, we've made good progress on that here in the last 2 years. That remains productivity, and driving productivity improvements is a critical part of the Epoxy strategy going forward.

And our next question comes from Kevin McCarthy from Vertical Research Partners.

A couple of questions on Epoxy. How would you describe operating rate in North America and Europe? And likewise, how would you describe your level of confidence that prices can increase enough through the course of time to offset the $20 million to $25 million of cost inflation that you referenced? What is the outlook there?

Yes, the outlook -- if you start back just a few years ago, the outlook has been improving over the past 2 years in terms of supply/demand fundamentals. So supply/demand, we think, continues to improve. We have not announced any operating rates. It's not public information, but it's definitely improving. We also see the crackdowns on the enforcement in China around the environmental regulations. As each month goes by, that seems to have more teeth in it, and that has helped the improvement as well. But also, you don't see any new additional capacity being added in the industry right now. And as long as we continue to grow in that 3% to 5% range that we've talked about before, we think conditions will continue to improve.

And Pat, as a follow-up, propylene prices have been relatively high and volatile lately in both the U.S. and Europe. Obviously, Olin is short of the molecule. Have you considered or would you consider vertical integration into propylene either on your own or synthetically through base loading someone else's asset?

Yes, I think that's something that we would continue to evaluate. Propylene, obviously, follows what oil has been doing, and oil has been hitting highs here in the last couple of months. So that definitely is a headwind, and we definitely are always looking at options to improve our propylene position.

And our next question comes from Jeff Zekauskas from JPMorgan.

On your Slide 7, you show trends in liquid epoxy resin pricing, and all of the 3 regions are decreasing as raw materials are going up. Can you describe what the market dynamic is? And do you have an idea where you think things will stabilize?

Yes, I think, first of all, I mean, if you look at where this started back probably the middle of last year -- third quarter of last year, you've seen a pretty good run up. And as I just mentioned earlier, I think our supply/demand fundamentals have been getting better across the whole epoxy chain. I think this little cooldown that you've seen here, I think prices have gotten pretty frothy towards the end of last year, the beginning of the year. So I think that things are stable, and we've seen things very stable here the last 3 or 4 months. So overall, with this improving supply/demand fundamentals, I think you're going to see better stability going forward than what you've seen in the past. And by the way, as John mentioned in his remarks, we do have a September 1 price increase out there in North America and Europe.

Okay. And I have, I guess, a question on caustic soda. I imagine that you have different caustic contracts that were signed at different points in time. If all of your contract caustic was now priced at the market price, would that make a difference to your earnings? Or how much might that change your average caustic realizations?

Yes -- this is Jim. Yes, we've got momentum in the contracts, and the contracts do renew over a period of time, 2 to 3 years oftentimes, sometimes extending beyond that. So we constantly have contracts that are renewed. And so we do have momentum going into the third quarter out of the second quarter, the prices that we attained there, index changes and so forth, that will continue to provide momentum into the third quarter, which is why we're saying that we will have higher domestic prices in Olin in the third quarter.

And I would just add to that. Typically, contract renewal season is in the fourth quarter. And we have contracts that run anywhere from 3 to 5 years. So we still have a group of contracts that were negotiated in the 2015 time frame, which you would say was not a seller's market at that point in time. And it's our expectation that as they roll over, you will see a meaningful improvement in our net back when we get to Q1 of 2019 versus Q4.

And the next question comes from John Roberts from UBS.

Was the improvement in epoxies concentrated at all in LER, epi or aromatics?

Yes, I would say that, that really was across the Epoxy, our whole Epoxy value chain, from the upstream to the midstream to the downstream.

Okay. So it is very broad-based you're seeing. And that LER price chart would be reflective of kind of the center of gravity of your mix?

I think it's a fair statement.

Okay. And then you gave your 2019 maintenance expense outlook. Do you have the capital budget yet for 2019 as well or anything else that you can share for us on a forward outlook?

Not at this time, John.

And our next question comes from Jim Sheehan from SunTrust.

You talked about the new capacity addition in Chlor Alkali as taking 3 years and not having a dramatic impact on long-term supply/demand. Can you talk about why -- the basis for your confidence in saying that?

If you look at the capacity announcement and the size of it and you believe that caustic demand is growing at 2% annually, the new capacity represents 2 months' worth of global growth and maybe 10 months of domestic growth. So that's really not a lot of capacity.

Great. And on your outlook for 2018 EBITDA, you've got the range of plus or minus 4%. Obviously, raw materials are a factor there. What would happen -- have to happen for you to get to the high end of that range?

I think the biggest factor for us would be if we have stronger-than-expected volumes. We've got some opportunities around pricing, both caustic soda and EDC, and I would say those are the 2 biggest.

And the next question comes from Matthew Blair from Tudor, Pickering, Holt.

John, you mentioned that you're expecting higher caustic contract pricing in Q3 despite some of the spot weakness. Could you explain what gives you confidence here? Is that just a function of what you're seeing on supply and demand? And also, could you talk about -- what kind of demand trends are you seeing in the U.S., Europe and Asia?

Matthew, this is Jim. We do have confidence in what we're seeing. The demand picture actually for caustic is quite good. North America, the GDPs that you've seen, the industrial production and so forth is very solid, very strong. We -- we're confident in our third quarter numbers because of the fact that we have had success in the first and second quarter. Demand is strong and those carry through with our contract situations that we have, and we'd expect that to continue on. There is nothing that takes us off of that. From a global standpoint, we have seen some things in Latin America and Asia that have impacted the export pricing. We believe those to be temporary. As capacity comes back on stream in Latin America, we've returned to the trade flows that we had about a year ago, and those were tight. And in Asia, we also expect -- even though we have seen some things in China in terms of the demand, we do expect some capacity to come off line, but we also expect the demand side to return to the norm there. So there's nothing that takes us off of the long-term trends that we've been seeing all along. Continued global GDP, very strong. There's no capacity coming on stream anytime soon, and there, actually, has been capacity taken out and good GDPs around the world that drive the caustic growth. So we expect a continued good environment as we go forward.

Okay. And then I guess, based on current pricing, what do you think greenfield and brownfield economics are for new Chlor Alkali capacity in the U.S., whether in terms of like an IRR or maybe a multiple?

I wouldn't necessarily want to comment on an IRR because, remember, you're building an ECU, and where the user puts his chlorine has a lot to do with that. I would say that we think, today, greenfield is probably north of $1,500 a ton. I think brownfield, all depends on who it is and what they're doing. There's probably some debottlenecking that could be done for $750 to $1,000 a ton, I would imagine. But those kind of debottlenecks don't create world-scale plants. They create 100,000 tons here and there.

And the next question comes from Arun Viswanathan from RBC Capital Markets.

Just a question on the operating rates. We're seeing, I guess, relatively high operating rates in the mid-90s now, and just wanted to get your thoughts on how we traject for the rest of the year. I mean, should we expect operating rates to remain high in Q3 and that would result in your kind of stable pricing environment for caustic and then maybe operating rates tick down in Q4 and that allows for some pricing on typical maintenance? Or is that seasonality kind of changed now?

Arun, I think you've outlined it actually quite well. We do expect operating rates to stay strong. During the summer months, you've got a strong chlorine demand, both from water treatment from a vinyl standpoint that will drive operating rates. There is some seasonality to those operating rates into the fourth quarter, and we would expect to see some modest decline, but it -- overall, the picture is still very snug from an operating capacity standpoint.

But is that the mechanism, that you do expect prices to reaccelerate in Q4? The reason I ask is because there's been an increase for Q3 and now we've seen a decrease of $5 in July. So I guess, should we assume that the price momentum picks back up in Q4 on the maintenance? And another reason I ask is because it seems like the maintenance has now been shifted, a lot of it, within the industry in the first 2 quarters of the year. But I may be wrong, so maybe you can just elaborate on that.

Yes, the operating rates definitely have an impact on the pricing, and that's what you've seen in caustic. And then any specific event-driven things that -- under a high operating rate environment causes some spikes, and we've seen that over the last couple of years. I think it's also important to note the chlorine side of the equation as well, and a lot of the chlorine derivatives, the tightness in the marketplace driving the chlorine side and the pricing on the chlorine side as well.

Okay, that's helpful. And then maybe you can just give us your thoughts on input costs as well on -- through the chain in vinyls. We've seen some increase in ethane. Is that an impact for you guys or is it not?

Yes, we have cost-based ethylene, and so ethane being an input into that, yes, it does have an impact on our cost structure.

And our next question comes from Eric Petrie from Citi.

A question on caustic soda prices. You noted going forward you expect smaller initiatives. At what price point do we get into a dynamic potential substitution in some end markets for either soda ash or alumina customers produce -- or purchasing more pure bauxite grades?

I think that customers are always going to want to try to optimize their usage and so forth. And so that's something that can be done whether -- in the alumina markets and so forth. They're doing that all the time. So I don't see any specific change on the pricing. Alumina prices are moving. The affordability is there in terms of caustic soda production. So -- and pricing. So we're not -- I'm not that concerned about that. Soda ash, quite honestly, there's a -- that market and those demands are running -- they're running high capacities. There's a large switching cost and so forth. So we don't see any impact from soda ash.

Helpful. And then secondly, on your Slide 7 with the liquid epoxy resin pricing dynamic and the gap between regions, are you seeing any competitive pressures from Asia producers into either the Europe or U.S. markets?

No, not really. It's been this way for many years, so we don't see anything really changing dramatically. Actually, we see much better fundamentals as the market tightens. We see better fundamentals in each of the regions. And I think that's been one of the main -- a good data point for the fact that things are tighter.

And our next question comes from Stephen Byrne from Bank of America Merrill Lynch.

I was wondering if you had a roster of Chlor Alkali plants in China that you've drilled into and whether you have a view on the fraction that's not operating at historical levels, whether it's more a function of a permanent shutdown or a temporary idling or whether it's just a matter of implementing some updated pollution controls.

I think the answer to that in general is we have some view, and it's some effect of all the 3 things that you mentioned.

And similarly, on epoxies, is -- are those Asian producers -- is that just a matter of improvement in emission controls that's driving that, because you're not really dealing with a coal-derived unit operation?

No, but you are dealing with -- sorry, this is Pat Dawson. You are dealing, though, with high energy intensiveness. I mean, that's where it starts with chlorine to get to epichlorohydrin, which is a key raw material. So you are dealing with high energy, high resource and a very environmentally challenging product from a water and a water treatment standpoint. So we do see those -- this new round of China regulations and enforcement continuing to have an impact on capacity in China.

And our next question comes from Dmitry Silversteyn from Longbow Research.

I have a couple of them. One on the Chlor Alkali segment. Can you talk a little bit about domestic volume growth that you're seeing versus export growth in terms of if there's big differences in the base of growth? You mentioned overall market growing at about 2% globally, but in terms of your volumes and where they're going? And in the export growth, can you talk a little bit about what kind of the main destinations are? Is it still sort of Asia Pacific and Latin America? Or are you getting more and more into Europe there?

This is Jim. The second part of the question in terms of destinations and so forth, the destinations out of the Gulf Coast are similar to what they have been, not a significant amount of trade differential. But Latin America has significant movement and also into Asia Pacific, a lot into Australia into aluminum. There have been -- there were earlier this year some movements to Europe in the second quarter. That's pretty much slowed down. But -- so not a dramatic shift in any of the trade flows out of the Gulf Coast. As far as demand, I think the best way to look at it is in terms of the GDPs because we have a tendency to track GDP quite well. And as you know, in the U.S., GDPs have been relatively strong. So we do have strong demand growth here in the U.S., and we expect to have that continue, strong markets, pulp and paper market and the process chemicals. Quite honestly, everything is relatively strong. So we see good domestic demand. That's not to say that the export and around the world the demand is dropping off by any means. You get some dislocations here or there, but I would say again, China is what it is and the alumina markets in Australia are quite solid. So the demand is there globally and, again, GDPs are probably the best driver to use for our demand.

All right. And on the second question, on Winchester, how should we think about the profitability of this business in an environment of persistently high raw material costs that you don't seem to be able to pass through? We kind of talked about $120 million, $130 million in annual EBITDA back in the day when you were relocating to -- from Illinois to Mississippi. How should we think about sort of structural EBITDA of this business, assuming that pricing stays where it is in terms of raw material and metal costs and your ability or lack thereof to recapture some of that margin?

Dmitry, last quarter, when we talked about Winchester, we said we did not believe that 2018 results would be better than 2017. I mean, all the factors that you just described, we have lower commercial volumes. However, we do think if you look back historically, commercial volumes tend to decline somewhere around 6 consecutive quarters off a peak. The second quarter of this year would have been the sixth quarter, so we have expectations that commercial volumes will stabilize here. The higher commodity costs, we are -- been able to offset some of that with better military volumes, which, for us should continue for several years. And we've got to improve our operating costs. I would say right now, as we look at the world, I think the $125 million was probably too high. But I definitely think that once we get to a more stable market environment, we will do better than what we did in 2017.

And our next question comes from Aleksey Yefremov from Nomura Instinet.

In Epoxy segment, your outage costs will decline approximately $20 million sequentially and raw material costs are going up $20 million to $25 million. Should we think about Epoxy pricing as a sort of a neutral factor here, and so your EBITDA could be about flat sequentially? Is it a good way to think about the segment?

Well, the one thing we did say was we expected improved volumes in the second half of Epoxy relative to the first half. So I think other than what you just said, if you add in improved volumes, it would be -- if you don't have improved volumes, it would be flat. I agree.

So John, just to clarify this $20 million improvement in outage costs, it does not account for that improved volume, right?

Aleksey, this is Todd. There are additional volumes beyond the factor that's just the $20 million of the outage and -- the outage costs as well as the unabsorbed fixed cost.

Understood. Okay. And then another question on Epoxy. If we look at Slide 7, Asia resin prices went up approximately $0.40 a pound. Is there any way to say how much costs went up and what's the current cost floor for these prices globally?

No, I don't think we have given any information out on the cost floor other than saying that if you look at the published indexes on epichlorohydrin and BPA, that those costs have been going up and that has a real impact on nonintegrated producers.

And maybe one follow-up for Pat. In epoxies as well, do you think sort of the next move in August for these prices in the U.S. and Europe is flat, up or down? And also, what gives you confidence in the September price increase?

I think what gives us confidence in September increase is just the tightness of the market. So there's been some turnarounds. We, obviously, just came off of a big turnaround ourselves, so we just don't see a lot of available product out there anywhere in the globe, and that gives us the most confidence.

And our next question comes from Roger Spitz from Bank of America.

I just want to help square the higher caustic soda pricing outlook and the higher EDC price outlook in the second half. I mean, usually, as you said before, EDC exports is where you -- one pushes chlorine to make more caustic, so they tend to move in opposite directions frequently. Wondering if you might address that.

Yes, Roger, remember, EDC for us is entirely an export product. The short-term improvement in caustic soda prices is in the domestic market. Those 2 markets do not react to each other. It's caustic soda in the export market, which we've talked about, was being lower and a factor for the higher EDC prices.

Got it. And on -- small product, but I guess you sell U.S. acetone co-packed out of your Freeport phenol facility. Is that all under fixed spread contracts? Or acetone has been weak here in demand and pricing, has that impacted you? Or it's all on cost plus fixed spread contracts for you?

Roger, it primarily moves around the indexes that you see published out there.

And our next question comes from Karl Blunden from Goldman Sachs.

Just a focus on Slide 14, your 2018 bridge to the near-term $1.5 billion potential. On the Epoxy piece, when you describe the Epoxy improvement in earnings, could you go into a bit more detail about what drives that? Is that a continuation of existing margins and simply run-rating a higher rate perhaps in the first half of 2019, 2020 relative to where we were in 2018? Or is there something else, maybe it's operating rates? Interested in your view on what drives it and how big that driver could be.

The biggest driver, as we move forward here, is the absence of large outages that occurred both in 2017 and 2018 that will drive lower maintenance costs and improve volumes. Pat talked a little bit about productivity. That's a piece of it. And obviously, we've been in -- we have the opportunity to be in a better long-term pricing environment as we move through '19 and '20 than we've been in historically.

Okay, got you. That's helpful. So part of it's you and then part of it's an expectation on market pricing holding up. Just on the capital structure here, you've announced this $300 million debt reduction target. What's the rationale for that? Is that tied in some way to the cash flow expectations you have for the business? Is it maybe more precision on where you want debt to be through the cycle? Any thoughts around that from Todd perhaps would be really helpful.

This is John. We have a debt target that is based on what do we think the trough EBITDA in this business will be. Because, as you know, it's a highly cyclical business. When the cycle turns, it turns, and I'm not forecasting a turn to the negative cycle here. But that's what we are targeting, a specific debt level based upon what we think we can earn in a trough, and that's -- that would be our objective.

And Karl, what we've said is that by the time you get to the $1.5 billion range of EBITDA, we'll have net debt-to-EBITDA under 2x. And doing that math, you need to repay approximately $700 million of debt from where we ended 2017. So $300 million -- approximately $300 million at a minimum is coming out this year.

And our next question comes from Owen Douglas from Baird.

Just a quick one in terms of the outlook for the higher cost -- sorry, the higher chlorine prices while also being constructive on caustic soda. How much of that is a reflection on market supply/demand balance for chlorine versus perhaps a little bit of sort of, I guess, cost push?

I think it's more reflective of the supply/demand environment, quite honestly. We talked about high operating rates earlier, and we're seeing a good demand on both sides of the ECU, and that's what's driving the pricing.

Got it. I see. So as things move forward in this -- in this mid-cycle here, do you think that there's a real risk to softening on the caustic soda economics?

This is Jim. I guess, the short answer would be no. We see a positive outlook with several years of runway left, and we would expect the economics to continue to improve.

Okay, that's very helpful. And final one for me. On the outlook for Epoxy, kind of sounded a little bit more cautious than I was expecting, with some of the commentary around the earnings potential for that business appearing that you guys were not too far off of it. Can you sort of help me understand what you think are some of the factors holding back the enthusiasm?

Yes, this is Pat. I think, first of all, you've seen on our graph 7 the runup that we've experienced here primarily in the last 6 to 9 months. And I'd say, we're cautiously optimistic about that runup and the sustainability of the supply/demand fundamentals continuing to improve. I think the other issue is around growth, and we talk about 3% to 5% market growth depending on geography and applications. And there's no question that we're probably seeing a little bit on the lower end of that growth curve than what we had expected at this point in time. And I would say, those are the factors we think about going forward. And of course, as we've mentioned, and we'll mention again, you've got the hydrocarbon volatility or the oil volatility that impacts our hydrocarbon costs that continue to be a concern looking forward.

Okay, that is helpful. And final one for me. I know that you guys, obviously, have performed well, but still have these legacy 9 3/4% and 10% notes, which take a little bite of the EPS, if you will. So just to help me understand a little bit, what are your priorities as far as some of this debt repayment? How much of it is around the absolute balance of debt versus also thinking about your funding cost and what that does for your earnings?

I think the debt reduction targets are based on the long-term capital structure. The debt that's being repaid is designed to put us in a position where we can refinance those 2020 bonds on the day -- first day we can call them.

2020 bonds? Oh, I see, sorry, the 2025 bonds and 2023 bonds, you mean?

Yes -- those -- the debt that was issued in conjunction with the Dow transaction. It's first callable in October of 2020. And because of the Reverse Morris Trust, can't really be called before October of 2020. And in today's economics on interest, you're looking at potentially saving between $50 million and $70 million once those bonds are called. So -- but that can't happen until late 2020.

There are no further questions. This concludes our question-and-answer session. I would now like to turn the conference back over to John Fischer for closing remarks.

Yes, so I'd like to thank everyone for joining us today, and we look forward to speaking to you again about our third quarter results.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.