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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Welcome to the Solvay Q1 2023 Earnings Call for Analysts and Investors. Solvay team, the floor is yours.
Hello, everyone, and welcome to Solvay's First Quarter 2023 Earnings Call. I am Jodi Allen, and Head of Investor Relations, and I'm joined by our CEO, Ilham Kadri; and our CFO, Karim Hajjar. Today's call is being recorded and will be accessible for replay on the Investor Relations section of our website.
I would like to remind you that the presentation includes forward-looking statements that are subject to risks and uncertainties. You may refer to the slides related to today's broadcast, which are available on our website.
And with that, I'll turn the call over to Ilham.
Thank you, Jodi, and good afternoon, everyone. I'll begin with an overview of our first quarter 2022 results on Slide 3. When we spoke to you in February, we shared some insights on our early view of the first quarter, including our expectation that volumes would decline in a weak macro demand environment as destocking effect from quarter 4 would linger into the first half of the year.
We also said that pricing would offset the volume decline, and we were confident in our team's ability to sustain profitability and margins. And this is exactly what happened. I'm pleased to report that our businesses, again, did a great job in a challenging inflationary environment, delivering EUR 421 million of price more than offsetting EUR 127 million of variable cost. The sustained pricing power was group-wide, meaning all 3 business segments delivered pricing that compensated for both variable and fixed cost inflation.
Now let me give you some color on the volumes, which declined minus 12%. The weak demand was evident across a number of our end markets, as expected, including in EV batteries where customers continued destocking. This impacted Specialty Polymers. The agro market was another area where customer destocking occurred impacting Novecare.
In construction, we saw reduced demand across several businesses serving this market including Soda Ash and also in Coatis. And in consumer-related industries, which impacted -- Novecare home and personal care markets and Aroma, food and fragrances markets.
And we had already planned for the expected normalization of the Coatis business, which significantly impacted the volumes. On a regional level, sales growth in Europe was offset by declines in the U.S. and Asia Pacific. China sales were impacted by the destocking of battery customers, while our consumer-facing market was impacted by soft demand from China.
Now the 14% selling price increase enabled us to fully overcome the volume decline and delivered 2% organic sales growth. The stock pricing momentum and our continued focus on cost discipline drove organic EBITDA growth of 22% in quarter 1, higher than our initial expectations. This translated into EBITDA margin expansion of 320 basis points reaching a new record of 26.5%. Keep in mind, this is in comparison to quarter 1 last year, where our pricing initiatives were only beginning to take traction. Looking back over the last 12 months, our EBITDA margin averaged 24.8%.
Moving to cash. I'm pleased with our continued track record of positive free cash flow generation for the 16th consecutive quarter. This has been one of my key priorities, as you know, and areas of focus since taking the helm at Solvay over 4 years ago. You may recall that we committed to delivering free cash flow conversion above 30%. And we have consistently delivered on that metric, and we expect to maintain that discipline even in a higher investment cycle.
I am pleased to report that our free cash flow amounted to EUR 125 million this quarter. And you will notice that this is despite the significant increase in working capital. That increase reflects the choices we made to invest in inventories to better serve our customers. Karim will give you more details on that later.
Now earlier this year, we shared our plan to invest in our future growth, and we indicated the higher capital spend this year. In the first quarter, our CapEx reached EUR 212 million, 40% higher than in quarter 1 last year. The growth projects this year include Specialty Polymers investments to address the future needs in a variety of markets. This includes the expansion of our sulfone technology in the United States of America to support our health care customers growth. It also includes our investment in PVDF in France to support future growth in EV batteries. We are investing in a new generation of green solvent in our Melle site in France, which aligns with our ambition to bring more sustainable solutions to the agriculture market.
We also announced a new bio circular highly dispersible silica process at our Livorno, Italy site utilizing bio-based sodium silicate from right husk ash. Finally, as you know, we are investing in our network Soda Ash expansion in Green River, Wyoming.
Aside from our investment in capacity, we also continue to bring new innovations to the market. I'm pleased with the Novecare team who launched a new naturally derived guar-based solution called Polycare for the Beauty Care industry.
And Specialty Polymers introduced a new high performance polymer to address the high heat and electrical insulation requirement in EV battery. Now, I also like to highlight some other recent announcement. In March, our 2030 climate targets were approved by SBTi, Science Based Target initiative. This validation reaffirms Solvay's targets to reduce Scope 1, 2 and 3 emissions as set out in our Solvay One Planet sustainability road map and reflects our ongoing commitment to raise the bar in tackling climate change.
We also streamlined our portfolio with the sale of our 50% stake in RusVinyl and received EUR 432 million in cash proceeds at the end of March. I am also pleased to share our latest customer highlights and new partnerships. Our [ Aero ] team was recently recognized by Northrop Grumman and won a prestigious Quality Excellence Award in March. We've been partners for over 40 years and this demonstrates the team's ongoing commitment to quality and service excellence. Just last week, we signed a license agreement with GHCAC in China, which will enable them to build and safely operate hydrogen peroxide units designed to support another propylene oxide production facility.
Finally, I'm really excited about our new strategic collaboration with Ginkgo Bioworks that we announced in April. They are recognized leader in scientific biology. Through this partnership, we acquired the lab in Cambridge, Massachusetts, which will establish a growth base in one of the most important biotech hubs in the world. The alliance will focus on new sustainable biopolymers and specialties, which could address a breadth of markets from home and personal care to agriculture and food. So it's only the start of the year, and I'm so proud we have many achievements to be proud of.
And now I'll give the floor to Karim, who will review the segment results and financial highlights. Karim?
Thanks, Ilham. Good morning. Good afternoon, everybody. As usual, I'm going to present figures on an organic basis, meaning at constant scope and constant currency unless we -- unless I state otherwise. We're going to start with the Materials segment, where sales increased 16% to EUR 1 billion. The driving force behind this growth was the increase in prices of 17%, and this much more than offset the modest reduction in volumes for the segment of minus 2%.
Sales in Specialty Polymers improved 15% driven by higher prices as customers continue to value what we bring are lightweighting solutions because these are mission-critical and they also have to reduce CO2 emissions. Volumes were slightly down mainly because of reduced demand in EV batteries as customers continue to reduce their high inventory levels. And that impacted the demand for our PVDF, but it's important to note that our PVDF suspension technology offered a differentiated value proposition, specifically for the high-end battery applications like NMC. And this supports margins even in the current inflationary environment. Elsewhere, sales grew most notably in the electronics market, where our polymers are used in semiconductors and also grew in our Life Solutions sector where our polymers are used in pharmaceutical packaging and hemodialysis.
Turning to Composite Materials. Sales were up 17%. And then we saw higher volumes and high prices. We witnessed a continued demand recovery in similar aerospace, driven by increases in the build rates in single-aisle aircraft as well as growth in space and defense programs. The volumes for high-performance automotive were slightly down.
Now although inefficiencies that are plaguing the aerospace supply chains are really persisting and they will continue to put limitations on production and orders. We're really pleased to see that overall, the recovery in the aero market is clearly underway. Thanks to the volume, performance and thanks to the pricing gains in the segment. Materials EBITDA increased 35%, with an EBITDA margin of 35.4%, marking a 600 basis point improvement against Q1 2022.
Turning to Chemicals on Slide #7. Segment sales for the quarter increased 2%, and they reached EUR 1.1 billion. Now this is due to our well-placed pricing measures that delivered 17% increase, more than offsetting for the reduced demand, which impacted segment volumes by 15%.
Starting with Soda Ash, sales growth amounted to 19% and was driven mainly by higher prices. Demand remains strong for Soda Ash used in container glass in photovoltaics and in lithium processing as well as for bicar, which is used in pharma. This partially offset modest and temporary demand weakness in the construction and detergent sectors and reflects the fact that we continue to prioritize pricing over volumes in select cases of new business opportunities, particularly in the seaborne market. This performance further illustrates the resilience that we've seen over the past years, indeed, as we highlighted in our webinar of the 27th of February recently. It's great to see those results continue.
Peroxide sales were down 6% in the quarter due to lower volumes and these offset pricing gains compared to Q1 2022. In particular, demand for HPPO used in Auto and in Building and Construction industry softened, whereas demand for peroxide that is used in Food and in Disinfection industries remained stable. Sales in silica increased 6% in the quarter, driven by pricing actions that were able to more than compensate for softer demand in the tire market. The fact that we work hard on developing innovative, sustainable solutions that our key customers appreciate adds to the resilience of that business as well.
We were really pleased, in fact, to see that one of our key customers, Bridgestone, launched in January Turanza 6 tire, which delivers best-in-class safety and fuel efficiency performance. You know what, we're really proud of the fact that Solvay Silica is a part of this exciting new product launch [indiscernible] Bridgestone.
Sales in Coatis were down 29% versus the strong comparable of Q1 2022. You may recall that this business delivered strong performance and exceptionally supportive market conditions that prevailed in the past 2 years, and we fully expected this to normalize with lower-priced exports from competitors from China and India, clearly, then it has an impact on market prices. So no surprise there.
Wrapping up Chemicals, segment EBITDA rose 19% versus the previous year's quarter, driven by sustained pricing in our Soda Ash and Derivatives business as well as Silica, and that supported an EBITDA margin of 27%, which is an improvement of 3.4 percentage points when you take into account the divestment of RusVinyl.
Turning now to the Solutions segment. First quarter net sales in the segment were down 9%, reflecting a 16% reduction in volumes, partially offset by higher pricing of 8%.
Starting with Novecare, sales decreased 14% against Q1 last year due to continued softness in consumer market demand. And that's a dynamic that we started to see in Q4 last year. Sales to the Coatings market was impacted by low billing activity. Home and Personal Care was also impacted by continued weak consumer trends, particularly in China.
In Agro, demand was weak, driven by higher inventories in the value chain and by delays in the planting season in certain regions. In general, pricing was positive in the quarter, and that reflected a continued improvement in mix and our decisions to prioritize profitability based on maintaining a pricing over volume strategy.
Special Chem sales increased 4%, mainly reflecting higher prices. Volumes in auto and in industrial applications were stable, whereas demand for Electronic Chemicals was softer than in Q1 last year. Sales in Technology Solutions in Q1 increased 15% with higher prices and higher volumes driven by strong demand in copper mining and in phosphorus derivatives. Demand for copper is expected to stay strong, helped by recovery of Chinese economic growth.
Aroma Performance sales decreased 31% in the quarter, driven by lower demand in vanillin, which is used in flavors and fragrances markets and inhibitors used in monomers.
Now while the Food and Beverage market is expected to remain resilient, the Fragrance market faced strong price led pressure from Chinese competitors. This is another example where our business chose to preserve pricing over volumes chose to preserve and protect value whilst also initiating further actions both to reinforce the competitiveness of our business and to invest in the industrial scale-up of natural vanillin, which is important because that will respond to an important growth trend that we're seeing as well.
Oil & Gas Solutions, sales were 18% compared to the same quarter last year, mainly due to a sharp decline in natural gas prices that result in a decrease in drilling activity. Second, overall, in the first quarter for the Solutions segment declined 9% year-on-year due to lower volumes across the segment, whereas EBITDA margin remained flat at 21.1%. This actually is quite noteworthy when you compare that 21% margin to the 17% and 18% we were talking about it a few short years ago.
The EBITDA contribution from Corporate and Business Services activities in Q1 improved by EUR 25 million compared to Q1 last year, as we reported the benefits of the stabilization of our energy activity, which included a net favorable impact of around EUR 11 million.
On Slide #9, you will see that EBITDA increased 22% to EUR 839 million, mainly due to sustained strong pricing. You'll also notice that fixed costs increased EUR 24 million -- sorry, the fixed cost increase of EUR 24 million was below the levels of prior quarters, and that results both from continued structural cost reductions and lower spend on group-wide investments such as in digitalization and in cybersecurity. As a result, EBITDA margin improved by 430 basis points to a record 26.5%.
Moving on to Slide 10. We continue to make progress towards our strategic goal of EUR 500 million in total savings, delivering an additional EUR 17 million in the quarter. Cumulatively, our structural cost savings now amount to EUR 484 million since 2020, and that's about 97% of our end of 2024 target. We also took an EUR 80 million restructuring cost provision as we take further actions to cut costs. And we're not going to stop looking for more opportunities, frankly, particularly as we look forward and we look to anticipate and contain any future dissynergies associated with our power of 2 projects. But of course, we'll give you more details on that later on in the year.
Our free cash flow in the quarter was EUR 125 million. As Ilham mentioned, this reflects our strong profits, our growth investments in CapEx and our investments in working capital as well as the benefits related to the successful resolution of the litigation. In so far as working capital is concerned, our receivables remain very tight. With average DSO, day sales outstanding, KPI of 43 days and overdues at a record of 1.5%. You will also remember that we ended 2022 with a low inventory balance. And so we invested in building inventories this quarter because we remain focused on being well placed to supply our customers throughout the year.
Payables are lower, mainly due to lower energy and raw material prices. We are adapting to the demand environment, and we expect working capital intensity to reduce over the next quarters because, frankly, we are resolute on driving cash generation.
And now a few words on our debt -- on our net debt. The underlying net financial debt was further reduced in the quarter by EUR 339 million to EUR 3.25 billion, reflecting the cash outflow from the dividend, the positive free cash flow from operations. And of course, as Ilham mentioned, the EUR 432 million in proceeds from the successful divestment of our interest in RusVinyl.
All in all, our balance sheet is stronger today than it's been for a decade or more. And these improvements have also enabled us to achieve a historic return on capital of 16.7% more than double to 8.1% that we reported at the end of 2019. And if anything, it truly reinforces and demonstrates our ability to create 2 champions by the end of the year.
And with that, I'm going to hand you back to Ilham to discuss the outlook and the closing remarks.
Thank you, Karim. So let me provide some insight now into our upgraded full year guidance. We have again demonstrated this quarter our ability to maintain our hard-won pricing gains, more than overcoming inflationary pressures.
Now looking into quarter 2, our April order book indicate continued weak demand. At this time, we have limited visibility into May and June, and we therefore do not bank on any recovery in volumes in the second quarter. It is also important to note that we have a tougher comparable quarter as our pricing actions began to take effect in quarter 2 last year on the top of solid volume growth. We, therefore, expect quarter 2 EBITDA to be sequentially lower than quarter 1. We remain confident in our ability to maintain strong margins, and we have upgraded our full year guidance range to reflect our current forecast. We are raising full year 2023 EBITDA guidance on an organic basis to a range of plus 2% growth so a decline of minus 5%. This is a significant improvement from our previous guidance of a decline of minus 3% to minus 9%.
As you can expect, this assumes that there will be no significant change in the prevailing macro environment and indeed, this range reflects different trajectories between now and the end of the year.
At the lower end, we foresee a scenario of volume stable at current levels and some modest gross margin erosion in select product lines. At the higher end, we anticipate profit growth based on modest volume recovery in the second half of the year and an expectation that we will sustain leading margins across much of the portfolio. On cash as a result of our upgraded profit expectations and improved performance, we are raising our full year free cash flow guidance from EUR 750 million to around EUR 900 million. We still intend to increase our capital investments relative to last year as we remain resilient in our determination to ensure that we sow the seeds for future growth.
Now to conclude, I remain confident in the capabilities of our people. They continue to demonstrate quarter-after-quarter, year-after-year and ability to deliver and overcome significant challenges. We are a stronger company today, and our balance sheet keeps us well positioned to progress on our separation journey, which will unlock value for our customers, shareholders and our employees.
And with that, Karim and I are happy to take your questions.
Thank you, Ilham. We will now move to the Q&A session. [Operator Instructions]
[Operator Instructions] Our first question today comes from Wim Hoste from KBC.
I wanted to dive a little bit deeper into the PVDF market dynamics. Can you maybe indicate how far the destocking has gone at the customer level? And also what's that destocking trend has maybe caused to pricing dynamics in the market? I know you have different technology in the mainstream and you're in the high rents, but can you maybe also elaborate on the pricing dynamics for your products and the market overall in PVDF?
Yes. Thank you, Wim. Indeed, the -- as Karim and I -- we told you that there has been a destocking which will continue probably to quarter 2 as well in general, in batteries in automotive. But as you've seen, frankly, and I will come back to batteries, our business is not only PVDF battery, right? I mean you've seen Specialty Polymer really doing well, including in other applications in auto under the hood, right? So we're in business of lightweighting, electrification, but please do not forget lightweighting.
On PVDF, Wim, yes, there has been a destocking on EV batteries and you've seen it in many other publications. We expect it again to continue in over quarter 2 this year. On the differences, and I think we've tried to do some education on emissions versus suspension, Karim alluded to that again. There are 2 types of PVDF technologies for EV battery suspension emission. No one material is inherently better or worse than the other, but we produce both. But the reality is that suspension-grade PVDF in which Solvay is the world leader, has a set of properties that make it better suited for nickel-rich high-energy density cathode like in lithium-ion batteries and specifically with NMC, which is the high-end batteries in the market, right?
So the suspension is the reference binder material in the production of those NMC material. There is basically no immersion PVDF used in NMC today. I know people are still trying to get there, but this is mainly suspension. And the emersion PVDF, it's commercial products available worldwide with Chinese competition. We expect that to be more commoditized in the midterm and with very little again and no significant penetration in the high end in NMC.
So what has happened, I think, for us, obviously, there is a raw material cost decrease. For us, we just kept our margin constant and even as compared to the end of last year. So without giving you that much number and sensitive competitive information, our Q1 PVDF battery margins have been stable compared to the end of last year.
So I think that's the message that's how we ask our team to fight for value pricing on PVDF. So we are more resilient than the other technologies. And definitely, we like our -- the investments we are doing in Europe and in the U.S. in the suspension because the barrier to entry for imports, for example, from China, like in the United States of America are pretty higher. The tariffs are high, more than 30%. So all of this makes our strategy very sound for future growth CapEx. Back to you.
We now have a question from Martin Roediger from Kepler Cheuvreux. .
My question is on Chart 8. The Scope effect was plus EUR 7 million on sales.
Can you repeat, please? Sorry Martin.
Okay. Sorry for that problem. The question is about Chart #9, where you show that the Scope effect was plus EUR 7 million on sales but minus EUR 36 million for earnings for EBITDA. Can you explain that gap?
Yes.
Sure. That's mainly RusVinyl, which you recall was equity accounted. Hope that helps. [indiscernible] that I can give you. Thanks Martin. The next question comes from Andreas Heine from Stifel.
Wasn't that strong if it comes to volume. And while you do not predict Q2 to be better, not to be better, it probably will also not be worse. Where do you expect then the [ Q1 to Q2 ] falling earnings to come from? So it has to be margin and it's probably not broad-based. But what are your assumptions that you come up with this Q2 guidance?
Sorry, Andreas, can you repeat your question? We didn't hear the beginning of it. Sorry.
Okay. On the sequential earnings trend, you said that earnings in the second quarter are probably lower than Q1. Looking at that -- what the explanation for that, it is probably not volume. Volume is not getting better from Q1 to Q2, what you said, but Q1 was already pretty low, and probably Q2 is not worse in volume. So it probably has to do with margins then. And if that is not across your portfolios, maybe one or the other thing might be weaker than the general trends. Could you outline where you think that the [ Q-on-Q ] earnings decline might come from?
Yes. Thank you, Martin. Well, listen, I think our quarter 2 -- and we have April in bad internally, but a month is not a quarter. But definitely -- and you could see it across all other peers and our customers who have established our quarter to order book volumes remain low. Therefore, we expect demand to remain soft. And we do not see yet any improvement, right, in consumer, construction or batteries, by the way, I just mentioned that there will be still some destocking. Some markets could soften further like semiconductors. So therefore, we see quarter 2 right sequentially lower than quarter 1 and -- that's what we see today, right?
So -- and we gave you the low -- the low and the high of the guidance, right, betting on H2, either there is some recovery of the volumes or not, right? So knowing that there is a seasonality marking between H1 and H2 in general. Our quarter 2, to give you some ideas, it can be anywhere between 5% to 10% below quarter 1 to give you some precision.
Next question will come from Alex Stewart from Barclays.
Well done on the results. You raised guidance 3 times last year, and you've raised guidance once already this year. The price increases that you've been doing. If they were indeed part of your overall strategy, then why have you had to raise guidance so many times because to my untrained eye, that would suggest the results were coming in better than you'd expected rather than as you'd expected. So I'm really interested to hear your view on that if possible.
Yes. Who is asking the question?
It's Alex.
Alex. Well, I think -- frankly, it's a good question, by the way. But remember, Alex, back in the fall 2021, we told you that we are going to start working on our value pricing. Quarter 4 2021, right, so the full 2021. And we started not knowing what 2022 will look like, and we have trained more than 1,000 of our salespeople on value pricing, right? We renegotiated and we opened thousands of contracts to look at our formula pricing.
And that's why last year, when inflation picked up as a consequence, specifically in Europe, with the crisis in Ukraine, we were ready -- we were ready to do a good job, right? So frankly, nobody has a crystal ball. Some are probably sharper than others in usual signs. But when visibility is reduced and [indiscernible] is higher, what I do normally is -- I -- my wisdom is not -- [ ways to ] good prices.
We are training our muscle called pricing part of our portfolio and probably 50-50, one is linked to supply/demand, right? When supply is tight and you know what it takes, right? And when inflation is there, we are baking formula pricing right linked to raw material or energy. And so that is one of the good examples we told you doing just that, right? Silica is another one.
And the other part is value pricing. And in value pricing, we are -- we have been testing our portfolio where pricing is going to be sticky. And frankly, we are learning.
Last year, I've been learning a lot personally on the portfolio and its stickiness on where we have a differentiated value at the product level. We've been proving the portfolio. You've seen it in Solutions, for example, where we have been making call pricing versus volume, and we let go some of the low-quality products we just didn't take, right, or seaborne in Soda Ash, for example. So I think that's by testing the market, but better understanding our competitive edge.
And in quarter 4, we told you. We told you that we are going to continue defending our value pricing, our margins. Now as you've seen, the EBITDA margin last 12 months has been at 24.8%. And without probably RusVinyl and the team, the IR desk can give you those data. We did it actually. We removed RusVinyl since I joined the company. And we've been gaining 1 percentage point right every year in margin, right? And those are leading Speciality margins. That's what we've been doing, right? If we can get the same level of record margin of last year, this year, I will be more than happy, right? While we will go and outperform the market in terms of volume, right? So that's, I think, what's the gain this year while continuously testing our value pricing and some of it should be sticky and will stay with our portfolio.
Perhaps if I ask that in another way. When you and Karim were chatting at the beginning of last year, were you expecting Solvay to deliver EUR 3.2 billion, EUR 3.3 billion of EBITDA or was that above your expectations, let's say, this time a year ago?
It's -- well, I mean, our team surprised us, Martin (sic) [ Alex ] I mean you remember the EUR 3 billion was even a big event in this company because since 10 years, we were looking at -- Alex, sorry. We were looking at that. Now, obviously, we didn't have a crystal ball earlier this year. The pricing was new in this company. In quarter 4, we trained the muscle. I remind you when we started in March, and we started our real campaign in pricing. We had a few contracts negotiated, but the team really outperformed and surprised us.
Now I think what is important. The end of last year, we started really going forward with value pricing against supply/demand and formula pricing. Makes sense, Alex?
Just to remind you, we had a word head start. We had a [ patient ] that have never been foreseen. So all of that added a greater degree of uncertainty. And so we're really pleased with what team has delivered in that context now. Our next question comes from Geoff Haire from UBS. Geoff?
Sorry, I didn't hear my name. Sorry. I just wanted to come back to the guidance and the comments you made about margin erosion in certain product areas. If you look at the low end and high end of the guidance, are the areas that you expect to see margin erosion the same as those that you'd expect to see margin recovery and at the high end? And could you give us some examples of where that margin erosion or recovery might come and what -- which businesses?
Yes. Well, I mean, again, the demand dynamics are still uncertain, right, in this world, and they will continue. Now as we told you and you know with the pricing comp will obviously be more challenging as quarter 4 last year was particularly very strong in this respect.
Now in our guidance, we don't expect much of the improvement in the macro environment. Volumes are still under pressure due to the soft demand across many markets, as we mentioned. So that's specifically quarter 2. Net pricing remains positive, but again, against a very strong comparable quarter versus last year. So that's why I even gave you some color on quarter 2 EBITDA sequentially lower than quarter 1.
And H2 levels will depend on the level of volume recovery, as we told you. So we have very little visibility now. Finally, do not forget our usual seasonality. H2 is usually lower than H1 with quarter 4 being the lowest quarter of the year. So that's the main thing you need to keep in mind. And frankly, we'll see how quarter 2 will develop. And obviously, we will come back to you.
On the business unit level or business level, we expect Materials and Chemicals to continue to do better in this environment, right? Although in some areas, spot area like batteries, the destocking will continue. Solution will recover more gradually. But again, we are taking our destiny in our hands, and we are really choosing to let go some volumes if they have low profitability. I remind you that this company had the problem on return on capital employed in 2019, just 4 years ago, it was 8%, and we have an issue of profitability of our assets. So we don't want to go back to fill the pot, right, to grow profitability products. So we will keep that in mind, and that's how we are looking at the portfolio. Makes sense?
Yes.
Our next question comes from Chetan Udeshi from JPMorgan.
My first question was a bit curious why did you feel the need to invest in inventory in this sort of environment where maybe like you said, volume visibility is quite low. So like what drove that inventory increase in Q1, like did the demand end up worse than what you guys were expecting through Q1. I was just surprised.
And second question was, if I look at the guidance range on EBITDA, it's roughly, I think, EUR 100 million to EUR 140 million EBITDA guidance range -- sorry, increase -- but the free cash flow is going from 1 -- EUR 750 million to EUR 900 million, EUR 150 million delta out of which EUR 90 million is from the payment from the previous owner of one of your assets. So where is the remaining EBITDA increase going in terms of free cash flow contribution? Why are we not seeing bigger increase?
Great question. I'll take the working capital, Karim, maybe the free cash flow later. It's -- well, frankly, the working capital was the million-dollar question when we started the year. I'll remind you, Chetan, that at the beginning of the year, we started with very low working capital percentage of sale in quarter 4. That's #1.
Nobody knew, and I remember even with you guys and others -- some peers stated Q1 is going to be a disaster and others, we don't know. And we had our own guests, but frankly, we don't have a crystal ball. The answer to your question is simple. It's customers, customers, customers. We -- our customers, and we have now since 2020, by the way, this is one of the positive things of COVID, we have a central order book where we go back bottom-up -- from customers understand their needs because at the end of the day, I want to be ready, whatever happens to supply customers' needs. The working capital, indeed, quarter 1, we have a higher is approximately EUR 300 million to [ EUR 250 million ] above historical level, an increase about 10% of net working capital, Chetan.
And when you take into account the effect of price and cost inflation, frankly, such increase could have been expected or is expected. So -- and we've done it by choice because we entered the year again with inventory. And we didn't know how the market will evolve. And we had several contradictory opinions on the development. So you need also to look at inventories and payables in inventories from low level. We decided to invest to meet customer demand and markets like [ Aero ] to address the ongoing recovery. We have some market in mining where our technologies are needed, as you know, to support the copper extraction. The agro season, right. And we expect this to be temporary, right, and we will go back to normal levels later in the year.
The second is the payable and they are lower than usual, primarily because of further sequential reduction of variable cost, energy and [indiscernible] you will see the impact in the coming quarters. And also because we buy less raw material as we intend to decrease our inventories.
So yes, I mean, despite the increase, we are doing much better than many of our peers, who published at least. We're approximately 17%. I asked the teammates actually to give me some median of the peers that are at 30% plus. And yes - and frankly, I don't regret that decision or that call with our President -- Business President because some of our material performance, some markets, the volume increase, and we were at the [indiscernible] round. I think those are business scores, and I don't frankly regret it. I think it was the right thing to do, and we have still 3 quarters to fix the working capital as a percentage of sales.
And your question, Chetan, on the -- why is the free cash -- I'm going to reframe the question, why is free cash upgrade relatively modest in the context of -- I think you said EUR 150 million profit guidance improvement. So I think there are 3 components. One, you rightly pointed out, we have a EUR 92 million, let's say, unplanned in our initial guidance of the year litigation settlement. That leaves you with a EUR 60 million improvement because we said around EUR 750 million to EUR 900 million. So 2 other factors are: one, the effect of the higher guidance and profits, less working capital, less tax effects.
Now -- and I'll come back to that. For the avoidance of doubt, we are, at this stage, not planning to change our CapEx investments compared to what we said earlier in the year. So why does EUR 150 million-ish of cash of higher profit increased the profits by cash by EUR 60 million. It's really to do with working capital and taxes. We're looking here at a cash conversion on the incremental profit around 40%, which is stronger than on average, as you note, but also it's important to note the phasing of that increase. If it's very back ended, let's say, towards Q4, not more challenging to crystallize into cash before the end of the year, that's part of the judgment we apply as well in looking at it. But any extra profits we generate will be crystallized into cash, and we'll do what we can to make sure it happens this year. The next question comes from Jaideep Pandya from On Field Investment.
Apologies for this, but just could you give us some color on the debt structure or the 2 companies when they are going to come into the separation and also just an update on the time line considering a lot of volatility in interest rate markets these days, how confident are you that it will not -- there is no risk of a significant increase in interest burden for both the entities.
And the second question, sorry to ask this, but to Ilham, I mean, you've done a phenomenal job in price versus raw materials really almost EUR 1.3 billion now if I look back to early 2022 through Q1 this year. In your experience in the industry, I mean, have you ever seen something like this? Because it is fascinating for us from the outside in for Solvay to report these kind of results. And we're obviously all scratching our heads in terms of sustainability of this. So just some color, some confidence as to if you can retain most of this EUR 1.2 billion, EUR 1.3 billion, that would really help us understand the new Solvay better. Well done again on the results.
Thank you. Karim?
Jaideep, let me just, first of all, start to address your questions, but I won't be able to answer everything at this point in time. And I'll start by reminding you that we said a few weeks ago that we'll be giving insights on the capital structures in the June, July time frame. So I'm going to ask you to please be little patient. We want to finish our work. We're going to do really well. So what should the capital structures be -- and I'm going to come back a bit about that in a moment. But the good news is our leverage is lower than it's been. Our cash is really strong. We've said consistently, we're going to create 2 strong companies with strong balance sheets. And I'm going to say we [indiscernible] for choice, but we have very, very strong Solvay SA balance sheet as we head into this.
Now once we finalize our own assessment of the capital structures, we will finalize our plan on the liability management. What do we do with the bonds, how do we incentivize, motivate, discuss debt investors to see the strength of the balance sheet of both companies, and that's the plan. Now in doing that, you talk about high interest rate, et cetera.
Let me just say this. We have more than adequate liquidity reserves. We will completely -- you can expect us to adhere to normal market practice in these situations.
And honestly, we think that people will see the strength of its balance sheet, and we will see the logic of responding to the opportunity that we put before them. But I'm not going to go into more than that at this stage beyond the fact that we have a lot less debt at the net of EUR 3.25 billion than we've had for years. So for the rest, [ Jaideep] you asked because what we do there will actually directly be linked to what we share with you in June, July on the capital structures of both companies.
Yes. And on the pricing and thanks for the words, phenomenal job actually on more metrics, by the way, than pricing. I mean this company looks very different and smell different than back in 2019. I remind all that we've been in through this transformation -- financial transformation and nonfinancials, by the way. And I'm so frankly proud on the debt reduction, the onetime today, just put us in a very solid position to have choices -- choices we didn't have just a few years ago.
The underlying EBITDA margin. I mean, I told you without RusVinyl now, which we exited fully, and we are glad about this. We have improved our EBITDA margin, which was already best-in-class specialty margins 1 percentage point every year till last year. And the free cash flow, and you know it, we were very much of lagger in our peer group, and we promised to you 30% at least to be in that [indiscernible] one, and we performed and we became a free cash flow machine and the return on capital employed. If there is one thing I'm very, very proud of with the employee engagement by the way, which is close to my heart is the [indiscernible] mean we're dating with the cost of capital and we doubled it. And this is not an easy one, by the way, because you need to prune the portfolio, you need to choose your products and you need to choose the customers as well.
So here on pricing, I think we moved from selling probably product to selling value. That's a big mindset shift in the company. It's not easy in my career, right? I've seen it in my previous companies, you need training, you need to know how to sell the value. And you need to understand which value you create with your customers and share the value created. I'll give you an example, when I replace a piece of metal under the hood application in any automotive customer, it's not about the euro per kilo of the polymer I'm giving away, right? It's not that. It's about the value I create by replacing metal at lower weight. Therefore, consuming less fuel ,emitting less CO2 at a lower total cost of ownership.
And now we agree -- we agree with our customers what's the value created and then we share the value created. So that's it, and I think the net pricing, solid pricing power, whatever means pricing net of the variable cost and fixed costs. And our salespeople are measured, are rewarded. We have even see awards in the company by now on those net pricing, which before was even on the volume side. So I think all of this is important.
On the second thing, and I know you have question all your head, and I think time will tell us, right? And we'll tell and frankly, we have been telling you now for more than 1 quarter, a few quarters. That's the fourth quarter in a row, half of our business -- of our portfolio is to supply-demand related. And this is in a site -- supply situation in safer area, you can push your prices, et cetera. And you know where we have tight supply. But more importantly is that we reviewed our formula prices, right?
We reviewed the components of its energy, raw material. We put surcharges and you've seen it last year. And there, if energy or raw materials up and down, we give back to our customers because we want to protect our margins, right? And around half of the portfolio is more Specialty. And there, we are experimenting -- we've been experimenting, now we are reinforcing areas where we sell a strong value proposition based on customized, innovative solutions designed to meet the customer needs. And I think that's important. And that's new in the company. And obviously, I'm calling on our teams to continue fighting for that. And it's about being offset by the value we create to our customers. But again, not leaving it all on the table, it's about sharing the value creation.
Can I just ask a follow-up? Sorry, go ahead.
At this stage, we will take 2 more questions. Matthew Yates from Bank of America is the first one.
Might actually be a follow-up on the last question. But specifically on the Materials division. If I look at your Q1 sales, there were a touch below Q4. Your EBITDA went up by EUR 60 million sequentially or about 20%. Just why would profitability be so much better Q-on-Q as the top line hasn't really changed. Do I infer from this that you've already started to see a drop in your raw material inputs that haven't been passed through in pricing. Obviously, 35% margins is pretty phenomenal. So is there a risk here and that's embedded in your Q2 guide that there are some products, perhaps with formulation clauses in that kick in with a lag or you need to give back some pricing in Q2. So just really want to understand why Q1 was so good relative to Q4 and the sustainability of that into the coming quarters.
Yes, it's a good question. I think the volumes, and I talked about the destocking right on the PVDF side. And we are more resilient than others because, again, our Specialty Polymer portfolio generally is not only automotive, by the way -- is only one sector that in automotive, is not only batteries. So I think the diversification which investors do like in the Specialty Polymers is really a good thing. We had many markets with Materials delivering volume growth with only batteries down. So in Specialty Polymers, we have a new fab equipment supported growth for our polymers using electronics. We also delivered volume growth, for example, in health care applications, such as pharma packaging.
I remind you, we are in pharma packaging. One in hemodialysis when one of the few leaders in hemodialysis in the world, and thus have been picking up nicely. I like this business since COVID time. Something important to note is while polymer demand for EV batteries was low due to destocking. Again, the polymers auto and non batteries grew in the quarter under-the-hood application. And of course, composite volume growth, I mean, I think we mentioned it in our prepared remarks, is linked to the ongoing recovery in civil aero and we are not back at 2019 levels by the way. So the pricing level versus last year, the business has demonstrated its ability to maintain higher pricing which was the main driver of the growth. So that's value pricing. I'm not going to repeat my favorite case and story of replaced metal under-the-hood.
Customers, they come to us when they have many ends, like they need chemical resistance, bridging resistance, et cetera. So as many ends needed they come to us. So that makes us very differentiated. And even, by the way, when you look at our batteries products, right. In the destocking, we kept the margins, right. The percentage sales -- the EBITDA margins for those products or gross margins for those products became stable.
So over time, we will continue value pricing our solution. While in some applications, we will get back pricing when raw materials are favorable, right? By the way, we did it somewhat in batteries because 142B, for example, as the raw material prices for those who are -- they know the Level 2 or 3 of the formula of batteries and PVDF we gave away, but we protected our margins, right? We sustained margins when -- even when the batteries volume and destocking is happening.
And longer term, we have Speciality margins here. That's what we are talking about. And we will look for more profitable volumes because given lightweight and electrification, we will continue penetrating with those technologies, like in composite, whatever the market that. So it's value pricing, right, not value based on cost plus, right, or cost plus? And I think that's what you can expect from us in the specialties and in Specialty polymers, specifically. Back to you.
Our last question -- our last question will be from Sebastian Bray at Berenberg.
It's on the segmental -- subsegmental profit contributors to the Materials segment, and it builds on the questions asked earlier. Between Q4 of 2022 and Q1 of 2023, was there a significant change in the profitability in absolute terms of the Composites business. In other words, what we are seeing in terms of EBITDA improvement is largely due to Specialty Polymers or the mix between the 2 is more even?
Yes. Thanks for the question. Well, I mean, we don't give, obviously, guidance and sensitive information at granular level right between Specialty Polymers and Composites. But as you know, when I joined in 2019, I already told you at that time that I didn't like the composite material margins, right, and we're going to do -- turnaround and really fix the profitability. And that's why -- and 2020 helped us, it was tough. It didn't go without tears and pain because we had to shut down a few assets which had the lowest return on capital employed in composite material, I'll remind you, which helped us actually to move products in other places, in other -- in existing manufacturing sites and which help us to fill the existing capacity and do better job there. So as we recover, as the aero is recovering, you will see improved margins here and there, but it's caused the Board.
I think Specialty Polymer again did a great job. I think the value pricing there was one of my dreams at the beginning. I told you is the crown jewel. I knew that we need to train. We need to understand better our value pricing. But there is no particular outlier. I'm very pleased, again, with the whole Materials segment, Specialty Polymer delivering strong results outside that reason, even industry, they kept their margins, so I cannot ask for more.
And this shows the strength of our diversified and unique portfolio of polymers that customers they value -- and that's the sincere story and we'll continue testing. I think you cannot imagine how much work is going behind the curtain in this company. Each business is actually delayering and I [indiscernible]. We are opening one after the other and understand where we differentiate, where we are not, where we are leaving value behind us, where we don't value enough our products. And no one has the strength and the depth of our Specialty Polymer portfolio. I truly believe it. And we're going to continue different margin. And through innovation, we'll do better words on value pricing. Back to you.
Well, I think we've reached the end of our call. So I want to thank everyone for your participation today and remind you that the Investor Relations team is available if you have any further questions. Thank you so much, and have a great day.
Ladies and gentlemen, this concludes today's conference call. Thank you all for your participation. You may now disconnect.