Kraton Performance Polymers' (KRA) CEO Kevin Fogarty on Q4 2016 Results - Earnings Call Transcript

| About: Kraton Corporation (KRA)

Kraton Performance Polymers, Inc. (NYSE:KRA)

Q4 2016 Earnings Conference Call

February 28, 2017, 9:00 am ET

Executives

Gene Shiels - Director, IR

Kevin Fogarty - President and Chief Executive Officer

Steve Tremblay - EVP and Chief Financial Officer

Analysts

Jason Freuchtel - SunTrust

James Finnerty - Citi

John Roberts - UBS

Curt Siegmeyer - Keybanc Capital Markets

Operator

Good morning and welcome to the Kraton Corporation Fourth Quarter 2016 Earnings Conference Call. My name is Louis and I will be your conference facilitator. At this time, all participants are in a listen-only mode. Following the Company's prepared remarks, there will be a question-and-answer period. [Operator Instructions] Today's conference is being recorded. If you have any objections, you may disconnect at this time.

I will now hand the call over to Mr. Gene Shiels, Director of Investor Relations. Sir, you may begin.

Gene Shiels

Thank you, Louis. Good morning, everyone, and welcome to the Kraton Corporation fourth quarter 2016 earnings call. With me on the call this morning are Kevin Fogarty, Kraton's President and Chief Executive Officer; and Steve Tremblay, Kraton’s Executive Vice President and Chief Financial Officer. A copy of yesterday's news release, is available in the Investor Relations section of our website, as are copies of the presentation material, we will review this morning.

Before we look at our results for the fourth quarter and full year 2016, I’ll draw your attention to the disclaimers on forward-looking information and the use of non-GAAP measures included in our presentation this morning and in yesterday's earnings press release.

During the call, we may make certain comments that are not statements of historical facts and thus constitute forward-looking statements. Investors are cautioned that there are risks, uncertainties and other factors that may cause Kraton's actual performance to be significantly different from the expectations stated or implied by any forward-looking statements we make today.

Our forward-looking statements speak only as of the date they are made and we have no obligation to update such statements in the future. Our business outlook is subject to a number of risk factors. As the format of this morning's presentation does not permit a full discussion of these risk factors, please refer to our Forms 10-K, 10-Q and other regulatory filings available in the Investor Relations section of our website.

With regard to the use of non-GAAP financial measures, a reconciliation of EBITDA and adjusted EBITDA to net income or loss or operating income, our gross profit to adjusted gross profit, as well as a reconciliation of net income or loss attributable to Kraton to adjusted net income is provided in yesterday’s earnings release and is included in the presentation we will review this morning.

Lastly I'll remind our listeners that all references to full year 2016 financial results for the Chemical segment are from January 6, 2016, the date of acquisition through December 31, 2016 excluding the stub period January 1 through January 5. For the January 1 through January 5 stub period, sales volume for the Chemical segment was approximately 3.3 kilotons and revenue was approximately $6.9 million. For the Chemical segment 2015 financial figures referenced in the presentation have been derived from the Arizona Chemical historic operating results that are being included for comparative purposes only. Following the prepared remarks, we'll open the line for your questions.

I'll now turn the call over to Kevin Fogarty. Kevin?

Kevin Fogarty

Thanks Gene and good morning everyone. Before we review our financial results in detail, I’ll offer a few thoughts and I believe it plays our fourth quarter and full year 2016 performance in the proper context. 2016 was a year of significant change in progress for Kraton. Early in the year, we closed the acquisition of Arizona Chemical and transaction has nearly doubled the size of the company.

The addition of the Chemical business broadened our scale, expanded our market presence and relationships with customers, diversified our raw material base and will ultimately drive for transaction synergies of $65 million. We began the integration process immediately while working to minimize disruption in the business.

Process of integrating two companies is a complex undertaking. However I believe overall the process went well. Not only do we acquire a highly profitable business, but leading market positions and solid growth opportunities, but we are also fortunate to add a talented and engaged team from Arizona that is now part of the Kraton organization.

In terms of synergy capture through hard work and focus, we exceeded our target, our G&A reductions and operational improvement for the year delivering a total of $37 million in 2016 or a total goal of $65 million. We remained firmly on track to achieve at least the $65 million in transaction synergies by the year end of 2018.

In parallel with our reference to garner the transaction synergies, we continue to make great progress on the cost reduction initiatives in our Polymer segment through which we expect to deliver total cost reductions of $70 million by the year end 2018.

In these efforts we also exceeded our 2016 goals delivering an incremental $12 million of cost reductions on top of the $19 million achieved through 2015 for an aggregate of $31 million realized against our stated $70 million goal.

Of note in the fourth quarter of 2016, we completed construction of our 30 kiloton HSBC plant at Mailiao Taiwan, completing the plant at a total cost of approximately $180 million, significantly below our original expectation of approximately $215 million and with 2.8 million man hours logged with no recordable safety incidents.

First batch of polymers from the plant was completed in December and we expect commercial samples to ship during the first quarter of 2017 as we continue to move through the customer qualification process and volume ramp in Mailiao.

We discussed in our third quarter call, we had an extremely successful preliminary Cariflex production run in Polenia Brazil for the direct connect process technology we are deploying. This conversion will utilize components of the USBC line at Polenia and as such, we have now formally announced that we will seize production of USBC product grades in Polenia and we will effectively shift USB production from Polenia to Bayer, France.

The direct connect construction phase in Polenia continues to go well and we expect completion sometime in the third quarter of 2017. The process of expanding our USBC production in Bayer, France is well underway and we expect that project to complete by the end of this year as well.

Going forward, we still expect to enjoy favorable economics as we leverage the low cost or lower cost of butadiene at Bayer. Historically, the favorability in butadiene cost relative to Belpre, Ohio has been in the range of $400 to $500 per metric ton. Given the recent increases in North America, butadiene prices – recent increase of butadiene prices in North America, this spread is quite a bit larger today.

2016 we more than doubled our adjusted EBITDA leveraging Kraton’s solid market positions and the global reach while benefiting from our synergy capture and cost reset initiatives. Despite the headwinds we faced, in certain areas Kraton generated an adjusted EBITDA margin of more than 20%.

In terms of our two segments, the Polymer segment delivered an exceptional year in 2016 with adjusted EBITDA of $183 million, up nearly 10% versus 2015 despite an increase in butadiene prices contributed to fourth quarter results. For the segment that we are lower than we had anticipated, the adjusted EBITDA margin for this segment was 17.9% in 2016 and this was up over 170 basis points from 2015.

With this strong 2016 performance, our Polymer segment continues the multi-year trend of growth in adjusted EBITDA. As a reminder in 2015, we posted adjusted EBITDA of $167 million exceeding full year 2015 guidance of $160 million and in 2014 we reported adjusted EBITDA of $147 million was up over 4% of $141 million reported in 2013.

Although we are currently focused on managing raw material price increases to mitigate the near-term impact of this on our unit margins, current demand outlook across the highly diverse group of end-markets we serve is favorable.

Now turning to our Chemical segment, following a solid first half of 2016, we faced increased headwinds in the second half of the year associated with competitive pricing conditions for TOFA and for TOR, that resulted in margin pressures in our Chemical intermediates business and the availability of low cost C5 hydrocarbon-based tackifier resins adversely impacted margins for Rosin Ester products in our Adhesive business.

These pressures had a more pronounced impact on our results in the second half of 2016. Nevertheless, our Chemical segment posted adjusted EBITDA margins of nearly 24% in 2016. Although the magnitude of these headwinds in 2016 was unexpected, the business continues to have solid growth opportunities and attractive – and an attractive free cash flow profile, which contributed to our debt reduction efforts.

In 2016, we generated adjusted earnings of $2.36 per diluted share and this was up 17% compared to 2015. Since the date of the Arizona acquisition we have reduced Kraton net debt excluding our joint venture in Taiwan by $118 million and as planned, we ended the year with Kraton net debt of $1.6 billion.

Now I am going to turn the call over to Steve, Steve Tremblay, our Chief Financial Officer to provide a financial review of the fourth quarter and the full year results and I’ll follow with some additional comments on market views and our outlook for the year in a few minutes. Steve?

Steve Tremblay

Thanks Kevin. I’d like to begin our financial review on Slide 5 with a look at the fourth quarter and full year 2016 operating results for our Polymer segment. Fourth quarter sales volume of 73 kilotons resulted in full year 2016 sales volume of 324 kilotons, which represents a 6% increase compared to 2015.

We experienced another year of solid volume growth in each of our three business lines with Cariflex up 19%. In addition, our Specialty Polymers business posted a headline volume growth of 7%, but again the growth was 10.5% when we adjust for the sale of the compounding assets in early 2016. And finally, our Performance Products business experienced 4% year-on-year sales volume growth.

Fourth quarter and full year 2016 revenue was $239 million, and $1.02 billion respectively. The decline in revenue from 2015 level is indicative of changes in raw material costs, the pressure on certain SIS grades and product mix.

Our portfolio shift strategy continued to move in the right direction in 2016 as evidenced by the increase in revenue associated from differentiated grades increasing to 61% of revenue in 2016 from 58% of revenue in 2015. Fourth quarter 2016 adjusted EBITDA of $42 million was a solid quarter for the Polymer segment, especially considering the macro headwinds around SIS margins.

While this was down $8 million from the $50 million we recorded in Q4 2015, we must acknowledge that Q4 2015 presented tough comparisons due to the favorable butadiene trend that prevailed at that time and given the exceptionally strong sales volume in the quarter. In fact, Q4 2014 had the highest fourth quarter sales volumes for the Polymer segment since the fourth quarter of 2007.

Full year 2016 adjusted EBITDA for the Polymer segment was $183 million, up 16% or nearly 10% compared to full year 2015. The adjusted EBITDA margin for the segment was a solid 18% representing an increase of over 170 basis points compared to a 60% margin in 2015.

Looking at the results now for our Chemical segment on Slide 6, volume amounted to 104 kilotons in Q4 2016 representing a 4% increase compared to the fourth quarter of 2015 with Adhesives volume up 5% and Chemical Intermediates volume up 3%. On a full year basis, volume of 412 kilotons was down modestly, primarily due to the lower volume in the Chemical intermediates business.

While sales volume was up for the segment, fourth quarter 2016 margins remained under pressure from the availability of low cost C5 hydrocarbon alternatives and the competitive pricing dynamics for TOFA and TOR. As a result, fourth quarter 2016 adjusted EBITDA for the Chemical segment was $35 million, but the associated margin remained at approximately 20%.

Full year 2016 adjusted EBITDA for the segment was $171 million and despite the margin pressures we highlighted, we posted an adjusted EBITDA margin of 24% benefiting in part from the significant progress we made in our synergy capture efforts.

This brings us to Slide 7, on a consolidated basis, fourth quarter 2016 adjusted EBITDA was $77 million. This was below our expectations for adjusted EBITDA in the low $80 million range as we indicated in our third quarter 2016 earnings call.

The lower than expected fourth quarter results were driven by three factors; lower SBS margins resulting from unplanned increases in raw material costs, the deeper than anticipated competitive market conditions for SIS and thirdly lower sales volume for Adhesive products in our Chemicals segment.

Full year 2016 adjusted EBITDA amounted to $354 million with an associated margin of 20%. The more than two x increase in adjusted EBITDA from 2015 includes the accretion provided by the Arizona Chemical acquisition, the volume growth and portfolio shift in our Polymer segment and the relentless execution of our cost reduction plans.

Adjusted earnings per share was $0.29 in the quarter and $2.36 per share on a full year basis, the latter up 17% compared to $2.02 per share in 2015. Following up on Kevin’s comments about synergy capture and cost reduction, I’d like to provide some more details of these initiatives as we move to Slide 8.

In short, we exceeded our 2016 targets for the Polymer segment cost reductions as well as the target we set for the Arizona-related initiatives. In total, we have realized $68 million of cost reductions to-date against the targeted range of $46 million to $55 million which we outlined in April of 2016.

In our Polymer segment, we have now realized $31 million of cost reductions, with an incremental $12 million realized in 2016. On the synergy capture side, we delivered $18 million of G&A reductions and $19 million of operational improvements in 2016 for an aggregate of $37 million.

By the time we end 2017, we expect that Polymer segment cost reduction initiatives will have increased to $50 million and the G&A synergies when combined with the Chemical segment operational improvements will have increased to $58 million.

And again, this reiterates our commitment to deliver at least the $70 million of cost reset initiatives in the Polymer segment and the $65 million of synergy capture associated with the Arizona transaction.

Of the total 2017 incremental benefit of $40 million, we do expect it to be more back-end loaded with 40% to be realized in the first half of the year and 60% to be realized in the second half of the year. A comment on the cost to achieve these initiatives, we expect that 2017 CapEx budget will include $35 million to $40 million of CapEx associated with the Arizona and Polymer segment cost initiatives with operating cost of approximately $20 million associated with those initiatives.

Moving now to debt reduction and our commitment to reduced outstanding indebtedness, we have provided the cap table on Slide 9. In 2016, we delivered on the end of the year net debt target of $16 billion and this represents a reduction in net debt of $118 million since we closed the Arizona transaction. Our plans for free cash flow are unchanged, specifically, we will apply free cash flow to lower outstanding indebtedness.

Let me pivot now to our views on 2017. First on Slide 10, a look at recent trends in butadiene and styrene this data is curacy of IHS. Looking at butadiene in particular, you can see that from January through August 2016, North American contract butadiene average $0.31 per pound. Prices began to move in September, reflecting the knock-on effects of outages in Asia, which led to increases in spot pricing in the region.

The $0.06 increase in November was disruptive given a prevailing view that butadiene prices will trend down in the fourth quarter. And as you can see, we saw a $0.12 upward moving in January, followed by an unprecedented 29.5 cent move upward in February, the largest monthly increase in recent memory.

We are currently expecting DD prices to move up again by somewhere in the range of $0.16 to $0.22 per pound in North America. To put this perspective, if the March increase is in this range, the cost of the three monomers will have increased by approximately $30 million in Q1 2017 compared to the December 2016 cost for the same basket of monomers.

Of this increase, approximately $18 million reflects the currently anticipated increase in March. As you can imagine, these estimates are dependent on where the March monomers ultimately settle. In response, we have been actively moving selling prices to mitigate the impact of these raw material price increases, but the inherent lag across the entire Polymer segment portfolio will be a headwind against Q1 2017 Polymer segment adjusted EBITDA which we currently estimate of $15 million.

On Slide 11, we have comments around our financial expectations for 2017. As mentioned this morning, the impact of various market factors on our financial performance was more pronounced in our results for the second half of 2016 in which adjusted EBITDA was $168 million or $20 million below first half 2016 adjusted EBITDA of $186 million.

As Kevin noted, thus far in 2017, we have not seen a significant improvement in these market dynamics. Given the continuation of these headwinds into 2017, exacerbated by the run up in butadiene and other monomer costs, we believe the second half of 2016 is a more appropriate baseline runrate for the business in 2017 and this would imply a starting point for 2017 adjusted EBITDA in the $335 million range.

With our targeted $40 million of incremental cost reductions, which will partially be offset by inflation in currency, our current expectation for adjusted EBITDA in 2017 is approximately $350 million. On a currency-adjusted basis, that is more in the $356 million range.

Near-term, we estimate first quarter 2017 adjusted EBITDA will be approximately $60 million to $65 million. We are targeting a further reduction in net debt of $100 million to $150 million in 2017, and this would imply that we will hit our $500 million aggregate debt reduction target sometime in 2019 rather than by the end of the year 2018.

Our 2017 cash flow expectation includes a relatively benign impact from working capital changes. This assumption really depends largely on inventory levels including the effect of product transitions and the raw material cost trend for the balance of the year. Not only do the raw material cost trends put near-term pressure on EBITDA, they also have a large effect on working capital.

For example, at today’s inventory levels, each $0.10 increase in raw material cost in our Polymer segment translates to more than $20 million of inventory valuation. In the appendix of this morning’s presentation, we have included a typical view of full year modeling assumptions for items such as depreciation, interest expense, CapEx and taxes.

So with that, I’d like to turn the call back to Kevin for his closing comments. Kevin?

Kevin Fogarty

Okay, thank you Steve. 2017 was a transformational year indeed for Kraton and the year of significant progress on all of the strategic initiatives we set forth for the company. In terms of execution, our teams did a fantastic job delivering our strategic objectives. As you have seen this morning, we exceeded our plan on cost reduction efforts, and then realization of transaction synergies.

I am highly confident that we will continue to do so as we continue to focus on delivering at a minimum $70 million of cost reductions in the Polymer segment, a $65 million of G&A and operational cost improvements associated with the Arizona Chemical acquisition.

However 2016, we did face market realities that resulted in our actual performance falling below expectations that we have set earlier in the year. In our Chemicals segment specifically, the margin pressure arising from availability of low cost C5 hydrocarbon alternatives, the impact of excess market capacity for TOFA and TOR was clearly greater than we had initially anticipated.

These pressures intensified in the second half of the year causing us to revise our adjusted EBITDA expectations for the full year and they factor into our current expectations for 2017. While the market pressures resulting from the availability of low cost C5 alternatives have not abated in 2017, we believe over time the market dynamics should improve particularly as crude oil prices continue to increase.

In the mean time, we are positioning our Adhesives portfolio to focus on market segments that we believe has a truly differentiate product offering. As it relates to our Chemical Intermediates business, while the market remains structurally long for TOFA, the outlook is improving given an increasing rig count, higher oil prices and higher prices for vegetable oil substitutes.

In this environment, our team has continued to leverage our global presence to focus on developments of new market outlets and as a result, we believe Kraton’s position relative to the global TOFA market has improved substantially.

Evidence of this improved outlook maybe as you have hopefully already seen that yesterday we announced a global price increase of $120 per metric ton for our TOFA product family globally.

It is important to note that despite these margin pressures underlying demand in the varied end-markets served by our Chemical segment remains sound as evidenced by the stability of sales volumes, the attractive cash flow profile, and the segment’s adjusted EBITDA margin of nearly 24% in 2016. These factors continue to give us confidence in the long-term attractiveness of the chemical business.

Our Polymer segment had an outstanding year delivering solid volume growth and margin expansion, despite ongoing competitive conditions for SIS and the recent increases in raw material costs.

While the magnitude of the raw material price increases over the past few months in unprecedented, we currently don’t see these increases resulting in significant changes in our demand outlook. We believe that capacity outages are the primary factor in the recent increases in butadiene cost.

This was the case for much of 2016 and certainly is the case thus far in 2017 with two of our suppliers being impacted by turnarounds or near-term production limitations. Ultimately, we expect these capacity limitations will be resolved leading to a more balanced supply demand environment.

In the mean time of course, consistent with our price right strategy, we will continue to implement price increases to defend our dollar unit margins. Now in addition to the tactical adjustments that we have made in our pricing our market approaches, I want to share with you some additional steps that we have taken to address the market challenges that exist particularly for our Chemical segment.

First Heba Botros recently joined Kraton coming from Polypore and previously GE Plastics. Heba now heads up our Corporate Development Group and in addition to leading traditional strategy work, she is specifically tasked with leading a dedicated team to provide significantly improved market insights in and outs to the business and this certainly includes forecasting.

Secondly, we recognized that particularly in the near-term, there is significant value still to be realized within our individual business segments. In light of the fact that our Polymer segment and our Chemical segment have many unique growth opportunities and challenges, we believe our ongoing efforts will benefit from leadership of a dedicated executive for each segment.

We are therefore very pleased to announce today that Marcello Boldrini as Senior Vice President of our Chemical segment. Marcello joins Kraton from Houghton International where he served as President, Asian and President of its Global Mining and Metals business. Previously Marcello served as the Senior Vice President and Chief Marketing Officer of Momentive a global specialty chemical company.

Parallel with his appointment, Holger Jung, currently Kraton’s Chief Commercial Officer will similarly assume the role of Senior Vice President and the Polymer segment President. We still fundamentally believe in the market overlap and cross-selling opportunities that exist between our two operating segments and therefore technology and product development will continue to play a vital role in our future.

So we are also very pleased to say that Vijay Mhetar has recently joined Kraton as Senior Vice President and Chief Technology Officer. Vijay has oversight and responsibility for our Global R&D organization and innovation processes. Previously Vijay worked for General Cable Corporation as Senior Vice President of Global Technology where he successfully transformed the R&D function to provide a competitive advantage to the company. Prior to General Cable, Vijay worked for GE Plastics in various roles including Global Technology Manager, Global Innovation Leader and Product Developer.

Now in closing, we accomplished a great deal in 2016 and the positive momentum on our cost reduction programs and cash flow profile carry into 2017. Our Polymer segment had a strong year in 2016 and we expect to build upon that success as we leverage our recently completed HSBC facility in Mailiao Taiwan, and as we complete our Cariflex USBC and - Cariflex and USB expansion projects in the second half of 2017.

Our Chemical business faced margin pressure in 2016, but even so, it remained an extremely profitable business. We still have significant cost benefits to deliver in 2017 and 2018 and we believe the recent additions to our management team will help us accelerate realization of the potential and upside that exists in both our Polymer and our Chemical businesses.

With that, I’ll turn the call back to the operator and happy to open the line up for some questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question is from Jason Freuchtel from SunTrust. Sir, your line is open.

Jason Freuchtel

Hey, good morning.

Kevin Fogarty

Hi, Jason.

Jason Freuchtel

I thought you guys noted several positive surprises last night and today, first on the pine-based chemicals business, the price increase for your TOFA product sounds positive and I assume your guidance does not assume realizing the higher prices. Was the price increase announcement primarily driven by the sentiment in the market? Or by some of the proactive actions you are taking to find new outlets and upgrading the TOFA product? And I guess, with that, do you have sense on whether your competitors will follow your price increase?

Kevin Fogarty

Okay, so several questions in there, Jason. First of all, I am not going to kind of distinguish between what’s in our forecast for the year EBITDA and how that plays into this price increase. Obviously, the timing coincided with our earnings announcement mainly because of the timing of what’s happening in our markets and our desire to obviously put this price increase throughout the effective date of March 15.

But nevertheless, yes, what is it reflected? It reflects how we see the business evolving. And we talked all last year about creating a number of new outlets for a business that we thought was tremendously underperforming. And I am very proud of the team for the steps they’ve taken in creating those new outlets.

So, we are looking at this certainly first and foremost in terms of how we are viewing our order book and how we are viewing our operational rates as compared to that order book here in the coming weeks and months and therefore, given the margin erosion that’s occurred in the business, some underlying cost increases occurred as a result obviously of energy moving up and therefore position this price increase, we believe at the right time.

The last part of your question, I’ve been in several businesses over my career and I could never predict the behavior of competitors in this context but at the end of the day they’ll have to make their own decisions.

Jason Freuchtel

Okay, and given the higher raw material prices in 2017, I think the free cash flow guidance is much higher than the consensus view. And trying to understand the free cash flow bridge in 2017, can you walk through how to think about maybe total working capital impact of raw material changes? And if there are any other benefits that you can potentially see in free cash flow in 2017?

Steve Tremblay

Hey, Jason, it’s Steve. You probably haven’t had a chance to digest the various modeling assumptions that we’ve laid out, but I can take you through it in summary. We are expecting as I mentioned, a relatively benign working capital change and that’s really going to be driven by where inventory levels land and mainly in the Polymer segment.

The biggest variable there from historical is where product transitions play out and that the impact of that on our overall inventory levels by year end and have caused the assumption of where raw materials go. Our overall cash flow forecast and there for the relative benign slightly positive to perhaps slightly negative.

Working capital was based on a view that we continue to have that is that even though we are in a period of mocked run up in raw material cost that that should begin to abate and some of the modeling we’ve done suggest that there will actually be some potential price declines later on in the year which would help liquidate any working capital we put up during the year.

But if you take our $350 million guidance and take the cash flow assumptions with respect to cash interest, the CapEx range we gave, the operating cost to achieve and a tax assumption that’s kind of in line with 2016 of around $10 million to $11 million and apply a modest decrease or increase in working capital depending on where monomers flow and inventory levels flow.

We get to that range of $100 million to $150 million of cash flow. Again, as we see it right now, the biggest variability continues to be raw material cost, its impact on near-term EBITDA as well as its potential impact on overall working capital.

Jason Freuchtel

Okay, and just to clarify your EBITDA guidance does not assume any change in raw material prices, is that correct?

Steve Tremblay

Well it assumes that what we’ll do is, we cover for sure the $50 million headwind that I mentioned and if increasing – if raw material cost continue to increase, that could potentially be some temporary near-term headwinds, but our price right strategies only going to be negatively impacted by the lag effect.

Jason Freuchtel

Okay, great, and I guess, on the cost savings and synergies side, you have exceeded your targets in 2016 and highlighted where you think they could end up in 2017. It sounds like, it should be driven by slightly higher – more synergies and savings, can you provide greater detail on some of the operational synergies expected to be achieved next year and how to view the cadence of synergies versus savings throughout 2017?

Steve Tremblay

Yes, certainly, I can do that for you Jason. On the Slide 8 in the material, our expectation is on the G&A synergy side of the equation where we generated $18 million in 2016. We still target $25 million and we may be cutting it razor thin here but we expect maybe $1 million of rollover into 2018.

So we are putting out a target of $24 million of the $25 million will be garnered in 2017 effectively achieving the target about a year earlier than what we thought, and then on the operational improvements – I mean, off to a really great start to 2016 that $19 million was anywhere from $5 million to $9 million above the early estimates. The team did a remarkable job. The carryover effect of those projects coupled with new initiatives will take that $19 million up by $15 million to $34 million or nearly 75% of the $40 million total target with $40 million being still the target for 2018.

Kevin Fogarty

And if I may, Steve, a couple of things. It’s also important to note that from a perspective of implementation particularly on the cost out initiatives, it is kind of back-end loaded in the calendar year this year just because of the timing of when we expect to realize most of the benefits, starting this year in Brazil and in France?

Also, just as a comment, I mean, you can imagine, when we put these plants together, obviously, we are always not designing for the number, we are designing for a number that’s bigger than the number that we’ve rolled out to you all as investors and as we get closer and closer to fruition date.

It’s our goal as a management team to capture the – if you will the upside and that kind of overall project scope and so that’s how we are working and as we get closer and closer to 2018, we will be updating about whether or not some of these individual projects might actually exceed some of the expectations that we put forth.

Jason Freuchtel

Okay, thanks. With that I’ll be fair to other participants. I’ll jump back in the queue and return later with any follow-ups.

Operator

Thank you. And then next question is from James Finnerty from Citi. Sir, your line is open.

James Finnerty

Thank you. Good morning.

Kevin Fogarty

Good morning.

Steve Tremblay

Good morning, James.

James Finnerty

Good morning. On the headwinds on the Chemical segment, between C5 and the adverse supply in TOFA and TOR, can you give us an idea of which is the bigger part of the headwinds in 2016 and going into 2017?

Kevin Fogarty

Well, it’s certainly in 2016, we would say it was C5 and again, a lot of its relative to our expectations that whole C5 chain kind of evolved over the course of the year and that pressure gotten more and more as the year unfolded. But then if we think about 2017, I would say, given the fact that we are increasing or introducing a price increase in our TOFA side.

But yet we still comment that C5 pressure that we are feeling is still an existence and clearly, we are still very concerned about that C5 direction. I’d also point out some of you might not appreciate, as we run our Chemical Intermediates business, a portion of our Chemical Intermediates business is also the TOR product family which is the precursor to make Rosin Esters for Adhesives, but we also sell – and sell a lot of TOR into the open market.

And this is an example where the combination of our Chemical colleagues coupled with Kraton’s already exhausted market reach in Asia on the ground as develops some of those positive outlets that I spoke about earlier and that to me is one of those – what I would characterize is unqualified synergies that’s occurred between the two companies, because we’ve been able to leverage particularly in the region of Asia and even places like India a combined sales force.

James Finnerty

And just historically speaking, at C5, what’s the lag and moves with C5 stream relative to oil prices? How should we think about that?

Kevin Fogarty

Well, in theory, directly coupled, I mean, in theory, that we should be able to see a direct correlation, but when we talk about the C5 chain in the context, we are talking about this integrated C5 chain from cracking right through to producing of hydrocarbon-based adhesive alternatives to our Rosin Ester portfolio.

So, what happens is, is depending on circumstance of a particular supplier and of course, whether those suppliers happen to be integrated in that hydrocarbon chain, if there is an oversupplied market, how they position those products from a price point in the marketplace has been undoubtedly the key factor in the margin erosion that we’ve experienced.

So the good news is, like anything, when it comes to overcapacity causing supply demand, it will take some time to work out, but in the mean time, we are not sitting back on our heels as a company, the team has dug in and really developed some new market outlets taking advantage of our quality renewable product offering in and itself as well as just the individual properties of our Rosin Ester offerings and developed some new accounts, new markets, outlets that I think are going to serve us well, particularly when those C5 markets recover are we able to get the margin back into business where it historically has been.

James Finnerty

Great. Thank you.

Operator

Thank you. And the next question is from John Roberts from UBS. Sir, your line is open.

John Roberts

Thank you. You mentioned improving trends in early 2017. How do you separate out the normal seasonality? I assume you should be seeing some seasonal pick up in ordering some Roofing and Paving. And any early buying from customers to get to an underlying business trend for you?

Kevin Fogarty

So, John, good morning, it’s Kevin. Let me just talk about that for a second. I am glad you raised it. I mean, what we are looking at certainly, a continuation of the positive overall market momentum that we saw last year for our Paving and Roofing segment as we think about 2017. Certainly, a combination of continued penetration in growth into modified bitumen applications as well as quite frankly, some pent-up demand that needs to be satisfied.

So, that coupled with the overall supply demand and balance picture and by the way, the butadiene situation which I’ll talk about in a second and how that kind of evolves into the markets that we serve primarily which is North America and Europe has resulted in. What we will call at the beginning of the season, a fairly robust order book and outlook.

Now that all being said, one thing I do want to point out too, in this butadiene run up, while we are obviously working hard to pass through and Steve commented about what we are presuming for our Q1 results and how quickly we passed through that credible amount of cost push that we are feeling.

I’ll point out one major difference between this run up and the prior one that many of you on the call might remember, which is 2011 and that is – this one is driven primarily or at least originating in Asia, whereas the 2011 occurrence was originating in North America. So, why that’s important is, because, the Asian competition that is obviously something we are very sensitive to in our North American and European primary markets are experiencing cost – quite frankly cost increases, quite frankly larger even than we are, in our North American and European production.

So, you can imagine that, that paints a much different picture in terms of export – excuse me – import resin to our markets. And we are going to watch it very closely. As I said earlier, I think that butadiene run up is mostly structural in terms of outages. It’s not fundamental supply demand-driven. And so I think that we still believe that once those outages both planned and unplanned correct themselves, the market will trade more and balance with real supply demand.

Operator

Thank you. And our next question is from Curt Siegmeyer from Keybanc Capital Markets. Sir your line is open.

Curt Siegmeyer

Hey, good morning.

Kevin Fogarty

Hey, Curt.

Curt Siegmeyer

Hey, would you mind providing us with an update in terms of those three monomers that you talked about that make up a significant portion of your raw material spend? What percentage of your raw materials to those three comprise in 2016? Or if you prefer how many pounds I guess, maybe of each?

Steve Tremblay

Sure, right in line with historical trends in the business. Roughly, 50% of our volume is BD and that translates into somewhere in the 40% of our raw material spend is BD. Styrene monomer is in the 27% range, both in terms of volume and spend and then isoprene although is smaller in terms of volume, because of its cost position relative to the other monomers can represent upwards of 45% of the total.

Curt Siegmeyer

Okay, great. And then, could you maybe provide sort of your general 30,000 foot view of your demand outlook for the Chemical segment. Which of those markets across Adhesives, tires, roads and construction, do you expect volumes to maybe be up in 2017 versus down?

Kevin Fogarty

So, I may happy to, I think I didn’t take them kind of one at a time. I’ll just broadly talk about them in terms of our Adhesive business and the Chemical segment as well as our Chemical Intermediate segment. The Chemical Intermediate segment is a little bit more diversified. It has many market outlets.

And this is something that, from the time we are first introduced to the business and certainly, now that we are over a year into it, we still very – feel really good about growth prospects in the business. The headwinds that we’ve spoken of with respect margin pressure is driven fundamentally by timing of supply demand, coupled with obviously the substitute pricing of alternative products, particularly in the hydrocarbon space.

But in terms of underlying demand, and underlying growth potential, it’s all very real. I am excited each and every day I get with the team and hear their story about the things we are working on because there is lots of untapped potential to get after. And we are spending more time and energy, as you might imagine having been in the business now for a year, thinking about some of the structural trends that will drive that growth, which is why we’ve – which is why we have introduced some new members of our leadership team including the dedicated Chemical leader.

Happy to have Marcello join the team in about a month, because we want to make sure we are going out and capturing those opportunities. And then I’ll remind you all that, one of the biggest competitive advantage of this business is our raw material position. The raw material position is primarily baselined against the contracts we have from the prior owner of the company and I am going backwards to the original strategic owner which was International Paper and the contract that was put in place at the time that business was carved out, it’s still got multi-years left in it and it’s a contract that puts us in a very good position in terms of assorting the supply, quality in supply, good list of logistical location that goes to overall cost benefit.

So, for those reasons, I mean, there is no issue here with respect to our view on capturing growth and continuing to improve the overall outlook of the business. Clearly, we’ve got some headwinds we need to get through. We may have underestimated what some of those headwinds were in 2016.

But it doesn’t change anything in terms of the attractiveness of the business vis-à-vis the margin profile and the cash flow that this business generates allowing us to pay down obviously the debt that we are managing.

Curt Siegmeyer

Great. That’s helpful. Thank you.

Operator

Thank you. And as of this time, there are no questions in queue. I hand it back over to Mr. Gene Shiels.

Gene Shiels

Thank you, Louis. We want to thank all of our participants this morning for their interest in Kraton and their thoughtful questions. The replay of this morning’s call will be available later today.

To hear a replay over the internet, you can access the Investor Relations section on our website at kraton.com and navigate to the Events tab. To hear a telephonic replay, you can toll-free dial 800-337-5635 and international callers can dial 402-220-9654. This concludes our prepared remarks. Thank you.

Operator

Thank you. This concludes the Kraton Corporation fourth quarter 2016 earnings conference call. You may now disconnect.

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