Avery Dennison Corporation (AVY) Earnings Call Transcript & Summary

This call is not for media representatives or BofA security investment bankers or commercial bankers, including corporate and commercial FX. All such individuals are instructed to disconnect now. A replay will be available for Bank of America Securities investment bankers and commercial bankers, including corporate and commercial FX. The replay is not available to the media. Good day, and welcome to the BofA Securities hosted call with Avery Dennison. Today's call is being recorded. For opening remarks and introductions, I would like to turn the call over to George Staphos. Please go ahead.

Thanks, John, and good day, everybody. I'm George Staphos, BofA Securities' paper and packaging analyst for the Americas. And I'm delighted to be hosting Mitch Butier, the Chairman, President and Chief Executive Officer of Avery Dennison. As you all know, Mitch became CEO in May of 2016, having joined the company in 2000 from PwC. Mitch, welcome, and thank you for joining us today. We welcome your comments. I understand that some of your -- our questions you might not be able to answer as directly as you like or as we like, and we understand and apologize in advance. Before we begin, I just want to mention also to the audience that we won't be taking live mic questions, but rather taking questions by e-mail. We got some of those already by e-mail yesterday evening. Please email me at [email protected], if you like me to ask a question to Mitch. And then lastly, just to keep the ground rules firmly in view, the call will be ending at 5:00 p.m. Eastern Time. So again, Mitch, thank you so much for being with us.

Thank you, George, for the opportunity.

It's our honor and pleasure, as we say. I guess, let's start with the review of the state of your LGM and IHM operations. And let's also assume that we're going into recession because that's what the economists and strategists have been saying. Dealing with LGM first and to the extent that you can comment, what would you say a good rule of thumb for how LGM performs in recessions would be for investors to keep in mind? The company revenue way back in '91 declined about 2%. And the '99 through '01 period, revenue didn't really decline, it decelerated. And then obviously, pressure-sensitive material before, and for LGM, core sales declined 7% in '09 and then rallied back in 2010. So how would you have us think about that?

Yes. So I can comment on previous recessions and where things came out. This is a different type of recession, if we go into one. Right now, the volumes within our Label business, LPM, are quite strong. When you look at all the inventory stocking that's happening and just the move towards packaged goods, food labels, cleaning -- labels for cleaning products like hand sanitizer and cleansers, and obviously, a lot of supply chains operate on use of bar code labels, for which we provide the base material. So that said, as far as the last recession, you commented on a few of them. LPM will be down 5% to 10% for a few quarters, and then we would experienced a post-recession -- what we call, post-recession bounce. That decline is more than -- and consumption reduction in the past of what we've seen just because of destocking. The balance I referred to is when you have the restocking occurring later. If you look for the company and for LGM as well, basically, what we look at it across the entire recession, we lose about a year's worth of growth and a year's worth of momentum. Specifically for LPM right now, that -- this one is starting out a little differently, should we be going into recession.

Interesting. We've certainly been hearing about the stocking up phenomenon. I'll come back to that in a minute. Again, in a normal recession, if there is such a thing, is pricing typically a headwind for LGM, when on recession, beyond the normal pass-through of raws, which you typically see? What have been your past observations? And it sounds like based on what you just said, the answer would be no. But are you seeing any increase in competitive activity right now given that we may be entering a recession in LGM?

Like I said, the volumes are actually relatively strong. So I think it's hard to point to a typical recession. In the last recession, what we did see and we are seeing today, inflation in raw materials. But at that last recession, actually, pricing was not a significant headwind relative to raw materials, especially. And if you -- where we are today, us and other players in our market are focusing on the high level of demand that there is right now. So we don't see pricing as a headwind. And while we do have the material deflation, we obviously have higher costs from overtime and so forth because we're running close to capacity in a number of our plants.

Interesting. When we think about the geographies and the order patterns that you're currently seeing right now, again, recognizing you're quite busy in LGM. To the extent that you can comment, are there any variances, say, between China, Europe and North America? And perhaps this is not a good template. But if we did use China as a template, since it was the first to go into a downturn because of coronavirus, what was the progression, if you will, that you saw in terms of demand and then perhaps recovery? If you could share some comments for that, it'd be great.

Yes. So I'll just share with you what we're seeing so far for the total group and then by region. So for the quarter, we're seeing revenue up a little bit more than 2% quarter-to-date. We've got 1 week left before the end of the quarter. And for the month of March, talking about the high volumes I referenced earlier, revenue's up almost 7%. And if you look at that, it's heavy in North America and Europe, and I'll come back to that. Asia Pacific is pretty much flat, down slightly for the quarter and up 6% in March. But that's really driven by strength both for the quarter and for the -- we're seeing strength for the quarter and in March in ASEAN and India. China, as we all know, was the first to feel this. Things are getting back to normal. But in China, we're seeing it down high single digits for the quarter. And that level of decline has abated, but it's still down a bit in the month of March. So things are definitely stabilizing. I wouldn't say back to normal, but getting back to normal within China. We're seeing strong growth in South Asia. Now it looks like there are new actions being implemented potentially in a number of South Asian countries. And so some of that, we think, is the strength that we're seeing is inventory building. And then North America and Europe have been extremely strong. So revenue up close to mid-single digits for the quarter, but between mid- to upper single digits for the month of March. And that's on a revenue basis. Volumes are up even a little bit more. And that's from inventory stocking as well as just increased consumption. People are eating out more, eating more packaged foods, using more packaged goods, in general. E-commerce is a big push there. Obviously, a lot of bar code labels are utilized and so forth. So overall, if you look at just the quarter for LGM, it's coming in ahead of our expectations overall from what we thought just a couple of months ago. And March, in particular, is quite strong. Now the amount that is due to not just consumption, but actual stocking, the question would be when would that be -- when would destocking occur? So there could be some lumpiness on the horizon. But overall, yes, the business right now is seeing a pretty strong demand.

And Mitch, you said North America up mid- to upper single digits on revenues right now. Did I hear that correctly for the quarter?

North America and Europe, I was combining the 2.

Okay. Forgive me. And Asia, you said was up...

Asia was overall flat for the quarter and up mid-single digits in the month of March.

Okay. Right, right, right.

But that's all South Asia. China is still -- China was down significantly in January, as you'd expect, and still down in the month of March.

Are there any weak pockets for you in LGM at this juncture? I mean, obviously, we have base label, we have specialty and durables, we have graphics and reflectives. I would imagine some of the more -- well, especially in durables and graphics, would probably be a little bit more cyclical and therefore, maybe less strong than the total for LGM. But how would you have us think about that at this juncture to the extent that you can comment?

So specialty is still seeing strength. And we consider specialty label even unique food reclosure labels and so forth. But you're absolutely right on durables and a number of the graphics products. And it's hard to talk about just on average, but a number of the graphics products, obviously, you'd expect some slower demand. People aren't wrapping their cars as much right now as you'd expect. But quite a bit of graphics also go on to emergency vehicles and so forth. But that's obviously the minority. So the industrial labels that are tied to automotive and graphics, in general, I would expect to start seeing -- we've seen this last week a bit of a slowdown. We'd expect to see that continue there. And the numbers I was quoting earlier around revenue were LGM, including graphics. And I think we'll continue to see strength. We have seen strength in LPM. I'm not sure what the future holds, of course. And graphics would be a bit of a headwind.

Okay. Fair enough.

As well as the industrial special labels, as you mentioned.

Yes. Understood. It's hard, I know, for you to speculate here. But given that we are seeing some stocking up that's embedded in the revenue growth, is there a way to maybe parse how much is, from your vantage point, stocking up and how much is actual consumption? So that when we get through the first portion of the cycle, the stocking-up period, we can somehow try to adjust in future quarters for what your volume might decelerate by? And I know it's not as difficult -- it might not be possible, but figure out to answer the question, nonetheless.

Yes. It's tough for us to assess. We go into so many end markets and our products, as you know, are ubiquitous and critical to all the packaged goods people are consuming as well as stocking up on as well as the supply chains. I'd go back to our -- because what we're largely tied to in this business is nondurable consumer goods. Whatever your assumption is about what the trends are going to be on that is how this business over time, over a 2-year cycle is going to play out. And historically, we've seen destocking followed by restocking. This one might be the opposite, where there's some restocking upfront followed by some destocking. But there's also questions there might be changes in just consumer behavior about how much inventory levels and so forth people hold on to. So who knows exactly what the inventory level and landscape and psyche will be going forward, whether people will want to have more stock of packaged items or not.

Understood. And Mitch, you already touched on this to some degree, but when we get into e-commerce and that channel, we've seen in trade publications related to the box business. That business has been quite strong here. That's probably not a surprise for anybody on the line. Within your business, logistics, shipping and variable information are about 12% of the company in total. I would imagine you're seeing a pickup here. I imagine it's mostly in LGM, but if you could comment -- I don't know if you can put any numbers around what you think is the e-commerce-related piece, that would be helpful.

Yes. So overall, we are seeing a significant growth within the variable information labels. And it comes in 2 places: one -- 2 primary places: one is variable information that is bar code label base material and labels in graphics materials. And within that, overall the LGM, it's roughly 20% of revenue, more on volume. And about 10% of RBIS is -- we have a printer solutions business, and a good chunk of that is tied to consumables that they also have logistics companies and some of the e-commerce companies as direct customers as well. So that's -- both of those businesses, and that's rough size, are perhaps seeing strong growth in.

And this question -- thanks, Mitch. This question came from the audience. And again, if you have any questions, I'll do my best to field them as we speak. Just send an e-mail to [email protected]. Recognizing that you make adhesives, what kind of environment are you seeing in raw materials right now to the extent that you can comment?

Yes. So overall, we're in some places seeing some areas of raw material deflation and others now with some of our specific categories, with the volumes that we're seeing, capacity is also constrained. So even though there might be some deflation further upstream, we aren't always seeing that in other places where we are seeing it, specifically on the raw. So I think the other thing to evaluate some of that's being offset, obviously, by a higher cost to serve around -- particularly around overtime and so forth.

Understood. Let's pivot to industrial and health care materials. And I think we've largely covered this already. But nonetheless, roughly 55%, 60%, looking at your charts for IHM is industrial. It's automotive, it's electronics, building and construction. I imagine those markets are maybe seeing somewhat weaker order patterns. If you mentioned it earlier, I apologize for missing it. But can you tell us what you're seeing there? And this segment has evolved over the years, so we don't have quite the framework that we would have for, say, PSM/LGM. What are we seeing in past recessions in terms of the demand characteristics there?

Yes. So I'll just tell you what we're seeing, this quarter is down for the quarter as well as continuing into March, so no change in trajectory. It's down upper single digits. And that's essentially all China. So China -- while China is getting back to normal, the industrial side is not yet. And given everything that's both in China as well as just globally, everything had been going through, we'd expect the industrial demand to be down. So as far as what we've seen in past recessions, this one being -- just as you'd expect, it would go down and -- to various degrees, 5%, 10%. But it would actually -- this is the one business that doesn't see the bounce back the following year. It took a few years for the similar set of businesses that we had in the previous recession to come back, which is what we would expect as well. And then strong growth after that linked to the various end markets as well as the penetration tapes are having as it replaces mechanical fasteners.

Understood. I -- let's move, just given the time constraints, we've covered LGM and IHM, I think, in good measure. Let's move to retail branding information systems. And we've been actually getting a lot of questions from the audience, both today, now, and earlier, yesterday on this. So I guess, first off, RBIS and its forerunner, retail information solutions, was formed after the '01 recession. So we only have the great financial crisis to go off of. But during that time, organic sales were dropping for several quarters between 12% and 16%, I guess, from 4Q '08 through 3Q '09. Is that your sense of what we would see going forward? At that time, you were also coming off of the Paxar deal, so there may have been some other factors contributing to your organic sales decline. What should we expect? And then to the extent that you can comment, what kind of order times are you seeing right now?

Yes. So what we're seeing right now, RBIS revenue is up modestly. It's relatively flat for the quarter, but actually a strong March, up -- upper single digits in the month of March. And that's in -- coming out of China, Hong Kong, Vietnam, being the key drivers of that growth. That said, we expect that to turn, obviously. And we don't know to what degree. But we see malls are closed and retail outlets and stores are closed, that's obviously going to have a negative impact. And we're actually seeing retailers and brands lowering their orders for the coming seasons. So we do expect and are preparing for a reduction in volumes beginning here in Q2. But not seeing it right now in March, but we do expect that to start happening beginning in the second quarter. As far as what happened in the last recession, yes, it was down double digits, as you said. We had a couple of quarters that were down actually close to 20% for 2 quarters, and then down 10%. And then again, also had a post-recession bounce after that, and we came back in 2010. The difference is last time, it was driven by both end demand being down as well as inventory -- dramatic reduction in inventories. Inventories have gotten much lower since the financial crisis, and retailers and brand owners have been quite disciplined at maintaining lean inventories. So we don't think there's going to be quite as much impact from that as the impact of demand could easily be as big. So we don't know -- yes, what are we expecting our outlook is, we don't know. We're preparing for a number of scenarios here. But last recession, it was actually down 20% for a couple of quarters and down 10% the quarter before and after that. So down in the teens across the course of the year.

Mitch, looking back, how much of that -- if you had mentioned it, I apologize for missing it. But if you could remind us how much of that was the destock, the inventory reduction? And how much was the true sort of organic consumption decline?

I don't have it top of mind, George, but I would estimate it would be roughly 1/2 or 1/3 to 1/2 of the inventory destocking. But we saw similar behaviors at the time that we're seeing now, where they just would immediately lower their orders while they gauge what they wanted to ultimately order. So right now, I think a lot of people are on hold, evaluating what the situation is and lowering their levels of orders before they decide what they're going to be ordering. Because a lot of what's going on right now is actually already, obviously, summer, but also some back-to-school items and so forth what the retailers and brands are planning.

So it would be fair to say that the reduction in orders that you're seeing right now is not just a 2Q factor you're going to have to deal with, not this is going to surprise anybody. But if your customers are reducing their inventories -- excuse me, their orders, then that's likely something that you're going to be dealing with well into the third quarter. Would that be fair?

Yes. I don't know what we will be. I think everybody needs to make their own assumptions about what the world looks like. It's been changing very quickly in front of all of our eyes. What we're doing is we are making sure we are prepared for all scenarios. That's been a strength of ours as a company over the last number of years, something we, as a leadership team, have really instilled that we have our eyes open to what all can happen on a variety of scenarios and have plans prepared and the dynamic team is ready for action. And so our base plan, I will say, for RBIS, is that we will go into a lower growth environment and sales declines. I don't know what exactly people should expect. And a lot of it has to do with what people's conclusions are about what the -- not the only impact directly of the virus, but what the economic hangover would be in the magnitude of it. But this business clearly has a near -- a bigger near-term impact than LGM, for sure. Ultimately though, similar to LGM, it ties -- links to consumption. People continue to buy clothes. This business has great high-value segments around RFID and external embellishments, where we see tremendous growth opportunities. RFID, actually, its strengths of enabling quicker supply chain and lower inventories, and we just think it's going to be further reinforced by a more strained environment. So we're prepared to manage through a tough period here should we need to. We're also prepared and focusing on how we capture the opportunities as we go through that. And that's not only in RBIS, where we're expecting some of this more challenging quarters ahead, but across the company.

Understood. You touched on a couple of things that were questions we received yesterday. So one is, it's been a fairly common question about retail and the effects of store closings. And the question typically goes, won't this be a negative and suggest from your comments that it will be, from all the store closing that we're seeing. But the counter to that is that in an omnichannel world, whether you were planning on going out to buy the shirt or have it order online, you still bought the shirt. So what's really the issue here? My sense, it's really not a question of where you get it from, but rather in a period like this, you -- as a consumer is making a decision between whether they go and buy a carton of milk or buy the tie. And that's really the bigger issue. So any thoughts on that would be helpful.

Yes. And this is why I think people need to draw their own conclusions. If people assume there's going to be no change in the purchasing or consumption of apparel and it's just going to move online, then, yes, that wouldn't have as much of an impact on us because we're selling to -- all the companies we sell to are selling one or both of those, but a lot of them are omnichannel, as you say. So this business will be linked to consumption of apparel not only over the long term in terms of the apparel aspects, but in the midterm, if you will. What you happen to have is there's going to be an impact reaction, particularly at the individual retail and brand level, where they're managing what they're open to buy is and how much they're going to order for the coming season. And if their retail stores and malls are closed, we're going to -- we don't know exactly what the reaction will be, but we are going to be prepared for a decline in volume overall. And as I shared, we're actually seeing retailers and brands reducing their levels of orders for the coming seasons.

Right. And then in a period like this, Mitch, another question we're getting, twofold. One, no one will question -- I shouldn't say no one, but few would question the returns that you see in RFID, there's a payback in, I think, from the numbers that you've shared in the past, perhaps in less than 2 years. But nonetheless, there's a cost to invest for that conversion. So I don't know if you can talk to what kind of order patterns you're seeing in RFID or plans to convert through trials that sort of thing. It would be helpful to have some color there. And then one question that we got, how much cheaper does RFID have to get before some of the largest retailers -- and I know you're not going to speak to specific customers, but the question that we had gotten referenced to Walmart and Amazon. How much cheaper would RFID have to get for some of the largest retailers would have an incentive to switch from bar-coding to RFID?

Yes. So within apparels specifically, overall, your question, are we seeing a slowdown? Those who are adopting over -- right on the cusp of adopting, we're seeing everything move forward. Not seeing any signs of delays of trials and so forth, not that I'm seeing. But I would -- there might be a 2- or 3-week stutter step up. Overall, my expectation is people are going to realize the importance of technology, speed and lower inventory levels as a result of this environment that we're experiencing. So I think it further reinforces the strength of RFID and the broader intelligent label platform we're looking to build. So as far as how much cheaper does it need to be? It's already there. The ROI is clear. And that's why we're seeing the growth that we're seeing overall, including a number of the large retailers. So they are adopting or have adopted, depending on which one you're referring to.

Right. One question that we got from the audience and really it cuts to the chase in what -- where we've been now. Should investors worry about liquidity and the dividend for Avery Dennison? And in the aftermath of the great financial crisis, obviously, Avery had some challenges. I think it was in the commercial paper market and also had to cut its dividend. It sounds like things are going well for you here, but why would investors not need to worry about a repeat of this in 2020 relative to 2009, 2010?

Yes. Well, George, we are well positioned here. And we've been preparing for a downturn for some time. Didn't expect it to come in this form, of course, but we've been prepared for it. And we've talked about we wanted to be in a position not just to be able to sustain the business, but to find opportunities in such an environment so we can lean forward as others pull back. That's commercially, operationally and financially. This gets to leverage. So we are prepared. We issued a $500 million 10-year note a few weeks ago. We also drew $500 million off of our revolver with $300 million left. We are not relying on the CP markets nor do we expect to at all for the coming year. We are net cash position. And again, our focus here is to make sure that we are focused on how to best operate the business and to be in a position of strength should opportunities arise. And so that is -- we're well positioned overall on leverage.

And you said you took $500 million down on your revolver right now?

Yes.

Okay. From our vantage point, Avery has been one of the better capital allocators in the sector when we look at EVA or return on invested capital in what might wind up being a more challenging macroeconomic environment, like the one that's ahead of us according to the economists. What might you do differently from a capital allocation standpoint? Any broader thoughts on that, obviously, whatever you can share.

Yes. Well, we look at our near-term capital needs relative to the volume outlook that we have. So we would definitely be taking an eye of that. Those are long-term investments, but we would be looking to ratchet back some capital investments, obviously. I'd expect pretty solid free cash flow for the year in a variety of environments. In the last recession, we actually had very strong free cash flow. I'm not sure it would be quite as strong because it was exceptionally strong, and that was partially because we were coming out of the period where we didn't necessarily have the best capital discipline. But we instilled some strong capital discipline coming out of that last recession and have maintained it since. So this is a key focus of ours, EVA. We're an EVA company. As you know, George, as far as annual incentives, free cash flow is one of the measures for annual incentives for the leadership. So we will adjust some of the capital allocation, but we're going to continue to invest in the key drivers of our profitable growth over the long term. We see tremendous opportunity in a number of our markets and that's both in the base business as well as the high-value segments and intelligent labels being the standout one. So these are clearly challenging times. The team is doing a tremendous job managing through it. Our priorities in this situation, in this current environment is the health and welfare of our employees and quickly following that are our customers. One, because of our customers; and two, because a majority of the products we sell are just so crucial to be food labels, medical labels and just to supply chains, in general. So we will be adjusting capital allocation. I feel good about the resilience of our balance sheet and really thankful that we have. We should all be thankful as investors, thankful for the leadership and the teams that we have in place and the dedication and resilience here.

Thanks, Mitch. Maybe the last one, and we'll end here. You talked about perhaps prudently ratcheting back capital spending, depending on what volume environment we might be in. On the other hand, you mentioned -- you were talking about this one, you're talking about what you've done to maintain your balance sheet and liquidity. This is perhaps a time where you lean forward. So do you think -- and I know it's hard to speculate. Do you think you come out of this with as strong of a growth rate as you've seen over the last several years, if, in fact, you're ratcheting back CapEx to some degree? Or do you see an opportunity, as you mentioned, where you might be able to invest for greater growth, given whatever disruption this downturn, whatever it looks like, provides you? Thanks, Mitch. And good luck the rest of this quarter, and thank you so much for your thoughts here.

Thank you, George. Yes, I think that, overall, our focus, as you know, is driving GDP-plus growth and top-quartile returns. We continue to expect that to be our opportunity long term, and we'll continue to invest to achieve both of those. And those 2 -- delivering both of those will continue to be able to deliver superior returns over the long run. So that's how we're thinking about investments, and we're not going to constrain investments that drive long-term growth overall. So thank you, everybody, for joining the call.

Mitch, thanks very much. Everyone, thank you very much for dialing in, and feel free to reach out to us if you have any questions. Have a good rest of the day. Thank you.

This concludes today's call. Thank you for your participation. You may now disconnect.