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
Dave Begleiter - Deutsche Bank
John Roberts - Buckingham Research
Mike Sison - KeyBanc
Jeff Zekauskas - JPMorgan
Dmitry Silversteyn - Longbow Research
Peter Goodson - Eminence Capital
Ashland Inc. (ASH) Ashland Analyst Day Call November 15, 2011 8:30 AM ET
Good morning and welcome to Ashland’s 2011 Analyst Day. I am Dave Neuberger, Director of Investor Relations. As a reminder today's event is being webcast live and will be available for replay for 12 months on Ashland’s website www.ashland.com. As shown on slide 2, forward-looking statements as defined in securities laws will be made during this presentation. We believe any such statements are based on reasonable assumptions, but cannot assure that such expectations will be achieved.
Please turn to slide 3. Please also note that during this presentation we will be discussing adjusted including pro forma and baseline results. Also we ask you to be aware that when we refer to EBITDA in the course of this presentation, we maybe referring to EBITDA, adjusted EBITDA or baseline EBITDA depending upon the period being referenced.
We believe these adjusted and baseline results enhance understanding of our current and future performance by reflecting certain key items and adjusting for the effects of certain acquisitions and divestitures.
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.
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?
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.
Now, let’s go to slide 24. The combination of Ashland and ISP trade some significant strategic benefits. First, it strengthens our position in a number of important high growth, high margin end markets. These include Pharmaceuticals Excipients, as well as Hair, Skin, and Oral Care.
The acquisition also expands our offering in the market such as Food and Beverage, Energy and Coatings. Second, it broadens our intellectual property portfolio of water-soluble polymers, film-forming technologies and our global R&D and applications capability. Along with this enhance product portfolio, we’ll be putting together a strong pipeline and new products and product solutions.
In addition, we’ll combine ISP’s strength in a Settling and Acrylic derive chemistries with our own strength in Cellulosics and Guar. We expect this to generate increased sales as we developed new products. Third, it deepens relationship with existing customers and enhances penetration of existing markets; with complimentary product offerings will increasingly be seen as the partner of choice in customer new product development efforts. This partnerships-based approach has a historically led to Ashland’s highest growth opportunities.
Please turn to the next slide.
This slide shows the product offering each business brings to the table. With the business combination, Specialty Ingredients is now one of the world leaders in high margin water-soluble products. Given the increasing fleet global shift away from solvent-based products, this provides significant avenue for growth. We support this water-soluble platform with the large number of functional ingredients such as Surfactants, Defoamers, Emollients, and Emulsifiers.
In addition, we now have a line of active ingredients through ISP, which includes UV Absorbers, Biocides and Skin Care Actives. These are the platforms that we will now bring to bear against our 2014 plan.
Slide 26 shows how Ashland and ISP’s product offering complement one another. The blue bar represents ISP and the orange bar represents the sales of functional ingredients. As you can see in the areas of hair care, oral care, pharmaceutical and skin care, ISP significantly increases the size of our existing market penetration. ISP also strengthens our position in both, Energy and Food and Beverage, where functional ingredient is the larger contributor.
In addition to these market positions, ISP provides a number of technologies that complement our existing portfolio. An example of this is Hair Care where Ashland is strong in Shampoo thickeners and conditioning polymers and ISP offers fixatives for products such as hair gels and hair sprays.
In Oral and Skin Care, our portfolio of rheology modifiers is complemented by ingredients enabling Tartar control, UV Absorbers and Anti-aging ingredients. Within pharmaceuticals, our controlled-released Excipients are supported by a strong portfolio of immediate released ingredients.
In Energy, our portfolio of drilling aids and cement additives has been expanded with Fluid Loss Additives and hydrate inhibitors for both water-based and oil-based drilling fluid.
Last, in Food and Beverage, our strength as a Texture modifier and thickener has been combined with an industry leading set of beverage clarifiers, primarily used in beer and wine.
As you can see, the ISP acquisition significantly strengthens each of these important market segments.
Let’s turn to slide 27 to look at some of the direct synergies from the business combination. Ashland is now targeting $50 million of cost synergies. $20 million will come from the direct commercial overlap between the two businesses. I’ll provide some more details on this later. In addition, we are anticipating a fair amount of top line synergies. We now estimate potential sales synergies at $200 million to $300 million over the next three to four years. These synergies can be divided between short-term and long-term opportunities.
In the short-term, Specialty Ingredients will sell heritage functional ingredients products through a now-broader pharmaceutical and personal care channel. Likewise, we’ll sell heritage ISP products through the now-broader energy and food and beverage channels. We should also be able to take advantage of the deeper customer relationships I’ve already described.
In the long-term, we see considerable new product development opportunities. ISP is strong and short-chain monomer chemistries and building product solutions from the ground up. Functional Ingredients is strong in cross-linking technologies, focused on later stage polymerization. Together, our R&D group should be able to use their respective strengths to develop ground-breaking customer solutions.
Now that we’ve discussed ISP and the benefits of the business combination, let’s go to slide 28 for an overview of our key markets and applications. Our key markets and applications are shown here. While I won't spend much time on the details, I’ll note that our primary market of interest can be read from left to right.
So as you probably expect, we’ll be focusing a lot of our efforts on the Pharmaceutical, Personal Care and Coatings market that make up the majority of our earnings.
On the next several slide, I’ll provide additional details about each of these markets shown and related opportunities. Let’s start with Pharmaceuticals on the next slide. We sell Excipients to pharmaceutical companies. This is a $1.5 billion market growing at roughly 5% to 6% per year. Excipients are generally inactive materials that provide important functionality to the Active Ingredients. This includes binding, which allows the pill or tablet to be formed; coating, which can provide aesthetic or functional benefits such as color or stability; disintegration, which includes super disintegrants, allowing rapid release of active ingredients; and time release, which allows for longer beneficial effects and reduced pill intake.
We have a leading position with binders and disintegrants and the vast majority of sales go into oral, solid dosage, which includes pills and tablets. Roughly two-thirds of prescriptions take this form.
I am sure we all appreciate the underlying market drivers here. We have an aging global population with rising rate of hyper-tension, diabetes and obesity. People are living longer and taking more pills. Regulatory requirements continue to tighten and customers are primarily driven by compliance, convenience and product effectiveness.
Slide 30 provides an example of what we do in this market. With more than 60% of new drugs currently in development having poor solubility, along with nearly half the drugs coming off patent in the next ten years, it is increasingly important to choose ingredients that increase the solubility and bioactive availability of the active drugs. We now offer a variety of ingredients to assist formulators with these needs.
Our ingredients and process technologies improve drug efficiency and reduce formulation costs, while potentially reducing side effects, especially in long-term users. Our Plasdone and Polyplasdone product lines have proven performance in enhancing drug solubility in solid dispersions and liquid-filled soft gels.
In injectibles these products inhibit crystal formations. These products also act as super disintegrants for increasing the rate and extent of drug dissolution.
As shown on the graph our Polypplasdone XL-10 technology offers faster drug release when compared with other disintegrant technologies and up to 100% dissolution.
Now let's take a look at the personal care market on slide 31. Specialty chemicals sold into the personal care market are a $5 billion to $6 billion opportunity and we are focused on the areas of skin care and oral care. This market is growing at 4% to 5% annually and we are an industry leader in fixatives, rheology modifiers and dental adhesives.
Emerging regions such as Asia are growing at rates closer to 10%. The primary market driver here is the global emergence of the middle class and their increasing familiarity and demand for personal care products. Products are now heavily customized and the amount of product differentiation is extreme. Walk down your grocery store aisle and you will see multiple products customized for thin, curly, dry, oily or even chemically treated hair.
There are toothpastes that not only clean your teeth and freshen your breath, but also prevent tartar and gingivitis, renew enamel, reduce sensitivities and offer whitening properties. In the skin care arena there is a huge variety of lotions, anti-ageing products, wrinkle reducers, sunscreens, facial cleansers and body washes.
This relentless drive for innovation and superior product performance creates a tremendous opportunity for specialty ingredients.
Let's go to the next slide where we will review a few of our opportunities in personal care. Skincare is a very attractive market and through ISP’s Vincience line of products we now have a number of active ingredients.
Let me explain why that’s exciting. The historical functional ingredient business as the name suggests was based on inactive products that impart functional benefit such stabilization and suspension. At a very high level, we help manage the rheology or flow properties of water-based systems.
Now, we’ve also offer ingredients that directly address customer’s health and beauty concerns. Within skincare, we help end users achieve a fresher, younger look. Not only can we help you look younger, but we can also help protect skin from further damage from the sun and other environmental stresses. This partnering of actives and inactive chemistries enables us to offer a much a broader, more complete range of solutions to our customers.
Our primary research in technical supportive is conducted through our global skincare research center in France. We’ve more than 30 dedicated researchers on staff including licensed dermatologists. We also have the ability to analyze product efficacy starting at the cellular level and progressing through clinical trials. These capabilities enable us to meet the exacting requirements within this industry.
Slide 33 provides an example of our offering in hair care. Our Stylez W line of products offer a wide range of benefits. For example, we help protect hair against thermal damage caused by hair dryers, curling irons and flat irons. Users who pretreat their hair with products containing Stylez W experience upto 25% less hair damage.
We also can help prevent fading of color-treated hair and provide superior humidity and water and weather-resistance styling. Our key capabilities in hair care include formulation and application expertise coupled with our proprietary industry-leading technology.
Let’s go to an example of what we are offer in oral care. We now have a product that goes into toothpaste that delivers teeth whitening results comparable to whitening strips. Our Peroxydone product is based on our PVP chemistry complexed with hydrogen peroxide. This product is used as an active ingredient in tooth bleaching gels, films and other novel products.
In addition to Peroxydone, we also now offer Gantrez Copolymers which aid in tartar prevention and help deliver and control the release of active ingredients in the mouth. These products complement our Aqualon CMC binders and thickeners and stabilizers for toothpaste.
Now let’s turn to our coatings market on slide 35. Additives for waterborne paints and coatings is a $2.5 billion global market. We primarily sell in the water-based architectural paints where global volumes are growing at a rate of approximately 5%. Growth is largely being derived by emerging regions where the combination of an emerging middle class and a rapid shift away from solvent-based paints is a driving force for growth.
This shift began decades ago in North America and Europe where environmental regulations, consumer preference and comparable or better performance from water-based paints have led to a steady decline of solvent or oral-based alternatives.
In more developed markets, two primary market drivers have been low VOC paints and the drive for one-coat coverage. VOCs or volatile organic compounds though reduced remain present in every water-based paint. VOCs often give off an undesirable solvent smell when you are painting your room. These smells are hard on the environment and hard on you.
So the market is now shifting toward ultra-low and zero-VOC paints. Many of the new additives we have developed enable high performance at virtually no VOCs. One-coat coverage often marketed as paint and primer in one saves time and reduces labor cost by providing great hiding and consistent finish often with a single coat. Many new technologies come together to make this work. One very important component is referred to as flow and leveling. Think of it as a carefully engineered paint consistency, fluid enough to make brush marks disappear, but then rapidly thickening to prevent drips and runs. Our newest Aquaflow XLS rheology modifier is among the best in the industry for this perfect balance.
Let’s turn to slide 36 to take a look at how our Natrosol product line helps prevent paint spatter. Natrosol is a highly efficient cellulosic thickener with excellent spatter resistance during roller applications. The benefits of this product are shown on the slide. The top picture shows a paint made with a more conventional ATC-based product. The lines you can see are called Fibrils. As you roll paint on the wall, these sticky connections break and cause spatter. You can imagine how this would look if you’re painting close to your white ceiling or haven’t appropriately covered your furniture and floors.
The bottom picture shows a paint made with our recently released Natrosol HE 3KB product line. You see little or no specs and your furniture and floors are now safe. Additional benefits of HE 3KB include high coverage and low titanium dioxide formulations and enzyme resistance allowing for long-term stability.
Now let’s take a look at our industrial markets which include construction and energy. Energy with a market opportunity of $4 billion is growing at an annual rate of 3% to 5%. We primarily sell our products into large multi-national energy service providers. Typical applications include drilling, cementing and stimulation additives. Construction is a $2 billion market opportunity growing at 4% to 5% per year. Growth has particularly been strong in emerging regions and the developed economies are still recovering.
Product applications here include grouts, mortars and cements. Market opportunities include greener additives for use in energy such as our natural Guar-based products as well as further extension into construction markets with our new redispersible powder offering.
More on this a little later, but first let’s go to the next slide for an example of our offering into the energy market. Our XxtraDura Cement Additives were created for use under extreme operating conditions of pressure, temperature and salinity. The XxtraDura GMA products which are based on a combination of HEC and proprietary synthetic compounds are primarily used to prevent gas channeling through uncured cement during well construction. This helps ensure a safer process protecting people, assets and the environment. There is broad interest in such product given the incidence in the Gulf last year.
Please turn to the next slide. Today the construction market requires high quality performance from dry mortars. Desired qualities include strong bonds, protective finishes and performance across the wide range of climate conditions. Redispersible Powders or RDP are integral to our growing our construction business. Our line of Aquapas Redispersible Powders is a new addition to our construction portfolio.
These products are particularly well suited for energy-saving applications such as External Insulation Finishing Systems where the primary concerns are superior adhesion to substrates and durability under extreme weather conditions. Aquapas also provides performance benefits in other dry motor applications such as house cements, repair motors and skin coats.
Now let's look at our Specialty Performance market on slide 40. What we call our Specialty Performance market consists of a broad collection of industries and applications. These include agriculture, ceramics, electronics, inks and printing among others.
In this market, we sell high performance polymer additives as well as specialty solvents and intermediate products. The market drivers here are varied, but include increasing global demand for BDO and other specialty solvents.
Other market drivers include the global need for alternative energy sources, benefiting our position in rechargeable batteries and the demand for higher crop yields to maximize output from existing farmland. On average, these markets are growing at a rate of 2% to 4% annually.
As a part of our strategic focus, we will develop new products such as dispersants, solvent alternatives and tank mix adjuvants for use in agricultural chemicals. We also explore adjacent markets for potential use of our existing products.
Please turn to the next slide. Our newly acquired polymer production capabilities come with significant backward integration. We have two primary manufacturing routes to reach butanediol or BDO which for Ashland is generally an intermediate product.
One manufacturing route is based on natural gas which is first converted to a settling. The second manufacturing route is based on a butane-hydrocarbon input. Of the roughly 160,000 metric tons of BDO produced, approximately 35% is sold directly into the merchant market where the larger applications include spandex fiber and plastics. Roughly 45% of our BDO is sent downstream to make solvents such as THF and NMP for consumer sale.
These specialty solvents and the BDO sold into the merchant market comprise our intermediate and solvents product line which are part of our Specialty Performance business. These products are both manufactured and require very little technical service. The remaining 20% of our BDO is used in the production of specialty water-soluble polymers such as Polyvinylpyrrolidone or PVP. Overtime as volumes of these highly valuable polymers grow, we will continue to shift more and more BDO to polymer consumption.
Now, let’s take a look at Specialty Ingredients global manufacturing capabilities on the next slide. We have 29 manufacturing facilities worldwide and are in the midst of expanding this manufacturing network to meet increasing global demand and to better address local and regional needs of our customers.
Many of our products are highly valued powders and our manufacturing strategy has been to generally operate large facilities that enable us to achieve low unit costs. With the acquisition of ISP, we’ve added many new liquid based products and freight will become a more important consideration as we expand our manufacturing footprint.
Our focus over the last several years has been to build-out our manufacturing and supply position in Asia. Our most recent capacity expansion was a Greenfield ATC facility in Nanjing, China. This was a $90 million investment that took about two years to build. The start-up of this facility in December 2010 went extremely well and we’re now operating very near to 10,000 metric ton annual capacity. Given strong growth of global demand, we recently announced additional ATC expansions which I’ll describe a little later.
As shown on slide 43, we offer a broad set of capabilities to address our customers’ requirements. Starting with our customers, we have the ability to understand their formulation and product needs. We have expertise in material science where we can develop new molecules for use in existing applications. We also have the capability to synthesize new polymers. We possess pilot and scale-up capabilities that enable us to reliably bring products to market. Through our specialized manufacturing, we can further tailor our products to meet customer specific application needs.
Our analytical resources enhance our ability to develop new products and troubleshoot customer processes. Having this full range of core expertise and capabilities, positions us as the supplier of choice to our customers.
Please turn to the next slide. Shown here is the Specialty Ingredients baseline performance for the past five years. From 2008 to 2009, sales and EBITDA did decline primarily due to lower volumes and profitability in the Industrial and Performance segments. Since that decline, sales and EBITDA have expanded considerably.
EBITDA margins have remained fairly consistent and averaged approximately 23% of sales over the last five years. From 2010 to 2011, Specialty Ingredients costs rose by more than $150 million all of which has been recovered through pricing.
Please go to slide 45. We have four main strategic levers to reach our 2014 plan. First, is strong ongoing growth of our baseline business where we expect that particularly strong contributions from the higher margin pharmaceutical personal care and coatings markets.
Next is new product innovation, where we will build on our leadership position and leverage the expanded strength of our broadened R&D organization. Third is productivity gains. This would include obtaining cost synergies from the acquisition of ISP as well as incremental cost improvements at our various manufacturing sites. Last is geographic expansion, where we expect to maintain our growth momentum in the emerging regions of the world.
Let’s get into the detail starting on the next slide. There are five primary megatrends that we expect to help drive future growth and performance. This includes the increasing green focus at the customer, at the consumer, commercial and regulatory levels. Given our large percentage of naturally derived chemistries and water soluble polymers, Specialty Ingredients is uniquely situated to take advantages of this trend through our existing technology platforms.
This also includes strong growth in emerging regions such as Asia where a growing middle class and their associated desire for higher quality of life presents a particularly appealing growth opportunity. We are taking the necessary steps to capitalize upon this growth including making significant capital investments in both manufacturing facilities and applications laboratories. We are also pursuing a number of commercial relationships to better establish our local presence in these important markets.
Three of these megatrends can be thought of as one concept; value, performance and convenience. Put simply, end consumers and manufacturers want easy-to-use products with a high value in use and with increased performance and quality. A fine example of how we capitalize on this set of trends is in coatings, where we have products that provide the one-coat coverage and low spatter better than end consumers’ desire and a high-value and ease-of-use that manufacturers require. The combination of these megatrends are existing infrastructure investments and a broad portfolio of products should position us well to achieve accelerated growth.
Let’s go to slide 47. When we consider all of the various markets and applications in to which our products could play, we estimate the overall opportunity at $40 billion to $50 billion. When we consider our strengths, capabilities and infrastructure, we can pinpoint our highest return opportunities within specific segments. This amounts to a roughly $20 billion to $25 billion market that we know well and can address already with our business capabilities.
Given the high margin nature and unique utility provided by our products, we are primarily focused on the oral, solid dose segment of pharmaceutical, the skin, hair and oral segments within personal care and water-based architectural paints within the broader coatings market.
Let’s get into some more details starting on the next slide. Our pharmaceutical and nutrition business represents some of our highest margin operating opportunities. Our leading product lines include Klucel hydroxypropylcellulose and Benecel MC which offer efficient tablet binding and controlled release. Our Plasdone products that we described earlier. Our Aquarius coating line which provides a full color palette as well as in terra coatings to resist disintegration in acidic stomach conditions and our Polyclar and CMC product line that go into food and beverage market.
Sales in the pharmaceutical and nutrition are roughly $450 million today and have achieved a fairly consistent 8% compound annual growth rate over the last five years. This is not a cyclical market and you will notice that even during the recession, sales were stable. By leveraging our industry leading excipient product line and broadened research and development capabilities, we expect to build upon our success in these high margin markets.
Please turn to slide 49 for a look at our opportunities in Personal Care. Personal care has been one of our more consistent growth vehicles with a 6% compound annual growth rate over the past five years, our largest position in Skin Care, which accounts for about 35% of our approximately $570 million of sales into the Personal Care market.
We also have sizeable positions in Hair and Oral Care, which represents 31% and 25% of our sales in the Personal Care respectively. The vast majority of our pro forma historical sales into Personal Care came from ISP’s settling-derived chemistries.
Products include both functional and active ingredients as shown here. We now have the opportunity to combine our expertise in cellulosics with ISP strong market position and application capabilities. The resultant product should enable us to further capitalize on the green megatrend occurring in the Personal Care space.
Please go to slide 50. Coatings has been a great market for Specialty Ingredients. Over the last five years, we've grown at a 10% compound annual growth rate and sales held up very well even during the recession. This market is one that is particularly well-suited for cellulosic chemistries and we've considerably evolved our product offering over time.
A sampling of our industry leading portfolio is shown here. Our superior coating chemistry, along with technical collaboration with customers, enables us to develop leading edge products specifically designed to address market drivers. We expect these leading edge products to drive growth as part of our 2014 plans.
Please turn to the next slide. Many of our key product lines are in sold-out positions and a number of our plans are approaching full capacity. Capital projects, typically take one to two years to execute. So we’re continuously projecting our future demand so that we have adequate capacity in place. Given the general size in fixed costs associated with these facilities, we try and fill any new capacity as quickly as possible. For example, our Nanjing ATC facility, which opened less than a year ago, is already at full capacity. Given the success, we’re increasing our global ATC capacity by another 7,000 metric ton. This will involve expansions in China, Europe and North America.
In total, we’re planning to invest approximately $600 million over the next three years in order to support our planned growth. This includes both, maintenance and growth capital. These investments will be distributed across all regions but I expect emerging regions to be disproportionately favored.
Now let’s go into our New Products Strategy. Our New Products Strategy is built directly around market need. We’ve well built-out process with the define set of metrics to determine success. We incorporate a portfolio approach to R&D, spending time on breakthrough technologies, as well as product line expansions.
We encourage our scientists to explore new market adjacencies provided there is a clear connection to our core. These scientists are typically dedicated to a specific market and often have additional specialty based on customer needs. This market driven approach to product development has led to some of our key product line and has supported our historical growth.
The chart on the right shows our productive sales growth from New Product Innovations as part of our 2014 plan. The historical data shown includes product introduced by both Ashland and ISP. As shown on slide 53, ISP and Functional Ingredients have had a similar attention to New Products development. New Products represented approximately 25% of Functional Ingredients 2011 sales and 21% of ISP’s excluding the sales for our intermediates and solvents product lines. New Products are defined as those products introduced to the market place within the last five years.
Over the next few slides, I will elaborate on how we will hit our New Product goals.
Our Innovation Platforms are shown here. I won’t get into the details as I have already shared many of these examples. But needless to say, we possess a lot of different avenues for innovation-driven growth. By focusing on specific platforms, we can leverage our knowledge to better connect with customers and increase our ability to bring new products to market. Now let’s go to our innovation pipeline on the next chart.
This chart shows what we expect some of our New Product Platforms to launch. Most of the current product launches I have already described. As you can see, we have numerous projects in the pipeline that we expect to bring to market over the course of the next five years. There is no good rule of thumb when it comes to the product development cycle. We have a long-term approach trying to capitalize on developing trends and to help our customers anticipate market needs.
Our next slide shows where our research facilities are located globally. We have organized our New Product development around 10 centers of excellence spread around the world. An example of this is our facility in India focused on pharmaceutical Excipients and our facility in France focused on Personal Care.
There are key regions where a lot of our customers’ product development is taking place. We support these centers with a number of application and technical service labs providing more localized support for our customers.
Let’s move on to the third contributor to achieving our 2014 performance goals.
Our planned Productivity and Cost-Efficiency targets came from two areas. First, is obtaining the expected $50 million of synergies from the ISP acquisition. We expect roughly $20 million of these savings to come from eliminating commercial overlaps. The other $30 million will come from reduction in back office support and corporate costs. The timing for removal of these costs is largely dependent upon systems integration and our plan is to achieve this by the end of fiscal 2013. Due to Ashland’s corporate allocation methodology, Specialty Ingredients will receive only a portion of the planned $30 million of savings. The rest will be spread across Ashland’s other commercial units.
The next area is Productivity and is reduced manufacturing cost. We have a dedicated staff of plan engineers who are tasked with identifying cost savings opportunities throughout our manufacturing network. Typically, these engineers will focus on energy consumption, raw material yield and overall conversion cost. We’re focused on obtaining these savings and this is an important contributor to our 2014 goals.
Let’s go to next slide for emerging region strategy. As you heard me mention a number of times during this presentation, the emerging regions are focused for 2014 plans. Our primary emphasis is on China, India and Brazil where we are targeting double-digit sales growth. To support these efforts, we’re building out our research and development capabilities and expanding our regional application laboratories. Each region will be tasked with developing a five-year innovation plans specifically to meet regional customer needs. These plans will be geared toward our targeted Pharmaceutical, Personal Care and Coatings markets. In addition, we’ll emphasize construction in these regions due to the strong growth of infrastructure and housing.
Growth within Latin America and Asia-Pacific has been extremely strong with sales up 50% in the last two years alone. We are well-positioned in these areas today and we have plans in place to take additional share in these high-growth regions. Let’s put it altogether on slide 59. Specialty Ingredients is targeting $795 million of EBITDA by fiscal 2014. The only element that I haven’t elaborated on here is the reduction caused by our intermediate and solvent business. As I described earlier, the profitability of these products expanded dramatically from 2010 to 2011 due to good volume and very strong prices. We don’t expect that trend to continue and we built in lower margins in these product lines as a part of our 2014 plan. Volume will also likely decline given the good growth in our polymer business and the use of more BDO for internal production. Of course, these headwinds will be more than be offset by our growth initiatives and productivity gains.
In total, EBITDA should grow by more than 30%. This would imply an EBITDA margin of approximately 25% for the fiscal 2014. Please turn to slide 60 and I will summarize what you’ve heard this morning.
Specialty Ingredients is a high margin business with a history of strong growth. By brining together the Functional Ingredients and ISP organization, we’ve created a global leader in water soluble polymers with highly differentiated products and strong market positions in Pharmaceutical, Personal Care and Coatings. Key drivers of our 2014 performance will be ongoing growth of our base business, leveraging our research and development expertise, productivity gains and cost synergies and maintaining our momentum in emerging regions. I am extremely pleased to be leading this world-class organization. We’re truly bringing together the best of the best and I can’t wait to show you what we can do.
Now I think we have 15 minutes or so for questions. So, David, how are we going to do that.
So John why don’t you take the questions.
Dave Begleiter - Deutsche Bank
Dave Begleiter, Deutsche Bank. John can you just quantify again in the solvents business that benefited BDO to ISP over the first nine months this year or on LTM basis and your expectations in the next 12 months of that business, how much it will decline because (inaudible) your prices.
Yeah, so I think the easiest way for me to give you a perspective around 2012 through 2014 is that we envision by the end of 2014 approximately $40 million will be reduced in that business and that's what we have baked in the plan. So that's from 2012 to 2014, something around $40 million will be a headwind for us in that business, primarily driven by supply demand imbalances in that time period.
These are generally big production site. So when they come on, they are big units, they come on, they build capacity and it takes supply demand a little time to kind of level out in that business. So if you are looking at what kind of numbers to be thinking about, it’s something like $40 million over the next three years.
John Roberts - Buckingham Research
The $600 million in capital spending or $200 million a year, how does that compare to the pro forma last two or three years, what have you been spending on an annual basis?
Yeah, well, you have to take the two pieces and add them together. So heritage ISP we are spending about $75 million a year and that was pretty close $75 million to $80 million is what was being spent in the heritage Aqualon functional ingredients business. So you are comparing about a $150 million to $200 million, something like that.
Steve Fish at [Dominic Investments]. How big of an impact has the (inaudible) supplier issue been and when do you think that it will be up and running and kind of what’s your theoretical benefit over the next couple of years compared to 2011?
Yes, so that was an issue with a supplier in North America and they had an explosion which probably had a about 8 to 10% impact on cost within the heritage ISP business in fiscal 2011. That supplier is in the process of putting that unit back on line and it’s I think a first half deliverable of 2012. So we expect that they will come back on line and that will put us in a better position around the settling. So that’s right now what we have baked into our thinking going forward.
Hi, [Daniel Laurence] Solera Capital. On slide 22, you’d mentioned there was high capital costs to replicate the manufacturing capabilities of ISP. Could you provide a little more detail in terms of dollar amount and how many years it would take to replicate you know some example facilities?
Well, the facilities are like order of magnitude I would say we spent like $90 million to build the ATC plant, we just built in China and that took us a couple years to design and a couple of years to build. The ISP plans are more sophisticated than that, more reaction steps than that. So it depends on exactly which train in the reaction you are talking about, but it’s hundreds of millions of dollars to replicate that kind of manufacturing capability and it would take you a very long time to have an integrated approach like we have there. So it’s very sophisticated and very integrated.
[Gary Noel] with BlackRock. I am curious on the revenue of targets that you have for 2014, it looks like it’s implying your 8% compounded annual growth. It looks like the 2007 to 2011 was closer to 5.5% to 6%, is there anything that changed either in the marketplace or where you got a targeting that would support the acceleration in growth going forward?
Yeah, I think that some of the accelerated growth is really driven by the combination of the two businesses. So what we have created is we have a really a much stronger channel as an example in the pharmaceutical where we now have created a lot more leverage in the business. So I think it’s a combination of the two businesses give us some pretty nice upside. It’s also the combination of the new product launches that we have coming from the combined new business that gives us, we feel additional growth opportunity on top of what was kind of the core growth that the company had experienced.
So I would say it’s less kind of a market driver and more kind of around the business integration that gives us.
Mike Sison - KeyBanc
Mike Sison, KeyBanc. When you think about the 14 EBITDA bridge that you have wrapped out on slide 59, how much of that and if you think about it over those years, is it a fairly linear improvement, are there hockey sticks on the way, are there certain things here that you know look more visible upfront versus later?
Yeah, we see it pretty linear. There is seasonality in the business, so quarter-to-quarter generally quarters two and three are generally are the summer months , we get a little bit of improvement in those. So there is some seasonality in the business model a lot, but in general we see the years pretty steady as far as growth. It’s not no growth or little growth, little growth hockey stick kind of approach, it’s pretty steady growth, but there’s little seasonality in the quarters.
Jeff Zekauskas - JPMorgan
Hi, Jeff Zekauskas from JPMorgan. In the ISP business from 2009 through 2011, I guess revenues went from roughly $1.3 billion to 1.85 billion. So how much of that was price?
I think last year as an example I think the combined ISP business including elastomers got about 200 million of price. So you could use that for 2011, I think the number is right around $200 million, split about a $100 million in what is now the businesses associated with ASI and about a $100 million associated with the elastomers business it’s now part of the performance materials. So I don’t know the years prior to that but I know for 2011 that’s about 200 million.
Jeff Zekauskas - JPMorgan
Just in theory, why is it that you should retain all of that price?
Well, what we’ve seen in the business is that as raw materials increase, we are pretty good at getting the cost up and we can hold on a lot longer when materials start to decline, I mean the history has been. So you know if there was a real rundown in raw materials, would we retain a hundred percent of the price, probably not, but we would retain a fair amount of it.
Jeff Zekauskas - JPMorgan
So I guess just lastly, can you talk about the margin you made above your raw material and inflation over some historical period of time and what the sources have you being able to do that for?
What I can tell you is if you look at like the heritage Ashland functional ingredients business in our most recent quarter. We had discussed that we had prices pretty well ahead of costs. And the reason we are able to do that is the specialty nature of the products. They are formulated into a whole host of customer formulation that are very difficult to change.
And so we have a fair amount of pricing power to be able to raise prices and hang on to prices in the customer applications because we are so formulated in. So when you are into toothpastes and paints and all these personal care products, it is very difficult to get in and it is also very difficult to get out. Okay, so it puts us in somewhat of the unique position that if we have manage properly, that we can have pricing ahead of costs.
Thank you John. Good morning. Today, I’ll walk you through the Ashland Water Technologies business starting on slide 62. With sales of $1.9 billion and adjusted EBITDA of $194 million, Water Technologies is a leading provider of specialty chemicals and services to water-intensive businesses.
Our largest market is paper which accounts for 57% of our sales. Our industrial markets include pulp as well as heavy and light industry where we sell into a very broad and diverse range of customers and end markets. Conceptually, any water intensive business is a potential customer. We also sell into the municipal market for wastewater treatment which represents 10% of sales.
Our products are divided into process, utility and functional chemicals. Process chemicals the underlying production process. They help our customers run more efficiently, minimize down time, lower environmental exposure and help reduce capital requirements.
Utility chemicals are those products that help preserve critical plant assets, supporting day-to-day operational systems at the customers manufacturing sites. These chemicals also provide water and energy savings typical utility systems include boilers, cooling towers and wastewater treatment.
Functional chemicals go into a variety of paper-based products. They impart properties such as strength, printability and water resistance. This is a geographically diverse business with greater than 50% of sales coming outside North America. Growth has been strongest within our emerging regions which have grown at rates three to four times the Water Technologies average.
Let’s go to the next slide. By our estimation, we play in a roughly $30 billion water market growing at an annual rate of 3% to 4%. Paper markets represent a roughly $6 billion opportunity and we hold the number one position in specialty paper making chemicals. Globally, paper is growing about 4% to 5% annually and demand is migrating to the emerging regions of Latin America and Asia Pacific.
Industrial markets presents a huge opportunity, estimated at $25 billion in total. Growth within these markets varies widely with demand generally driven by the need for process improvement, increased operational efficiency and reduced costs. While, the overall industrial market is growing at roughly 4% to 5% annually it contains fast growing segments such pulp, mining and food and beverage.
We estimate the available market for municipal at $1 billion. For our business, this is typically a lower margin price driven market with limited opportunity for service differentiation.
The next slide helps demonstrates the wide variety of uses for our products. I want to elaborate on everything you see here. But our primary focus is on process and utility chemicals. Typically, these are highest margin and most differentiated service offerings and technology.
Now let’s get into our historical performance on slide 65. Our baseline sales are up roughly 14% since 2009 on underlying volume growth of approximately 7%. EBITDA and EBITDA margins grew considerably starting in 2008. As you may recall, Ashland closed on the purchase of Hercules in November 2008.
Synergies achieved by combining the respective water businesses along with lower raw material cost more than offset the effects of lower volumes. Synergy efforts continued thorough fiscal 2010, however, we began to face significant raw material cost inflation starting in the latter half of that year. These increased raw material costs continued into 2011 and have just recently leveled off as we closed our fiscal year.
I’ll provide some more details on the next slide. From fiscal 2010 to 2011, our total cost increased by roughly $120 million. This was almost exclusively due to increased raw material cost particularly in propylene and more broadly hydrocarbon based raws.
Pricing efforts continued throughout the year and we recovered nearly $100 million in total. Raw material cost have recently stabilized and cost recovery did improve as we closed out the fiscal year. Of the $20 million of increased cost we did not recover in the fiscal year, $15 million was within the wastewater polymers product line.
Wastewater polymers primarily consist of Polyacrylamides, a flocculant that goes into a number of competitive markets such as municipal. In total, only about half of increased costs were recovered in wastewater polymers. This contrast with the rest of our Water Technologies business, but has done quite well recovering approximately 95% of increased cost.
Let’s go to slide 67. Wastewater polymers is very different from our other product lines. Customers typically shop on price and service requirements are minimal. The competitive environment has been very difficult with major competitors largely backward integrated and arguably more volume driven. Even so, there are some higher margin and more technically differentiated opportunities particularly in emulsions.
Over the next several years, we expect to add emulsion capacity in Asia to capture strong growth. At the same time, we will maximize returns for our European powder production which generally carries lower margins. We will also rationalize our customer and end use market mix to selectively serve higher margin applications. This will involve minimizing our efforts in a highly competitive municipal market, enhancing our capabilities to serve the higher margin paper and industrial markets and exploring opportunities in oil and gas. These actions should lead to improved profitability overtime.
While the rest of our business has been generally successful in recovering cost, we will remain vigilant. I expect our team to maintain a pricing discipline and focus on higher margin applications to improve our overall profitability. I further expect our team to exercise tight control on SG&A and make sure spending grows at a rate less than overall sales growth. By taking these steps Water Technologies will expand margin overtime.
Slide 68 describes where we have been and where we want to take the business going forward. During the past three years, we have been getting our business structure in place to drive sustainable growth. Disintegration of the Hercules and Ashland Water business creating necessary scale to support our growth efforts in key regions.
During this integration, we delivered $120 million in overall cost savings. More recently, we standardized our pricing policies and procedures, enabling us to more appropriately respond to rising material costs. I now believe we have the structure in place to support our growth targets.
Over the next three years our business will be focused on growth and margin expansion. We expect sales to grow at a rate of 5% to 6% per year in excess of the overall market. This will be driven by a portfolio of differentiated products and services which should allow us to expand margins.
Now lets turn to the next slide for the strategic levers we can pull to drive our growth. We have four main strategic levers to reach our 2014 EBITDA targets. First, we will build on our number one position in the Paper Markets. Secondly, we will further expand in industrial markets with an emphasis on the higher margin, fast growing pulp, mining and food and beverage segments. Third, we expect to maintain our strong growth and performance in emerging regions. These regions will be crucial to our long-term success. Last is margin recovery, where expect us to recover the remainder of our increased raw material costs from fiscal 2011.
Let's get into the details starting on slide 70. We have sales of about $1.1 billion into paper which includes Packaging, Tissue and Towel and Printing and Writing. Each of these segments is expected to grow. Specialty chemical spending in both the Packaging and Tissue and Towel segment is expected to grow 4% to 5% annually over the next three years. Growth rates should near double-digits in emerging markets such as Asia.
Globally, Printing and Writing production is growing 2% to 3% per year. Regional splits here are dramatic. Asia Pacific and Latin America are growing at 15% to 20%, while North America and Europe are contracting slightly. Since 2009, our sales into Paper have grown roughly 20% as compared with 14% in our overall business. We've grown in all three Paper segments with our strongest sales growth in Packaging, which is up approximately 35% since 2009. We expect to expand on our number one market position in Paper and are pursuing four main avenues for growth. First, we are developing new process chemistries that help reduce down time and maximize throughput in the paper mill. Second, we will be commercializing a line of sustainable strength platforms and I expect to have this available to our customers shortly. Third, we will maintain our focus on the high growth emerging regions. And fourth, we’re expanding the low cost production of functional products to drive down unit cost and improve margins.
Overall, I expect us to build on our leadership position through an improved product mix, strong organic growth, ongoing product innovations, and an emphasis on cost control.
Slide 71 provides an overview of our Industrial Market opportunity. As I mentioned earlier, we are concentrating our efforts on the higher margin, higher growth, Pulp, Mining and Food and Beverage markets. In order to drive success, we are putting teams in place of market-focused specialists, dedicated to these markets.
These specialists include corporate sales, commercial application experts and research and development personnel. These specialists will be able to provide complete product and service solutions to solve customers’ unique problems and meet their specific requirements. We also expect to expand our position in the boarder industrial markets such as heavy industry and power generation. To meet our growth targets, we must become an industry leading innovator. We are focused on process chemistries as well as our utility water platform.
More on this later. For now, lets get into our Targeted Growth Markets, starting with Pulp on the next slide.
Pulp, for those who may not be familiar, is a precursor material used in the production of paper and some new applications such as (inaudible) and dissolving pulp, which are sold by others into our Specialty Ingredients commercial units. Pulp mills may be either integrated into the front end of a paper facility of these standalone operations. The key driver for pulp production is an increasing shift towards emerging regions.
This is caused by strong demand within those regions as well as the availability of low cost fiber sources, such as eucalyptus and acacia, which are prevalent in these parts of the world. This market is also changing rapidly with many mills now producing pulp for exports. To serve these customers requires intimate understanding of not only mill operations and specifications, but also of customer requirements around the globe. This creates a significant opportunity for us given our global reach and capabilities.
We have a very strong position in the pulp market today with sales of approximately $150 million in to what we estimate to be a $1 billion opportunity. Our primary value proposition to this market includes customized process and utility chemistries enabling lower cost and productivity gains, coupled with our best-in-class in-mill service and applications expertise.
Please turn to the next slide. Mining has become an attractive market for reasons most of us know. Commodities are high and mining activity has increased dramatically. When coupled with global water scarcity, and tighter regulatory environment for effluent treatment, this market provides significant prospects for growth. We estimate the available market at $2 billion and our sales today are roughly $60 million. The primary customer needs are superior efficiency and mineral recovery operations and higher throughput, all while continuing to meet regulatory requirements. The products and service solutions we offer include anti-scalants, dust-control additives, filtration aids and viscosity aids.
Our customer intimate sales and service model enables us to meet the need of this market segment and we expect to grow with the market and capture additional market share.
Let’s go to slide 74. Food and Beverage manufacturers are faced with an increasingly difficult environment. Food safety and environmental regulations are becoming more stringent. The amount and type of contaminants permitted in waste water effluent are heavily regulated and the requirements get stricter every year. Food processors look to the water treatment providers to deliver not only better chemistries into these unit operations but also to bring specialized expertise to help them meet these types of requirements.
We will compete in these markets with a heavy focus on our utility water offering to directly address this growing customer needs. Other opportunities within Food and Beverage will be pursued on a highly-selected basis. One example of this is the high growth, bio-fuels market. Within this market, we’re developing unique process aids to help ethanol producers maximize Corn Oil yield and overall profitability. In total, Food and Beverage represents a $2 billion opportunity and we have sales to day of a little over $50 million.
Now please turn to slide 75 and I will walk you through some of our New Product development opportunities. To achieve our growth in our Industrial Markets, we must have a strong offering in the utility water space. Historically, the primary customer concern was asset preservation and minimizing down time. In other words they wanted their on site utilities to last forever and require very little maintenance. Given the increasing need for clean, reusable water, the associated cost and the associated cost and regulation imposed on industry, this view as evolved. Today, our customers increasingly want to significantly reduce the use of water, energy and chemical products, all in an attempt to improve their profitability. This is where we fit in.
Lets go to the next slide. To meet these evolving needs, Ashland has recently developed and commercialized our OnGuard Monitoring and Control Platform. This fully integrated water treatment offering enables real-time monitoring and system control. It accurately measures organic and inorganic fouling and enables optimization of water usage in cooling and boiling water systems. This platform distinguishes itself by a number of key features. They include the amount and type of data collected by our industry leading sensor technologies, patented programming logic which provides superior system control and easy-to-use data mining analysis and statistical capabilities. This is a significant improvement over our previous offering and should position us ahead of the competition. We will be rolling out this platform over the course of 2012 and it will be a cornerstone of our broader industrial market strategy.
As market penetration of OnGuard grows, it should create additional cross selling opportunities into customer plants and other facilities.
Let's go to slide 77. This slide shows the sampling of our other innovation platforms and new product development efforts. Each of these products is specifically tailored for a unique industry application. One example is our newly introduced extraction aid to maximize corn oil yields. This biogradable nontoxic product enables up to a 300% improvement in corn oil production.
Another example is our Biosperse, microbiocide for microbial control and recirculating cooling water systems. This industry-leading technology is derived from our spectrum product line which is one of the most widely used biocides in the paper industry. The primary benefit of this product includes improved system cleanliness, reduced corrosion potential, lower operating cost and reduced environmental impact and worker exposure. These two products and the other shown here are but a sample of what we have in our products pipeline today.
The next slide shows our progress in emerging regions. Market growth in these regions has largely outpaced the mature economies. As I stated earlier, the paper markets are migrating to emerging regions and our targeted growth markets are pulp, mining and food and beverage are expanding faster in these areas than they are in North America and Europe.
Latin America and Asia Pacific will be key to our long-term success. We are well positioned in these regions and over the last few years, we have increased our sales by roughly $100 million. This is a roughly 40% increase over 2009 sales. With sales growth triple that of overall Water Technologies business, these regions will command greater resources over time. To support this growth we will incrementally migrate resources including sales, technical service and manufacturing capabilities to these regions.
Now, please turn to slide 79 for a look at how our strategy ties together to bring us to our 2014 EBITDA target. Over the next three years, we expect Water Technologies’ EBITDA to grow by $120 million to a target of $310 million. The largest contributor to these targets will be strong growth in our paper business followed closely by our efforts in industrial. Emerging regions and margin recovery are roughly equal contributors.
Let’s see what this means in terms of EBITDA margin on the next slide. With this target we expect 2014 EBITDA margin of 14% to 15%, a 400 basis point increase from our 2011 performance. Although this increase sound sizeable, remember that 2011 was disproportionately affected by raw material cost increases. As we recover our cost, begin to improve our product mix and optimize our overall SG&A expense, we will increase margins. While these margin targets are below our previously stated midcycle goals, the EBITDA dollar targets are roughly similar. The main change in our thinking is that we now expect raw material costs to remain inflated.
Now let’s wrap it all up on slide 81. Our overall targets for 2014 are sales of $2.1 billion to $2.2 billion and EBITDA of $310 million. I expect to achieve these levels of performance primarily through volume and mix, although continued cost management remains a foundation of our overall business strategy.
In conclusion Ashland Water Technologies, is the number one global producer of specialty paper-making chemicals and a leading provider of specialty chemicals and services to water-intensive industries.
We now have a few minutes for questions.
Good morning. Could you clarify how much of a margin premium you have in the mining, pulp and food and beverage markets? And also for the OnGuards, can you clarify the differences in patent stage and competitive position gains of other similar [Tygant] tracking systems?
Sure. Yes, one of the reasons that we are especially interested in the industrial market and all three of those markets are sub-segments are within the industrial markets is the inherently high margin that comes along with processing utility applications. So each of those markets is a blend of process and utility business for instance mining is almost all process business. Typically, those carry somewhere roughly between 1,000 to 1,500 basis points higher margin than average. And so that’s why you can see the mix is such an important lever for our business, because if we target the industrial businesses that are that blend of processing utility its just inherently going to – just by capturing the volume in those markets it’s naturally going to move our margins.
And the second question was about OnGuard and what I am most excited about the OnGuard platform is the fact that it actually monitors the failing of the systems. For the competitive offerings are really about monitoring what sort of treatment is being applied within the utility, the cooling tower, boiler, so there is chemical in there, you can’t really say whether it’s enough chemical or not enough chemical. In our case, the OnGuard platform actually monitors the failing of the unit and therefore is definitely a step change in what’s offered by the competition.
You mentioned growth Elkton, but you didn’t mention maximizing your return on capital if the secular trends in the mature markets that have paper in decline are eventually going to impact the emerging markets; why would focusing on growth now and capital expansion now be the way to maximize long-term returns?
Yeah, I think one thing to keep in mind is relative to perhaps ASI, our capital intensity is low. So from a supply chain manufacturing perspective, although we have an extensive supply chain network, we also are agnostic as to whether we produce a product or whether we buy it. So from a supply chain perspective, I think to capital intensity is just fundamentally in a different place than ASI.
Therefore the ability to focus instead on growth and especially as I mentioned before if we can grow in process and utility water it’s not just about scale but it’s also about inherently moving mix. And so when we talk about growth it’s just not growth in the existing – you saw the breakdown of markets and products, we wanted to just especially expand the wedge in process and utility offerings and expand the wedge in industrial. So its fact that that growth provides margin expansion is really why we are focused on that.
David Begleiter - Deutsche Bank
Thank you. David Begleiter of Deutsche Bank Securities. Pulling out the leader in water, how do you view the new competitor of Ashland and Ecolab – Nalco and Ecolab; is it a strong competitor to you now because you’ll be constrained to capitalize for a number of years. Your numbers coming in the market, how is it competing; you can actually grow share longer term as a number three player here?
I appreciate and that’s clearly one of the key areas of our strategy that we focus a lot of our effort on. We feel great about where we are positioned in paper and on the industrial side you saw the slide, if you take the overall market, our share position is relatively low and that’s why you see entire dialog focused on what are the inherently attractive markets that we have right plan.
So we can clearly identify the ones I enumerate. So Pulp, mining, food and beverage there is no doubt that because of the competitive structure, industry structure and even our size like pulp we’re already the number one within that sub-segment but the other ones we’re growing very rapidly.
So we have confidence that we can compete in those. But the rest of the industrial market has to be very selective. So we have a few developmental markets I am not really wanting to talk about those at this point but we have a few developmental markets that are similar to those ones where we already have the right to play and we plan to expand over the course of a couple of years.
Perhaps specifically to address Ecolab and Nalco, as I mentioned we have a lot of effort and a lot of knowledge of the food and beverage industry, while we think there maybe some customers that prefer kind of one-stop shop, typically the cleaning sanitization is the bigger buy relative to utility water.
There maybe some that prefer that our experience in the industry is it not as panned out. There is a lot of customers who want to put that last bit of buy into the person that has all the cleaning and sanitization. And our experience is, we have been doing fine growing our utility water platform and we expect to continue to do that in food and beverage.
David Begleiter - Deutsche Bank
And how should we think about progression of EBITDA from $190 million in 2011 to $310 million in 2014. Is that a linear progression? And then I guess in addition to that how should we think about the margin recovery in terms of recapturing price over raw material costs, is that a 2012 dynamic, it seems as though off late water has started to grab a toehold on that?
Yes, as soon as possible as Jim has counseled me. We made tremendous progress in the second half of our fiscal year and like many competitors talking about price versus cost in the final quarter there, we certainly covered all the costs via price albeit over driving in the major products and then still lagging on the wastewater polymer side.
So we fully expect to -- we are looking out at the environment raw material versus price right now fully expect within the first half of our fiscal year that we’ll do the entire round trip on the raw material costs increase.
And I am sorry the second question was the linearity of the plan; yeah, the plan is quite linear, so there is no hockey stick there at the tail end. The way we achieve that however, does vary quite a bit. So you’ll see Specialty Paper margin recovery in emerging market growth been kind of the front end loaded impact of what gets us in 2012 and kind of part of through 2013, and then by virtue of the rapid growth in the Industrial Markets especially those ones we’ve focused on. It take them a while to get big enough for only to drive that improvement but those then tend to become more, more impactful in the 2013, 2014 timeframe.
Dmitry Silversteyn - Longbow Research
Dmitry Silversteyn of Longbow Research. On your last conference call, you talked about the pricing initiatives or the pricing policies or practices starting to impact some volume in the markets. As raw materials are flattening out, are you really re-looking at your pricing strategy and is there a volume recapture program that’s part of your growth?
We are adamant that we’re going to be sticky on the way down. We look mainly a year-over-year price versus cost but we recognized before that period there was additional run up in raw materials that we didn’t fully recover and so we’re going to be very focused on. Although the plan is just simply recovering the 2011 impact, we’re going to target to try to move that even further as we progress through the year, and so we are definitely not going to go after volume using price. I would say the way that we’re going to after volume is more as I described earlier, we have a fantastic pipeline of differentiated products. Typically, those are the ones that were less affected, by the way, in terms of raw material costs. So lot about that is going back, reselling the value, making sure we’re very customer intimate and industry intimate. We have specialist rather than generalist focus on those, and I think that’s the way that we will actually, you know, that’s where the margin drivers as opposed to taking existing applications in trying to increase price within those existing applications, is really changing the mix of markets, customers and applications that get us there.
Dmitry Silversteyn - Longbow Research
Just looking at your bridge on EBITDA, so you are forecasting 4% to 5% sales growth in paper and industrial, if you do a 40% margin on that, it would be about $37 million in EBITDA over that period? So I guess the difference between those being the largest levers in your bridge is a lot of that makeshift?
Yeah, as I was mentioning the – if you look at even for those of you who are aware of kind of how we operate the business, we have what we call stream link, which is functional chemicals, plus our municipal market, and then the other part of the business is really focused on process and utility and relative, I mentioned before, its 1000 to 1500 basis points from the average to the margin and process and utilities and it’s much more than that, the gap between, say, functional chemicals mainly on the low end, and the profitability of process and utility. So if you think especially if you de-emphasize or just kind of focus really on the profitability of the functional and [muni] markets while growing just keeping the margin and growing the process and utility. There is this huge mix lever that you take advantage of.
So we will take about a 15-minute break. Please come back around 10:30 for the rest of the program.
Next up is Ted Harris, President of our Ashland Performance Materials Business. Ted will walk you through his 2014 plans.
Thank you, Dave, and good morning everyone. Let’s start on slide 84. The fiscal 2011 and on a pro forma basis, Performance materials generated sales of $1.7 billion and adjusted EBITDA of $133 million. These pro forma results include the contribution from the recently acquired ISP Elastomers business. The majority of our sales go into the building and construction markets, including industrial, residential and infrastructure. We also have sizeable position and transportation as well as packaging and converting and recreational marine. From a geographic perspective, we’re now heavily weighted toward North America, given the predominantly North American elastomers business.
We divide our business among three product lines; Composites, which represent about half of our total sales, and Adhesives and Elastomers, each of which represents approximately a quarter of our total. I will discuss these product categories in more detail beginning with the next slide. In Composites, Ashland’s resins are combining with fiber glass to form Composite materials, with specific physical properties like strength, corrosion resistance and durability and reduced weight. Generally, these materials are displacing more traditional materials of construction like wood and steel. Today, this is an $8 billion global market growing at roughly 5% to 6% annually with a vast majority of growth coming from emerging regions.
We are the number one player in both the unsaturated polyester resin or UPR and vinyl ester resin VER portions of the composite markets. At a very high level, the VER resins go into more technically demanding applications and command a significantly higher premium than UPR. The primary challenge in the composites market today is excess capacity. Demand fell by 30% to 40% in the matured economies during the recession and markets such as construction has yet to recover.
As we analyzed the market, we see two main opportunities. First is strong growth and higher EBITDA margins in emerging regions and second, is the attractive dynamics in segments such as heavy truck, wind energy and corrosion-resistant application. I will describe our strategies in some of these areas later.
Now let's take a look at our Adhesives business on slide 86. We find the adhesive business to be particularly attractive while representing only a quarter of our current sales, it represents about half of our earnings. This is an extremely large and diverse market and we are focused on specialty packaging and converting and structural adhesive applications. These applications tend to be highly tailored and specified by the customer and amount to a $3 billion market opportunity growing at approximately 5% annually.
This market is significantly less cyclical than the rest of our business and command significantly higher margins. The primary challenge in this market is its sheer size and number of competitors. To combat this, we've identified a number of attractive segments where we can focus and bring our technical expertise to bear.
Growth in these areas will be driven by new product innovations and a focus on geographic expansion. Now let's look at our elastomers business on slide 87. We picked up elastomers with the acquisition of ISP in August. We are now a leading manufacturer of cold Emulsion Styrene Butadiene Rubber or ESBR, the key polymeric ingredient in a variety of rubber applications.
We play in a $12 billion market growing roughly with global GDP and our focus is on tires and industrial adhesives. This is largely a commoditized business with lower margins. In a number of applications, we compete with natural rubbers which can be an opportunity or a challenge depending upon the price differential. The primary opportunities are to drive growth through our low-cost manufacturing facility in Texas, pursue potential raw material synergies on input such as styrene and achieve benefits from our added scale within the specialty adhesives space.
Let’s go to the elastomers financials on the next slide. ISP acquired the elastomers business in 2003 and made a number of improvement to its business model. In 2006 and 2007 elastomers was able to renegotiate its contract with key customers leading to improved profitability.
In addition elastomers is concentrated on reducing manufacturing costs, improving raw material supply position and upgrading its product mix. This business is predominately North American and sales are heavily concentrated within the North American tire market. As you can see from the historical financials, the business achieved sales of roughly $400 million with an EBITDA margin of 10% in fiscal 2011. Margins were down versus 2010 due to more than a $110 million of increased raw material costs.
Roughly all of these costs were recovered through pricing albeit with a one to two months lag in implementation. I will note that while margins have varied during the past five years, EBITDA dollars have steadily grown. Even in 2009 with volumes falling significantly, lower raw material costs and cost-cutting efforts enabled EBITDA growth over the prior year.
Please go to the next slide for the ASK Chemicals joint venture. On December 1st, 2010 we contributed our Castings Solutions business unit to ASK chemicals. A 50-50 global joint venture was Süd-Chemie which is since then bought by Clariant. ASK Chemicals is now a world leader in foundry binders and other foundry related products. Due to the relatively higher value of Ashland business contribution, we received a roughly $75 million cash payment from the JV to even up Süd-Chemie’s ownership stake. Süd-Chemie now Clariant retains operational control.
To give you an idea of size, the joint venture generates roughly $600 million in annual sales. These sales are not consolidated in Ashland’s results, but earnings are reported through the equity method. As a result of this business combination, Ashland is left with approximately $8 million of stranded costs.
As you will hear from Lamar, we are taking the necessary steps to eliminate these costs in the first half of fiscal 2012. The joint venture has had a negative impact on reported EBITDA. In fiscal 2010, the former Casting Solutions business contributed $24 million to performance materials. As I mentioned the joint venture was completed in fiscal first quarter and we included two months of casting solutions in our reported 2011 results.
The combined contribution from casting solutions for the first two months and ASK Chemicals for the rest of the year was $5 million. Roughly two-thirds of this decline was due to the associated JV accounting. Because our EBITDA is now derived from the JVs net income, the contribution is net of interest, taxes, depreciation and amortization.
The remaining decline is primarily a result of the relatively smaller size, of the contributed Süd-Chemie business. Going forward, we expect the JV to strengthen its market position globally while delivering on growth and cost synergy.
Lets’ go to the next slide. Now let’s change gears and start talking about business performance. Demand has been our biggest headwind. As you heard earlier, we sell into a number of economically sensitive end markets, all of which dropped dramatically during the recession. While we have returned to growth in 2009, we’re still significantly below previously described midcycle objective.
As you can from the chart on the right, this is almost exclusively an issue within the developed regions, where volumes dropped by nearly 40% from peak to trough. Slide 91 says North American and European volume trends for each of our major market segments. Each data point represents the rolling four quarters normalized to fiscal 2008 volume levels.
As you can see, Marine was hard hit, but has shown signs of growth. Construction, our largest market segment dropped by roughly 25% from 2008 to 2009 and has remained very soft with little or no sign of improvement. Transportation which was off roughly 30% at the trough has returned strongly with recent volumes approaching 2008 levels. Packaging and converting is our least cyclical market and is now roughly back to 2008 volumes.
Please turn to the next slide. Given these volume declines, we have taken a number of aggressive actions to decrease our cost structure and increase our asset utilization. Starting with an overall capacity of 1.5 billion pounds, we have closed six sites permanently removing more than 200 million pounds of capacity. We’ve also significantly reduced the number of shifts at our various locations, effectively reducing capacity another 160 million pounds. Altogether, we removed roughly 25% of our capacity in North America and Europe.
Conversely, we’ve added 90 million pounds of capacity in China where we’re enjoying very strong growth. In total the net effect of the capacity reduction of about 300 million pounds and reduced system-wide capacity was up 20%. These actions have enabled us to keep asset utilizations rate at roughly 80% to 85%.
Other major actions are shown on slide 93. Regarding our overall cost structure, we have taken out more than $100 million of costs. We have eliminated more than 400 jobs representing about 30% of that work force. Also given the opportunity for increased scales and overcapacity in the industry, we completed the ASK Chemicals joint venture effectively repositioning our Casting Solution business for long-term growth and profitability. Through these actions we have not only kept performance materials profitable, but we have also increased EBITDA by roughly $30 million over 2010 excluding the effect of the ASK Chemicals joint venture.
Lets go to slide 94 for more details on our performance. Before I get into the data please note that these pro forma results include elastomers for all periods as well as the results for the Air Products adhesives business which we acquired in 2008. In addition, we have excluded the results of Casting Solutions as well as the equity income from the ASK Chemicals joint venture. These adjustments will give a much clear view of underlying performance. I will not that the numbers on this chart do include results from our PVAC business whose sale was announced last week. The divestiture of this lower margin business was roughly $45 million of sales was the prime example of how we are repositioning our business for higher margins less cyclical growth.
Bearing all that in mind, as you can see from the chart on the left, sales took a considerable hit from 2008 to 2009 but have since returned. These increased sales were driven by volume growth particularly in the emerging regions of the world and strong pricing. The pricing was necessary to offset roughly $230 million of increased raw material costs. Even during the depths of the recession EBITDA held up reasonably well due to the actions I just described.
From 2010 to 2011, EBITDA grew considerably with all three product lines contributing to earnings growth. Our Base Composites business delivered improved earnings on higher volumes and greater unit margins; volume growth was the primary driver of the improvement in adhesives and elastomers.
Now let's go to slide 95 to see how we can further improve performance. We are well positioned in both our higher margin VER composites and adhesive product lines. In these areas, we have a good technology base and can more effectively differentiate ourselves from the completion.
Our primary issue is the lower margin UPR business. Despite sharply reduced demand, much of our competition has been less aggressive in reducing capacity and industry utilization rates have remained depressed. This situation is made worse by the slowing economic recovery in North America and Europe which we anticipate to continue for the foreseeable future.
To meet our profitability goals, we must continue to reposition our UPR business. We must maintain a pricing discipline and proactively target higher margin markets and applications. We may also pursue additional cost out as well as potential business partnerships. I am focused on this issue and expect to make continued progress.
Please turn to the next slide. Across all of Performance Materials, we have four main strategic levers to reach our 2014 goals. First, is ongoing business improvements stemming from additional volume growth and economic recovery. Next is targeted market growth coupled with new product innovation. Third is cost efficiencies and last is geographic expansion.
Let’s get into detail starting on slide 97. Our business is highly correlated with industrial production, new housing start and light vehicle build. Given what I believe to be relatively conservative assumption, growth within our base business offers the largest upside opportunity with a stronger economy.
Our current 2014 target assumes industrial production growth of about 3% annually. It assumes annual housing starts of 600,000 to 650,000 as compared with 570,000 today and 2.1 million during the last peak. Similarly, we are assuming light vehicle builds are approximately 13.5 million, this compares to 12.8 million today and 15.1 million during the last peak. As shown on the graph to the right, a moderate improvement in these assumptions could lead to an additional $15 million of upside to our targeted EBTIDA.
Now let’s look at our key growth markets on slide 98. We have three key targeted markets. First is adhesives, where we’re concentrating on packaging and converting applications. Second is energy, where we have unique technology offerings in the wind energy and Flue gas desulfurization segment. And third is mining, where we offer significant value with our products for highly corrosive applications.
Let’s start with specialty adhesives on slide 99. Specialty adhesives are an important growth market for Performance Materials and we are concentrating our efforts on packaging and converting applications. Three examples; are flexible packaging, graphics and label.
Our flexible packaging adhesives are used to bond two or more layers of packaging films together. This can help protect graphics, so that they don’t smudge or in something like salad bags that enables the bag to breathe ensuring freshness and product safety. In both graphics and labels, we offer custom formulated pressure sensitive adhesives that can either provide a permanent bond or be removable. Packaging and converting is a $1.5 billion opportunity growing at approximately 4% to 5% annually. This is our least cyclical end market with gross margins meaningfully above our average.
One major market need that we can fulfill is for more environmentally friendly adhesives. Custom formulated products that we offer include water-based and radiation curable adhesives that provides the same level of performance as solvent-based alternatives.
During the next several years, I expect adhesives to be a key contributor to our growth objective. This is an area where we can clearly leverage our technical strength to drive both growth and margins.
Let’s take a look at our opportunity in wind energy on the next slide. As you can see from the illustration, Ashland sells a lot of different products into the wind energy markets. I am sure as most of you realized this is a fast growing market with average forecast growth rates of approximately 10% per year.
A large portion of this growth is taking place in China which accounted for nearly half of the new wind installations worldwide in 2010. China’s now the world leader in wind power capacity and we have a strong position in China with the Chinese plants dedicated to the local markets.
The major market needs here is longer, lighter blades with increased life. Generally, we compete up to the 50-meter blade arena. To put this in perspective, a single blade is more than half a football field in length. While today, our business is primarily UPR, our Derakane vinyl ester resins performed very well in this segment providing faster cure times, equivalent strength characteristics and a lower cost than epoxy resin based systems which are generally used on longer blades.
We currently have sales at about $60 million in wind energy markets and have achieved a compound annual growth rate of nearly 25% over the last five years. We estimate the total available market opportunity at approximately $500 million.
Another target market is flue gas desulfurization as shown on slide 101. Worldwide energy demands are leading to one new coal fired power plant coming online every week. The associated emissions of sulfur dioxide which are responsible for acid rains are becoming more and more stringently regulated.
As a result, power plants that burns fossil fuels are increasingly required to remove this acidic gas before releasing their exhaust into the air. These gases are highly corrosive and composites are viewed as the construction material of choice for any equipment that handles the gas and that’s where we come in.
Our Derakane and Hetron vinyl ester resins provides industrial leading corrosion resistance and have a 20 plus year track record in the field. In total, this market represents a $100 million sales opportunity.
The last target market is mining on the next slide. As Paul described earlier, mining has been a very attractive growth industry over the past several years. Performance Material specific opportunity is due to the highly corrosive environments found in mining operations.
With this harsh environment comes a natural fit for our composite materials and has significant avenue for Performance Materials growth. Applications include corrosion resistant pipes, towers, tanks, separators and other processing equipment. We estimate the available market for our products to be roughly $200 million and we have a number of collective activities going on across Ashland to further penetrate this high growth opportunity.
This is one example where each of Ashland’s four commercial units has a product solution targeted towards various elements of the mining operations. Specialty Ingredients has drilling aids, Water Technologies has process and utility chemicals, Performance Materials has composites and Consumer Market has motor oil and other lubricants. Given these overlapping efforts, we look to concentrate our sales efforts to bring to market a unified suite of Ashland’s products.
Let’s move on to new product development on the next slide. We define new product as those introduced to the market within the last five years. For adhesives and composites, this represented 21% of fiscal 2011 sales. Bear in mind this metric includes both more ground-breaking new-to-the-world technologies as well as incremental product line extensions. The latter are especially prevalent in our composites business where products are often developed on a customer-by-customer basis.
The chart on the right shows the expected 2014 contribution of our R&D pipeline. At that time, the target markets which we just talked about will make up about a quarter of new product sales. However they will generate nearly half of the gross profits from new products. By concentrating our efforts on these higher margin target markets, we can maximize the return on our R&D investments.
Let's go to the next slide. We anticipate an additional $17 million of cost savings by 2014. Roughly half of this will come from the full annual benefits of the two site closures we already made in 2011. The remainder will come from removal of stranded costs related to the ASK Chemicals joint venture. Lamar will give an update on this a little later.
Our next slide describes our opportunities around geographic expansion. The combination of a rising middle class and government investments in infrastructure, energy and housing make the emerging regions a highly appealing growth opportunity. We have been very successful in these regions nearly doubling our sales since 2009, offsetting much of the malaise in the mature economies. Whereas in North America and Europe we have been closing sites, in China and Brazil we have been investing in and adding capacity.
Given current capacity constraints, we have two new composite plants in China scheduled to come online during 2012 and 2013. We expect to fill these plants over the next three to four years providing an incremental $100 million of sales. Similarly, in Brazil we are expanding the capabilities of our recent AraQuimica acquisition which will allow continued strong growth in this important region, through this planning horizon.
In addition and due to strong Latin American demand, we are transferring more technically advanced products for local production. This will simplify our supply chains and help increase profitability. As part of our 2014 plans, we expect to maintain our strong growth in these emerging regions.
As shown on slide 106, when we combine all four of our strategic levers, we expect a roughly $100 million expansion of our baseline EBITDA by 2014. While this is certainly a sizeable jump, the plans that we have developed and that you’ve heard about today are achievable. Most of the success is within our control and we estimate that roughly 75% of the planned growth is independent of the broader economic recovery.
Please turn to the next slide. This EBITDA targets imply an EBITDA margin of 10% to 12% as compared with our baseline 2011 margin of 7.9%. Given the operating leverage that we have in place, this gap will largely be closed with additional volumes.
As shown on the left, incremental volumes contribute highly attractive margins due to the relatively fixed nature of our manufacturing overheads and SG&A. While admittedly over the long term, these costs are not fully fixed, it is safe to assume incremental volumes would have EBITDA margins north of 20%.
In addition to volume, our focus on higher margin segments and the ongoing pursuit of cost efficiencies will be additive to today’s margins. I will note, that although these margin levels are below our prior midcycle objective, elastomers was not a part of our business when those targets were set.
I will summarize on slide 108. As you have heard, Ashland Performance Materials is a leading global provider of composites, specialty adhesives and elastomers. Major elements of our strategy includes further improvements of our base business, growth in target markets, new product innovations, additional cost efficiencies, and expansion in emerging regions.
Our 2014 target is $225 million of EBITDA with an applied EBITDA margin of 10% to 12%. In closing, the actions that we have taken over the past three years have positioned us to achieve these targets and I am confident in my team’s ability to do so.
With that, I will open this floor up for questions.
Hello, it’s Kenneth [Hafner] from [Luma Sales]. If you look within this industry, there seems to be a few probably held North American competitors and it’s my impression that a lot of you have, a lot of the companies are running at much lower operating rates in your businesses, this with the volume probably not coming back of it being so construction driven and operators running well below capacity, it would seem that consolidation would go a long way to rapidly get plants up to a good operating rate, drive the cash flows.
So barring any type of industry consolidation, there seems to be lot of headwinds that make it challenging for the North American components business to really improve upon itself over the next few years. So the growth you are looking at is it more driven on international opportunities and hoping at best North America can just stay flat where it is today?
Yeah, good question. The growth that we are projecting is largely coming from the emerging regions as well as those targeted segments that I described. Flue Gas Desulfurization, wind as well as mining. You have seen over the last couple of years, the mass majority of our growth as shown on that one slide has come from the emerging regions and our expectation is that that will continue. This industry is right for consolidation, particularly in UPR, and one reason that as we look to improve our UPR business, we’re focused on those growth areas, we’re focused on further cost reductions but we also are focused on partnering opportunities that can provide value to Ashland, but also offer an opportunity to create some consolidation to help with the industry structure issues that you mentioned.
Just on the UPR business. Does that help you at all in VER business, could you divesture of JV of the UPR business and not impact the growth or potential growth of the VER?
There is some overlap in UPR and Vinyl Ester, but I think in general they can be standalone and we could operate them separately. Dow, for example we bought DERAKANE brand from Dow historically and they ran that business without a UPR business. We do find some synergy, but it is not huge.
Mike Sison - KeyBanc
In terms of the adhesives business, if I were one big guy and it is fairly fragmented and I understand that you want to grow this side of the business, how do you do that with one big player out there and can you help in terms of the consolidation of that industry as well which I think could help improve profitability overall?
I think the latter part of your question I think absolutely we can help in the consolidation of that industry. I think there are really good opportunities to grow in that adhesives business through acquisitions. But the first part of your question, we compete head-to-head everyday with the [Henkels] of the world and our position is very, very focused. One of the strengths and opportunities of adhesives is it is very fragmented. That create some specialty elements to it and we compete very nicely there and focused on packaging and diverting and in our chosen segments, we are the market leader and so we have scale in our chosen areas and we operate as a leader in that business and compete with the [Dals] and Henkels and BASFs of the world everyday quite successfully.
Okay so with that I will hand it over to Sam Mitchell who will now cover the Consumer Markets business.
Thank you, Ted and good morning. Let’s go slide 110, (inaudible) for fiscal 2011 Consumer Markets generated sales of $2 billion with EBITDA of $251 million or about 13% of sales. As the name implies, Consumer Markets is primarily a consumer brand business. The vast majority of our products are passenger car and heavy duty lubricants sold under the Valvoline brand name. We also sell automotive chemicals, antifreeze and filters.
We sell our products and services to three primary channels, in the Do-It-Yourself or DIY market channel, we are typically selling products packaged for consumer use to retail auto parts stores and the mass channel, primarily Wal-Mart. Also within the DIY channel, we sell to warehouse distributors such as NAPA, we also serve the small garage installer market.
In the Do-It-For-Me or DIFM channel, we sell in roughly 15,000 separate installer locations including car dealers, quick groups and repair shops. These installers will then change the end-consumers motor oil and provide other automotive services. DIFM includes Valvoline Instant Oil Change or VOIC service centers, a blend of company owned and franchise stores.
The DIY and DIFM channels constitute our primary North American channel to market accounting for 35% and 38% respectively of consumer markets total sales.
Valvoline International, which includes our global commercial and industrial business or C&I has been growing very well and now accounts for 27% of our total. This does not include sales from non-consolidated joint ventures when we include our portion from these joint ventures and remove the North American portion of the C&I business, our total international sales would be approximately $640 million, roughly 60% of which would come from Australia and other parts of the Asia Pacific region.
Let’s look at some demand drivers starting on the next slide. The two primary factors affecting passenger car motor oil demand are the number of miles driven in the average number of miles between oil changes also known as the drain interval. After fairly steady growth, the number of miles driven in the US is leveled off at about 3 trillion miles per year.
As observed in mid 2008, early 2009 and more recently in 2011, short term declines in miles driven due occur generally correlated with supply and gas prices. Today, the average consumer drives about 4,700 miles between oil changes. Due to better engines, high performing motor oils and the prevalence of oil like monitors in newer vehicles, this number has slowly – been slowly extending overtime by about 65 miles every year.
Generally, there are more cars and light trucks coming on road every year and today there are 240 million light vehicles on the road. I’ll mention that we expect minimal impact from the evolution of alternatively powered vehicles. Hybrids do in fact use motor oil and consumer acceptance of all electric vehicles has been extremely slow. Thus, given miles driven in the current drain interval, we estimate the size of the US market for passenger car motor oil to be roughly 800 million gallons annually.
With increasing drain intervals and the minimal impact of alternative energy vehicles, we expect the market to slowly decline by approximately 1% per year. As a result, to achieve our North American growth objectives, we must expand our market share.
Let’s look at the factors affecting international demand on slide 112. We have significant growth opportunities outside our North American market particularly in emerging regions. These regions now account for more than half of global light vehicle sales with China and India growing the fastest. We estimate the available international market at roughly 6.3 billion gallons per year, nearly eight times larger than the US. Our focus is primarily been on heavy duty transportation and power generation. International lubricants are an attractive growth market and we expect long term volume growth of approximately 2% every year.
Our next slide shows Consumer Markets performance over the past five years. From 2007 to 2011 sales grew from $1.5 billion to $2 billion, a compound annual growth rate of roughly 8%. Sales grew steadily over this period in spite of the global recession demonstrating the non-cyclical nature of this business. Higher pricing to offset our rising costs and strong international and premium product growth drove the sales increase.
EBITDA and EBITDA margins have expanded considerably over the period. The largest contributor to this expansion was cost optimization. We simplified our business complexity, reduced the number of product formulations and focused on a smaller set of additive packages. This work has improved profitability by roughly $75 million on an annualized basis.
Other major contributors to this improved performance includes strong international growth, higher sales and profitability within Valvoline Instant Oil Change and particularly strong volume growth in our premium products.
In 2011, sharp raw material cost increases and the related price cost lag effect negatively affected earnings, I’ll provide more on this later. 2011 was also softer than our long term forecast. 2011 demand was also softer than our long term forecast down roughly 5% for both the DIY and DFIM markets since early spring. This is similar to what we’ve observed during times of higher gas prices in economic weakness. Given the long-term needs for car maintenance, we expect behavior to normalize in 2012.
Let’s go to the next slide. Fundamental to achieving our 2014 performance target is margin recovery. In addition, we expect continued international growth primarily from stronger distribution networks in developing regions and continued gains in our commercial and industrial business. We will also grow our North America by expanding our premium mix and capturing additional market share. Valvoline Instant Oil Change should also continue to grow to higher penetration of existing service offerings and the addition of both company-owned and franchise locations in North America.
Let’s turn the slide. Consumer markets number one raw material by far is base oil. The crude drive input produced by refiners. We are primarily a purchaser of what is categorized as Group 2 and Group 3. To put the spent in perspective, we buy roughly 160 million gallons of base oil every year.
The chart here shows monthly pricing for base oil as compared with both West Texas Intermediate and Brent Crude. As you can see, base oil generally track crude until mid 2011 starting around April, crude turned over and started to decline while base oil continued to increase. This advance continued until July and base oil has remained at elevated levels. Tightness in base oil is due to low utilization and inventory levels at the refinery as well as multiple plant turnarounds during the latter half of the year.
Looking forward into 2012, we see some stabilization in base oil as additional capacity comes on line. This situation will further improve in 2013 with other significant expansion. As compared with the base line of 2011, global Group 2 capacity will increase by nearly 20% and Group 3 capacity will nearly double. These capacity increases are in response to historically high base oil margins and rapidly increasing global demand.
The Group 2s and 3s are more highly refined form of base oil and demand is growing significantly in excess of the overall market at the expense of Group 1s. This demand shift is due to the global need for better fuel economy and reduced emissions requirements.
With this global shift, the higher quality – while this global shift, the higher quality base oil is significant given the amount of additional capacity coming on line we should be entering into an environment where base oils will more closely track crude. Regardless, of the cost environment, we fully expect to offset any increased cost and pricing.
Let’s get into some more details on slide 116. In response to rising cost, we have executed three separate price increases in fiscal 2011 recovering more than $160 million of annualized costs. We expect our most recent increase to be fully implemented by the end of the December quarter. We are also employing a number of promotional tactics to address competitive pricing in certain segments.
I would like to emphasize that the September quarter performance we reported last week is temporary, due to price actions achieved during the quarter, we should recover cost sequentially and further improve margins once our price increase is fully executed in December.
Historically, Consumer Markets has concentrated our base oil purchases with a small member of large global suppliers. This has been necessary to secure sufficient volumes. Going forward, as the supply of base oil improves, we will be in a better position to leverage our growing global business to garner the lowest pricing.
Each of the major international regions is generating solid profitability. We have a very strong business in Australia, a market that is similar to the U.S. and one in which we have a strong market share in the DIY, DIFM and C&I channel.
In Europe, we’ve made good progress, improving our distribution network and our profitability. We see strong long-term growth opportunities in Eastern Europe and Africa as we add new distributors. Latin America is also a profitable distribution model complemented by joint ventures in Brazil, Venezuela and Ecuador.
Our Indian joint venture with Cummins has been one of our biggest success stories. With sales of approximately $200 million, we are benefiting from scale, increasing brand strength and achieving consistent double-digit volume growth. In Asia Pacific and China we see many growth opportunities, and we are making good progress building on our capabilities.
Please turn to the next slide. To support international growth, we have developed significant relationships with a number of global OEMs. As part of these efforts, we are focused on developing proprietary lubricants, technology support and the after market business. Certainly our broadest and most successful partnership has been with Cummins, a leading global supplier of diesel engines with roughly $17 billion in sales. We have joint ventures with Cummins in India and China, two of the fastest growing markets in the lubricants space.
Cummins and consumer markets work together on new technology and engine testing, and have developed proprietary products to improve fuel economy and allow for extended drain intervals. This includes our Premium Blue, line of co-branded lubricants. With Mahindra & Mahindra, we have developed the line of co-branded lubricants for diesel engines, producing strong sales in India with the opportunity for significant growth in global markets. Similarly, we are leveraging our lubricant technology capabilities to forge strong relationship with Kubota and Aggreko, who share our commitment to the after-market sale and service opportunity.
Please turn to next slide. Now turning to our North American strategy, we expect to continue to grow in this region. We have a history of successful and program launches allowing us to grow volumes and increase share. This include our MaxLife motor oil for higher mileage engines, which has become $200 plus million business with sales up roughly 35% in the past two years.
MaxLife is successful because we met their real consumer needs, reduced oil consumption and increased protection for older, high mileage engine. And it continues to grow because it has a strong support of both retailers and installers, who command higher prices and margins for the sale of MaxLife. This also includes a Valvoline Engine Guarantee where we provide up to 300,000 mile guarantee for engines protected by Valvoline technology. This program is intrinsic to our value proposition and identity as a highly trusted brand.
Valvoline innovation such as these led to the creation of although one of the meaningful categories of motor oil. This include racing oil and synthetic blends and high mileage oil. These industry leading actions have not only increased our market share but have also attracted additional interest and support from the retailer and installer based.
These groups now increasingly look to consumer market to help them meet their own sales and profitability objectives. We expect to build on our success through a combination of strategic branding and product innovation with the goal of further improving our premium mix and increasing our North American market share.
Let’s get in some details about our Premium Products on slide 120. The chart shown here presents our historical premium mix which is defined as the percentage of branded volume that comes from premium products. These products represent a highest margin product lines and include our SynPower full synthetic, MaxLife motor oils and Premium Blue products. During the past five years, sales of Premium Products have grown significantly starting from the level of 23% in fiscal 2007, our premium mix has expanded by approximately 800 basis points.
Numerous factors contribute to this success. First, we focus our advertising and promotional spending to drive consumer trial of our premium products. Second, we work directly with the installer channel to provide field-based and online training that improves store-level execution.
Third, we developed differentiated technologies that address the demands of key segments. An example of this is our line of lubricants for diesel engines and equipment. Here, the combination of our Premium Blue extreme engine oil and Syn Guard Gear Oil is guaranteed to deliver a minimum 1.6% improvement in fuel economy. More typically, fleet owners are seeing improvements between 3% and 5%.
We remain focused on further growth of premium products and for fiscal 2014, we are targeting a premium mix of approximately 34% to 35%. The same consumer marketing and product technology expertise I just described is behind our latest major product innovation introduced earlier this year.
Let’s take a look at NextGen Motor Oil on our next slide. We introduced the NextGen brand in Spring 2011. It’s greener, more environmentally friendly motor oil. It’s composed of 50% recycled, re-refined oil and boasts the same high quality and performances of our more conventional products. With a similar price points, we believe this unique product offers broad appeal to any environmentally-minded consumer.
The primary goal of this product line is to increase consumer loyalty and grow our North American market share. This is not a margin play as the cost of producing this product is very similar to our other conventional products. However, by using a high percentage of recycled inputs, we’re helping to accelerate the development of the re-refined base oil market. This market should continue to expand and growth of NextGen will allow us additional purchasing flexibility. Some of the initial results from NextGen are shown on the next slide. Today, NextGen has more than met our initial expectations. As part of this launch, we now have broad retailer support with NextGen available in roughly 14,500 retailer auto parts stores. Awareness is continuing to build and in the first six months, we estimate that we’ve had more than 600,000 Do-It-Yourself for NextGen. NextGen is also available in our BIOC company stores, where it represented about 19% of our oil changes despite a temporary $5 premium. This premium helps us cover the higher costs associated with working in smaller quantity.
In 2012, we expect to have NextGen available in bulk distribution and sold without the up charge. One of our BIOC market has already made this move and the majority of consumers are now choosing NextGen in that market. As part of the overall launch, consumer feedback has been positive with survey results that indicate a very high repurchase intent from our early adaptors.
In total, NextGen has generated sales of approximately $34 million during fiscal 2011. While I'm very pleased with our initial results, we have a number of key steps to complete in 2012 in order to support the NextGen launch, completing these steps to allow us to further build on our success to-date. NextGen is yet another example of our ability to leverage the power of the Valvoline brand to drive share and set apart our product offering from the competition.
Let’s turn to the Valvoline Instant Oil Change business, which is the fourth major contributor to our 2014 target. We’re the second largest franchised quick-lubed chain in the United States. We have roughly 860 locations within the system of which 260 are company-owned and 600 are operated by franchises. Growth in this business has been strong with average same store sales growth over the past five years of about 7%. Growth was off slightly in fiscal 2011 due to the softness in the broader quick-lube market. During the past five years, our company stores have added approximately five oil changes per day while the quick-lube industry as a whole has lost roughly five oil changes. We attribute this performance to our best-in-class customer service models which provides fast easy service from trusted professional. In fact, our VIOC store teams consistently deliver five oil change services in less than 12 months. Now let’s take a look at how we plan to further expand this business on the next slide.
We expect continued strong organic growth from our company stores in North America. Growth will come from increase in sales over a wide range of services, just under which you can see on the slide. In addition, we are developing our selling tools and training program, which should enable better store level execution. We also expect to grow our overall store count by approximately by 40 per year. New stores will come primarily through the franchise system, which we expect to outpace company store growth by 2:1.
On note, the quick-lube industry still have refragmenting. In addition to building new stores, we have seen numerous smaller regional consolidation opportunities for both our franchise and our company operations.
Please turn to slide 125. Consumer market is highest in ROI business. We take great pride in our strong cash generating capability. Capital requirements are low and we are primarily leveraging a premium brand as been in the making for more than 100 years. To maintain these high returns, we will continue to tightly manage our cost structure with focused investments in key growth areas.
These will primarily include international investments as well as the expansion of our VIOC system. While we see increased advertising spending in support of the NextGen launch in 2011 and plan to spend at a similar rate in 2012, we are confident that we will achieve a positive payback in 2012 and deliver significant leverage and share growth in future years.
With that said we expect our SG&A as a percent of sales to improve from the 2011 level to a more normalized range of 15% to 16%. This improvement will allow us to further expand our EBITDA margins.
Please turn to our EBITDA Bridge on the next slide. Our 2014 EBITDA target is $420 million, a roughly $170 million increase over fiscal 2011. While the implied growth over this period is considerable, please bear in mind that our fiscal 2011 performance was unfavorably affected for reasons I previously described.
Let's go to the next slide to see what this means in terms of margin. Despite the significant pricing actions we have taken, the extreme cost pressures have led us to revise our thinking as it relates to margins. Based on the EBITDA dollar targets, the implied 2014 EBITDA margin is approximately 17%. This improvement over fiscal 2011 is driven by margin recovery and cost containment. While this is at the low end of our previous midcycle margin target, I will note that our EBITDA dollar targets have actually increased.
Slide 128 brings together some final thoughts. Consumer markets is a great business. Despite significant cost pressures affecting our recent performance, we have all the components necessary to deliver on our 2014 target. To achieve these targets we must first maintain our pricing discipline and recover margins. Second, we will continue to develop our international channels, particularly in emerging regions of the world. Third we must grow our market share in North America as well as continue our momentum in selling premium products.
Finally, we will further expand our Valvoline Instant Oil Change model by increasing service penetration and growing the number of stores. These actions should enable us to meet our sales and earning targets. And with that I’ll take your questions. Thank you.
Sounds like from your growth plans that there is going to be a fairly significant investment requirement, can you give us an idea of what kind of a CapEx or R&D investment you are looking to drive this type of growth in this type of EBITDA expansion?
As mentioned the type of growth investment that we are talking about making first directed towards the international business and it’s not so much capital investments that we are looking at. We have facilities internationally that help us produce our products, both company-owned that we use some tolling, but it’s primarily putting more people on the ground in some of these emerging markets and we are going to add some headcount. But you can see from the SG&A as a percent of sales, we plan to drive down SG&A as a percent of sales as we make those investments internationally because of this leverage that we have in the business.
Two questions on the international business, whatever the margins relative to the overall segment and how much is the heavy duty and stationary power as a percentage of the addressable market?
The margins in the international businesses are fairly consistent overall with our total business. There is some variation from one market to the next in terms of gross profit margin versus the return on sales margin, but overall we look at good strong performance in the International business which is now using distributors primarily in which we reach the market.
This second question I think you had asked a question about the size of the stationary market. I have to say I don’t have that data with me today. But the power gen market is a substantial market where we have got certainly a good position in.
You know fiscal 2011 was certainly a disappointing year in terms of price and raw material costs for Valvoline, but given the confidence you have expressed in pricing and the outlook for raw material cost particularly base oil, would you anticipate that you would be able to get back to or exceed fiscal 2010 earnings levels in fiscal 2012?
And if that’s the case, as we think about the past, from $250 million in EBITDA to $420 million of EBITDA would we expect a good chunk of that to come upfront?
Yeah I do expect a strong recovery in 2012 and so as we recover that price lag, that hurt us in 2011, we will regain that in 2012. We will start a little bit slow at the first quarter because we are still on the process of fully executing that last price increase, but come January the margins will be in very good shape and the fundamentals on the business are quite strong. So we will see you know a very strong improvement in 2012.
If base oil prices do drop eventually, do you have lower prices in your business? If base oil prices drop do you have lower prices in your product?
Well, that would be an interesting phenomenon. I am looking forward to that in the last ten years. It happened once. In terms of the pricing through the customer and how we look at it is it would have, we would look at to be a relatively longer-term structural move as opposed to a blip in the market. So we’d be careful looking at it before we adjust any prices. There’s a strong, as long as our business is strong in market share and we’re bringing value to our customers, you know, we’re not in a position where we’re having to look at price reduction in the marketplace.
I'm (inaudible) in Credit Suisse. What gives you confidence that your premium mix will continue to move up towards the 34% or 35% range based on what you’re seeing from consumers and your installer channel?
Yeah, it’s interesting even in this, talked about 2011 being a little bit softer demand situation, you know with miles driven being off and both DIY and DIFM being a bit up. The premiums have continued to grow and that’s for Valvoline, it’s even for you know some of the competing brands when I look at the retail auto parts channel. The lower price conventional segment shows the market decline whereas the premiums like the high mileage segment, the synthetic segments continue to grow.
So a good portion of consumers are still looking for the best type of protection that they can purchase. So the things that are going to continue to drive growth for Valvoline is really the work that we do, working closely with the big retailers such as the AutoZone and Wal-Mart to show them merchandising strategies that can help improve their mix and help educate the consumer on why say MaxLife would be a better choice for their older engine.
I mean that has one opportunity that still continues to be significant for both us and for our retailer and installer partners because more than I think it is about 70% of the cars in the road have over 75,000 miles. You’ve got an aging fleet out there and a lot of consumers are still realizing, still learning about MaxLife even though it was introduced more than ten years ago. I think I mentioned in the presentation that our sales over the last two years have been 35% on MaxLife. So it still shows that there is this long-term trends towards premium products and we are one of the big drivers for making that happen at both retailer and in the installer business.
John Roberts - Buckingham Research
John Roberts, Buckingham Research. The North America market is pretty consolidated. So for in order for you to gain share, is there enough smaller players out there for you to take share from because I assume that larger players are not going to give up share easily?
Share doesn’t move quickly in this business in North America. It is a mature business in a competitive market and so to shift it in the DIY channel, you have got to bring something new to the market. You have to have the partnership with the major retailers to help you drive share. So when I think about the DOI market and the importance of the NextGen launch. NextGen is a great way for us to grow our market share attracting more people to the brand. And when we look at the early results on NextGen and the source of volume, much of that volume is coming from competing brands. So it is through differentiated products and it is getting them merchandised properly in ways that are also good for our retail partners and on the installer side of the business, we will continue to grow Valvoline Instant Oil Change as mentioned, you can see the performance over the last five years. This is a business that we love and we love to see it continue to grow in terms of the number of units. But we also have good success working with major national accounts that we've added to the portfolio over the years.
And the reason why those major accounts are choosing Valvoline is that we can bring them, not only the brand but bring them the marketing programs and the training to help them improve their operations, help them improve their profitability, help them sell more premium oil changes. So the strategy that Valvoline employs is very different than our competitors which are part of big oil companies. We have a higher customer focused, customer service approach that brings more than just a product.
Thanks Sam. And just to get us back on-track for lunch, we’ll actually go ahead and proceed with the program starting with Lamar Chambers.
Thank you Dave and hello everyone. Thank you for taking your time today to show your interest in Ashland. We hope your expectations are being met today.
Now that all of our commercial unit presidents have described their detailed strategies for growth, let's take a step back and outline Ashland’s overall value proposition to our shareholders.
Over the next three years, we will concentrate on top-line growth and earnings expansion. This will come from four primary areas. First, is organic volume growth. We expect all of our businesses to grow in excess of their underlying markets. Underpinning this growth will be our broader focus on innovation and new technology.
Specialty Ingredients is our strongest growth vehicle and historically grown volumes at a rate of roughly 5% to 8% per year. The world’s emerging markets will continue to outpace the developed regions and we are well positioned to capture this growth. We expect our growth to be strongest in China and Brazil and these countries will command greater capital and human resources to support our efforts.
Second is margin expansion. 2014, our consolidated EBITDA margin should grow roughly 17% to 18%. This expansion will assume from greater growth in our higher margin commercial units. Additional cost recovery, primarily in Consumer Markets and Water Technologies, the business mix improvements and volume gains, particularly in Performance Materials where small volume gains can have a very positive effect on our EBITDA.
Third is cost efficiencies, where we are targeting $90 million in overall cost reductions. I’ll cover this in more detail in a few minutes. The $40 million of these reductions should be achieved by the end of the March quarter.
And fourth is capital allocation. Ashland should be generating significant amounts of cash. Given the relatively high returns and low risk a good portion of this money will be reinvested in our businesses to expand capacity and support growth. Excess cash will be focused on building liquidity, while we have a blending cash interest rate of approximately 5% I will note that our higher rate debt is callable in June 2013 at face value plus half the coupons.
Building on liquidity now put us in a position to call these notes; saving is roughly $60 million per year. Smaller bolt-on M&A is a possibility largely depended on value creation opportunities and likely focused on Specialty Ingredients. We believe our actions in these four areas makes a compelling value proposition to Ashland shareholders and should lead to our $9.50 to $10.50 EPS target for 2014.
The next slide shows our liquidity and net debt as of our 2011 fiscal year end. Total liquidity which is cash plus revolver capacity was a very healthy $1.7 billion. Our gross debt was $3.8 billion, $2.9 billion of which was used for the acquisition of ISP. Given pro-forma fiscal 2011 EBITDA of $1.2 billion, our gross debt to EBITDA is slightly below 3.3 times. Ashland has more than $700 million of cash on the balance sheet, taken our net debt to pro-forma EBITDA to 2.7 times.
As expected, upon our closing of the ISP acquisition and related financing, Standard & Poor’s did lower our corporate credit rating by one notch to BB for the stable outlook. Moody’s however maintained our BA1 rating.
Our first sizable debt repayment is not due until 2016 when the Term Loan A matures.
On the next slide, I’ll describe the financing associated with the ISP acquisition. We are very pleased with the favorable financing package put in place to acquire ISP. Due to the historically low interest rates and the ability to prepay without penalty, we funded the transaction with a new Term Loan A of $1.5 billion and Term Loan B of $1.4 billion. In addition, we have a revolving credit facility of $1 billion which remains undrawn.
As for the fiscal year, the financing package is fully repayable without penalty. At current rates, the overall ISP financial package including fees under the revolver will have incremental annual book interest expense of $130 million. We anticipate incremental cash interest of $115 million per year.
Now lest go to the next slide to look at Ashland’s overall interest expense. All-in, Ashland has annual book interest expense of approximately $230 million representing a blended interest rate of roughly 6%.
Cash interest is only about $205 million due to the non-cash amortization of debt instruments costs and miscellaneous items. As anticipated, we entered into a swap agreements to fix the majority of our debt. As a result, 78% of our total debt is now fixed for the minimum fix term of five years. Of the 22% of debt remaining, rates are primarily tied to LIBOR or the 1% floor over the spread of 275 basis points.
As shown on slide 135, our targeted long-term capital structure based on the gross debt to EBITDA at or below two times. Given expected cash balances, this will equate to a net debt to EBITDA of approximately 1.7 times. In addition, we will anticipate having a balanced structure with fixed and floating rate debt as we do know as well as stagger maturities overtime.
The rationale behind these targets is that we feel they would want an investment grade credit rating for Ashland. This preferred rating will serve to low our incremental cost to debt and will allow us to reinvest in our business on preferential interest rates. I will mention that no additional debt is required to meet our 2014 targets and that in the near term, we will expect the excess cash flow to building our liquidity. Ultimately, we expect to use this liquidity to pay down our highest interest rate debt, most notably our 9 1/8 notes that I mentioned earlier.
Ashland’s proven ability to rapidly reduce debt as shown on the next slide. Starting from the Hercules close in November 2008, we reduced net debt by $1.4 billion in the span of just two years. Over that same period, we reduced net debt to EBITDA to 0.9 times from the starting point of 3.2 times at close of the Hercules acquisition. And upon the sale of Ashland Distribution this past March, cash actually exceeded gross debt by almost $200 million.
Let’s go to the next slide, I’ll update you on our cost reduction program. Ashland has implemented an overall cost reduction program targeting $90 million in annualized savings. This will come from two primary areas; first, we’re eliminate $40 million of annualized trending cost as a result from our sale of Ashland Distribution and the formation of the ASK Chemicals joint venture.
Second, we are targeting $50 million worth of cost synergies from the ISP acquisition. As of the end of September, we have achieved $25 million of annualized run rate savings. These savings primarily come from reductions in supply chain and IT and finance. We should extract another $15 million in run rate savings by the end of the March quarter. The expected cash cost to achieve this $40 million of savings is $15 million to $20 million, primarily consisting of severance.
The ISP integration teams are working towards their synergy goals and we expect to achieve the remaining $50 million of savings by the end of fiscal 2013. Timing of this $50 million of savings will be dependent upon the migration of the heritage ISP Systems on to Ashland’s global ERP platform. We expect this to take roughly 12 months to 18 months to implement.
Now please turn to the next slide for an overview of our anticipated capital expenditures. Ashland’s capital spending in 2011 was $201 million. With the inclusion of ISP, numerous growth projects that we’re now pursuing, we expect the annual CapEx of roughly $350 million over the next two to three years.
We estimate maintenance capital levels to be roughly $200 million to $225 million. This represents the longer term annual spending required to keep a plant operating at their current levels of performance and capacity. Of course, in the short-term and in the event of any broader macroeconomic weakness, we could cut this number considerably to conserve cash.
The majority of our capital spending over the next three years will be concentrated within Specialty Ingredients. As you heard from John, this capital will enable us to further expand capacity and take advantage of the strong growth dynamics we see in this space. Expected return on expansions such as these, significantly exceed our cost-to-capital, allowing Ashland to be very selective in our capital allocation.
Let's go to the Operating Segment Trade Working Capital on the next slide. Ashland made a corporate decision four years ago to focus the organization on optimization of the working capital levels. This involved the detailed review, required inventory levels and appropriate payment terms both from Ashland to our suppliers and from my customers to Ashland. Given the importance of working capital to ongoing cash generation, we also changed our incentive compensation targets to include of this directly tied to our trade working capital as a percent of sales.
For Ashland, Trade Working Capital is defined as the payables, receivables and inventories employed in each of our commercial units. The number shown here do not included ISP or Ashland distribution. Since 2008, this process has generated the intended results and we produced our average working capital as a percentage of annualized sales on nearly 300 basis points.
Given Ashland’s current billion dollar sales level, this 300 basis point reduction frees up nearly $250 million of cash that we can invest in other value creating opportunities. You’ll also notice on this chart that from fiscal 2010 to 2011, we maintained our working capital at approximately 14% of sales. However, given the sales increase of roughly $500 million, working capital was a significant use of cash for the year.
ISP’s Trade Working Capital is generally averaged about 20% of annualized sales. Going forward and with the inclusion of ISP, we’re targeting a combined the Operating Segment Trade Working Capital level of approximately 16% of annualized sales.
Now lets look at our Pension Expense on slide 140. As described in detail on our November 9 earnings call, Ashland has made a recent change to our pension accounting. We now recognize actuarial gain and losses in the year they occur. This provision has no effect on cash or future funding requirement but does affect the ongoing P&L expense incurred this quarter.
For fiscal 2012, we expect annual pension expense of only roughly $5 million. This includes two separate pieces. First is the $37 million service expense that would be absorbed by each of our commercial units. Second, as a $32 million positive credit related to expected returns, which would exceed the interest expense and other pension related costs.
This benefit will be captured in our segment reporting under the corporate unallocated and other caption. Given the reduction in the discount rate to approximately 4.7%, as well as asset returns we suffered towards the end of fiscal 2011. We now anticipate cash funding requirements for both the US and non-US plans of roughly $120 million in fiscal 2012.
This is a nearly $70 million increase over 2011.
Regarding Ashland’s overall view on Pension, bear in mind that our primary pension plans have been close to new participants for some time, limiting the growth of our pension liability. New employees are now hired with a defined contribution plan. As discount rates returned to more normalized levels, our under-funded liability and pension funding requirements will decline.
Given our assumptions on asset returns and the latest actuarial review, a roughly 250 basis points increase in the discount rate would result in our pension being on a fully-funded status.
The next slide reviews our Tax Expectations. Our expectations for Ashland’s near-term effective tax rate is in the low 30% range. This should trend downward over time due to lower cash requirements in the US and higher relative growth and lower tax-rate regions of the world.
2014, we would expect our tax-rate to be in the high 20% range. However, there may be some opportunity to reduce this number even further and while we can’t firmly quantify the upside, we do believe there’s some additional opportunities as we work through the integration of ISP’s business structure and related legal entities.
As you build you cash flow model, bear in mind that we enjoyed a lower cash tax-rate and anticipate a cash rate of roughly 20% until 2012. This reduce rate is largely due to the use of existing tax attribute carry forwards. As we work through these attributes, our cash tax-rate will increase which should remain at a discount to book.
Now, let’s go to the next slide to bring all of these elements together for free cash flow. We remain very focused on a long-term cash generation. In order to help you understand our 2012 cash expectations. a Free Cash Flow Bridge is shown here. Starting from the 2012 Consensus EBITDA estimate of $1.3 billion, we would first deduct cash interest and taxes, and given expectations around growth, working capital would likely continue to be at use of cash and we’re removing almost $100 million here. Capital expenditures will be the largest use of cash and are forecasted for the year as $350 million as you heard earlier. Environmental and asbestos represents approximate cash outflows for these items, net of insurance recoveries.
Next, we deduct the cash pension and OPEB requirements net of P&L effect. And last, we removed dividend and other miscellaneous items including certain ISP transaction fees and synergy-related costs to arrive at an implied free cash flow generation of approximately $200 million to $250 million.
Lets go to next slide. Our expected EBITDA growth by Commercial Unit is shown here. The largest contributor to increase EBITDA will be Specialty Ingredients, Commercial Units. This high growth, high margin business is expected to contribute nearly $800 million of EBITDA, a roughly $200 million increase over pro forma 2011. Each of the other three commercial units will also be significant through contributors to attaining 2014 goals. In total, we expect to grow EBITDA by $500 million to a 2014 target of $1.7 billion.
Lets go to next slide to see what this means in terms of EPS. While we don’t typically break EPS at the commercial unit level, we thought it would be helpful to illustrate the relative contribution of each business to a 2014 target. For each business, we’ve estimate an approximate tax-rate based on regional mix.
Specialty Ingredients and water technologies for instance with more relative income outside the US, would have a tax-rate below Ashland’s average, in conversely Performance Materials and Consumer Markets which are more heavily weighted toward North America but have a tax rate higher than the Ashland average. As you can see here Specialty Ingredients was by far the largest contributor to EPS growth. Of course, a portion of this increase was due simply to the addition of ISP. As shown on the chart, interest, corporate expense and other items were essentially a neutral effect on EPS by that time. This reflects our expectations by 2014. Our debt would be back to more normalized levels and the stranded costs negatively affecting 2011 unallocated another will be long gone. As we look at our commercial units plans to grow their business, we anticipate generating EPS in the range of $9.50 to $10.50 per share of fiscal 2014.
I will turn the presentation over to Jim O'Brien for his closing thoughts. Jim?
Questions for Lamar will open up after we get done with this.
First of all let's go to slide 146. I have known many in the room for well over 10 years as we've continued to move Ashland in the direction of specialty chemicals and this day is one that I have been looking for, for sometime which is the transformation is now complete. So as far as dealing with all the questions about what I will do with this asset, what will I do with that asset, I think those days are over and now what you can talk to me about is how we are going to grow this business and increase earnings which is a fair question, a one that is going to demand all of our focus.
So as you saw through the presentation, our whole reason to be here is to show you our intentions and our ambitions to grow EPS. And I see this grow the top line but how are we going to grow earnings and how we become one that we could be looking at a consistent growth, a predictable growth of our EPS which in the past would be hard to identify because there were so many moving parts.
It was hard to really determine what next year's EPS would be nonetheless what it was in the current year. So the key takeaway is from this presentation you should have is that the EBITDA is going to be $1.7 billion by 2014. That's what we are planning to do and that's a growth of about $500 million, not insignificant, but yet not a crazy number either. Given some very basic conservative expectations around the economy, a lot of it is in our control to make this happen. And that’s on a pro forma growth over 2011 where we stand here today. They gives you an EPS of 2014 of $9.50 to $10.50 per share and that’s an increase of relatively $6 a share for 2011.
But you have to ask yourself, what gives us the confidence that we can achieve this. As we have put this company together and formed this specialty chemical company, it’s been formed by acquisitions of other companies that we’ve put together. And one of the primary aspects that we’ve been very sensitive to is the culture of the corporation, the culture of the people that were are bringing into the corporation.
What we have found to bringing Hercules in as well as ISP, there has not been a predominant Ashland culture. If you look at the Ashland culture historically, it was one of kind of a holding company. Each division had its own culture and it was multiple cultures. Very hard to maintain a certain focus and have a certain type of person that you are looking to hire to create the diversity inside the corporation.
We have a much more unified culture and as I look at it today it is underscored the old Ashland culture. We’ve created a new culture. Really basically based off of the historical Hercules and the historical ISP now coming together which are very similar in many respects with a compliment of some Ashland. So I think that the Ashland culture today, it’s really a totally new culture than it was.
I have been with the company now over 35 years and if I look back on it and think about what the company was and where it is today, I only recognize the company today versus where it was. It’s like it formed, it’s really hired into a totally new company.
So from that standpoint, it’s really good, getting stronger more focused, has a lot more attributes and a lot higher capability. The other area that we are really focused on with keeping with the key people in the company, they are going to matter going forward to continue this growth, it really creates a backbone of the company.
We have spent a lot of time incentivizing the executives that we have brought into the company to stay. And for the most part, we have been able to achieve 90 some odd percent retention of these key executives.
And that’s critical to be able to maintain the momentum and the growth of the company. So the people that this company is build up of are the people that have made it successful prior to bringing them together, and the other important part is yet to give these people responsibility and key jobs, and we have done that. The people we have brought in have that responsibility, have these key jobs and they are now the senior executives of the company and we look to them to produce.
The other thing you saw in these pages today are the numbers you have seen is not just some aspirational swag that we put out there saying we want to grow the company to $10.50 EPS. The $10.50 was a result of an accumulation of the commitment and the accountabilities that these executives put on these pages to present to you today and though what the Board is going to do and what I am going to do is we’ll hold ourselves accountable to these numbers and this is how we are going to get paid over the next three years.
The numbers you see on this page are accountabilities that the Board is going to hold us accountable for and if we get any incentive going forward, it will be because we have hit these numbers.
And what we have been really stressing here is that we wanted to have a buildout as far as the accountabilities that we have on put on this page, the things that we can control. We didn’t want to have a three-year plan that says that we have to have a 4% or 5% growth in the economy to make this happen. We want to define these things that we can control, the types of research and development projects, the new products that we’re going to move forward.
The investments that we’re going to make in capital equipment and how we expect that capital to produce results and produce earnings for this company that we’re going to do these things and we expect to have the outcomes that you see on this page. So as I look at what we presented to you today and how I feel about the confidence around it, I am totally confident we’re going to do this.
And I'm confident only because we’ve spend a lot of time working on the plans and the specifics and then breaking it down to individual sales people what they’re going to have to do to deliver this plan and we’re going to hold them accountable. So as you think about investing in this company we're investing our own future obviously in it and we have a lot of skin in the game because a lot of the ways we get paid is in stock and SARs and other ways to have equity type incentives to make it worth our while to make you money as we make money for the corporation or make money for ourselves. So I’d like to close up the presentation, I think that you all were very attentive, had great questions and I appreciate your attendance and we’ll open up for question before we go to lunch. So for questions for Lamar or myself or another executive at the table please. Thank you.
John Roberts, question for Lamar. Lamar, in the earnings per share bridge, the interesting corporate had minimal contribution, so the benefit of interest rate or interest expense reduction and tax rate coming down as you move cash and some cash gets moved to corporate. Obviously it’s not in the segments, is there – is that playing, I would have expected a material earnings benefit from debt reduction showing up in interest expense reduction?
Basically, plan lays out, the corporate and allocated another for Ashland if it is fully allocated to our commercial segment. So you saw the commercial unit plans that assumes the kind of above the ladder, the operating income rated aspects, our corporate support functions to be fully allocated to the segments by 2014. Today we have some stranded costs still left in the unallocated another. That’s not being pushed out. So we will be removing that. From an EPS standpoint, as you work your way down the P&L, we get tax benefit of the lower effective rate, we get the benefit from reducing our debt over that period of time and you basically work down to net neutral effect on unallocated another.
[Abhay Rajendran]. Another quick question on the EPS Bridge, how should we think about the linearity of it over the next couple of years and could you get as much as a third to a half of it in 2012 as well, just from the edition of the ISP results?
I think as you heard from me to the commercial units. Our plans between 2011 and 2014 are expected to be largely linear in terms of that progression side and I would think as we draw back and on the overall you should expect to see the same linearity. We have highlighted a couple of things going on around our stranded costs and our synergies related to ISP. So they tend to come a little toward the end of 2013 after our systems were implemented and so that that would be the one exception as we realized most of that $50 million more toward the end of 2013.
Just because the [call rate] that won't be linear as well.
Good point Dave. Thank you. Anyone along over here?
Peter Goodson - Eminence Capital
Peter Goodson from Eminence Capital. When we look at EPS, at this point you guys have something like $180 million to $190 million of non-cash purchase price amortization in your numbers; is that right.
Yeah, the step-up on ISP was about $115 million to the D&A of the Ashland-ISP individually had when we came together. So in total our D&A for Ashland now is running at around $440 million per year.
Peter Goodson - Eminence Capital
But in addition to that $115 million you had about $65 million from Hercules, right, about $17 million of purchase price amort a quarter?
It’s a lag.
Peter Goodson - Eminence Capital
And I guess my question is now that this non-cash expense is so large, you know its about $2.40 a share, are you guys going to give any thought to either cash earnings number or potential calling that out exclusively on the income statement so people can market that adjustment?
Yeah, in fact one of the reasons we went through the detail we did particularly during my portion of the presentation around the cash components of our free cash flow is to help you build those models. So we will continue to put a lot of sunlight on the cash aspect for instance the cash interest costs, the cash pension funding and it will allow you to do that. So we provided a pretty healthy disclosure related to the cash elements that would replace the book elements and some of those key items.
David Begleiter - Deutsche Bank
Thank you. David Begleiter; Jim of the four segment EBITDA targets which has the most upside in your view which is the biggest challenge to achieve?
Well the one that we think is going to take the most work is obviously the Ashland Specialty Ingredients. We have to make investments, we have to continue to do integration so that one probably has the most work involved in it because it has the integration aspect in the investment.
When you look at the Performance Materials they are the one most sensitive to the economic recovery, so they are going need probably more of the tail end of some recovery taking place because of the US market is probably most effecting to them.
Water I think has got some traction; pricing over the business they focus on this past year and the last quarter showed that they finally got some attraction in that area and takes some momentum but I think they are moving ahead and I have confidence that they are on the right track.
Valvoline was affected by having three price increases so close together in the middle part of the year that’s what affected their going to get pricing through when you get through that close it’s hard to move them all briskly through the system. So they at last took about six months, we’re disappointed with that, but we got it. And maybe just pray that you don’t have any more for while and if we get you know pricing that goes every three to four months in Valvoline that’s very manageable and it could be digested to the markets. So that how its turn out we’ll be fine.
So I look at the risk adjusting here is all on execution and lot of is in our control. So from standpoint of running this company, as running first time in a long time that I get to say a lot of what we have to do is inside of our own control, not to say that its slam dark, but its more operating company now than M&A company or a sell this, buy that; and really I am looking forward to not having the pressure or having by the way we do the cash. And we don’t have a lot of cash, because we don’t have a lot of excess cash running through the company so it’s going to be cash invested and it’s going to look more like a normal company for a change. I am quite excited about that.
Thank you. [Shuo Li] from Citigroup. My question is with respect to you achieving investment grade rating, do you have a timeline for that and if there is a very specific target you are looking for? In addition, should we anticipate paying down – your paying down of term loans and replacing that with unsecured loans?
I will answer the second part because I missed the first part, so I may have to ask you to repeat that. Investment grade, okay. Thank you.
The timeline around investment grade in our view is really going to be a result of our progress and how fast we can make progress on debt reduction and getting down to more of our targeted leverage ratio. So we think that with cash flows and as we kind of have time for today, particularly over the next two to three years, but by the time we get to 2014, we should have the kind of financial metrics that will support an investment grade rating.
In terms of potential for pay down or pay-off on the term loans, our focus initially will be on our tying of $650 million of notes that represents our highest interest cost debt. Those are called on June 2013. So we are going to build liquidity until June 2013 as the markets are similar to what they are today in terms of credit cost and so forth. Our expectation will be we’ll use that cash at that time to pay off those notes.
Very specific, how much you’re rating getting forth?
We would like to get across our hurdle investment grade rating but not much beyond that in terms of our target.
As it relates for the free cash flow bridge, so if you take the $1.7 billion that you guys are targeting for the 2014 of EBITDA, and compare that to the 2012 estimate of the $1.3 million, could you reasonably add that $400 million to your $2 million to $250 million and say that’s roughly the target that you guys have for free cash flow for ‘14?
Probably it wouldn’t be far off; there’s some puts and takes obviously and that matters, our tax rate on a cash basis as I have indicated might be going up a little bit and our interest cost should be coming down as we pay down debt over that period of time. Our pension funding depend heavily on what the discount rate does, but it’s not one reasonable to expect our pension funding requirements to diminish over that period of time. So I think the net-net is basically wind up close to where you are indicating may be the full $400 million doesn’t flow all the way to free cash flow, we wouldn’t be far off that.
Are you hearing me right, sorry Jeff. Two questions. Can you talk about the environmental as best as cash outflow for 2012 and whether that some more permanent condition? And in general, some of the petrochemicals have come down in value which really should bring down your inventories and maybe your receivables, are you really confident that you’ll have a use of working capital in 2012?
Our working capital management now is more oriented around optimized working capital rather than finding a whole lot of further reductions. We have been very focused on giving what we believe to be an optimal level. We have discovered in this process you can’t go too far with that and find yourself short of inventory and you can find yourself in difficult positions with your customers and suppliers. So it’s all about optimizing; frankly we think what we have done to over the last three or four years is pretty close to optimal.
The one question mark restarting and further will be what further we could do then what ISP did on their own. So we’ll understand that better probably in the coming few months but potential for the actual legacy businesses, we think that it’s 14% of sales levels about right maintain working capital.
I think the other part was to be as best in class environmental liability; what is that for 2012 and is that an on going expense?
It is an ongoing from the standpoint of reasonably foreseeable future. The last two years for instance our environmental disbursements net of insurance recoveries has averaged $46 million; I think one year it was $45 million and the other was $47 million so its very tight and becoming quite predictable. I can be a little hypothetic just based on the expected issue, but we think that’s become pretty predictable in that $40 million or $50 billion range. As best as will almost become actuarial and the ability to estimate the cost or the disbursements under these long range models and the long range models are tending to prove pretty accurate even for a given year in time. In total, I think our asbestos and our environmental outflows are going to average about $90 million per year.
Given that for all these transitions and divestitures and acquisitions, Ashland has become almost 50% international and probably, certainly looking at the growth prospects, will become over 50% international in short-term. How should we think about foreign exchange impact? Are you self-hedged or we should just worry about translation or there are mismatches between where you produce and where you sell that there can be a margin impact? And then second question, kind of on the same day, given that becoming almost a foregone conclusion that Europe will spend at least part of 2012 in recession and how should we think about the next 12 months in your ability to grow in that region.
On the foreign exchange aspect, we are largely self-hedged just the way we buy and sell around the world, I think you will have an update on the metrics. About 1% weakening of the dollar contributes to about $1 million of earnings. So it’s a pretty small impact there relative to what you might in peer companies. On your second question regarding Europe, we look at the businesses that are material over there, the Performance Materials business (inaudible) biggest impact because it is more around the construction business, but the other businesses that we are and even water which is broadly based on industrial markets is still very strong and seeing growth. It’s actually one of our better businesses. When you look at ASI, a lot of that’s around consumer and paint and they’ve had very strong growth through this period. So our assumption is that Europe is probably going to have a slight recession but we think that types of businesses that we are in and our experiences over the last 18 months, things continue to be very strong and performing. So it’s not going to (inaudible), that continues. But we haven’t seen any really, strong effects although the turmoil is going out of it.
Jim, in the past, you’ve talked about possibly selling the Valvoline business. More recently you said you’re not interested in that. I mean, what’s your thinking about that? It used to be 37% of EBITDA. It’s now 20% of EBITDA, the two great branded business, is that something you consider over the next several years?
When you look at Valvoline, I think with the impression got that we are going to sell Valvoline, it was – if we go back to 2008 when the company was under severe stress and you had no sense of where the bottom was on this recession, Valvoline was our best asset, and we had always debt and if we did anything that could be sold, it would’ve been Valvoline. And then during that period whoever were the buyer was not going to give you much for what you are trying to sell. So we decide to gut it out through that period. And see if we can fix it in other ways which we did. Now as you get into where we see Valvoline today in the portfolio, the challenge that we have is to invest in ASI and do the type of growth that we would like to do and have the free cash flow that we want. Valvoline is a very consistent predictable business. It throws a lot of cash.
When you look at this chart, it’s the second highest cash generator that we have, as very close to ASI. So to find an alternative for that cash would be difficult. And also, it has a very high return on investment. So, you look at the cash that way to put into it and the capital that we put is very, very minimal. It’s just a marketing-based company. So, it has more of an expense base around its investment that we have extended it so with trade, marketing as well as [pull] marketing or advertising. That’s where they have most of their investment that’s been made. So, as I look at that business, it’s a terrific contributor to the corporation and I love its cash.
Okay. That’s it. We do have lunch next door; hopefully you will join us. It’s past eight. You will go out and then you actually come in, eat at your tables. The Ashland management will kind of mingle throughout.
So, thank you again for your interest and your time this morning.
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