Avery Dennison Corporation (AVY) Earnings Call Transcript & Summary

Okay. Welcome back, everybody. Thanks for joining us. My name is Ghansham Panjabi. I want to welcome you again to Baird's 2020 Virtual Industrials Conference. It's a real privilege to introduce Avery Dennison management this afternoon. From the company, we have Mitch Butier, Chairman, President and CEO. Mitch has been CEO since 2016. Previously, he was Chief Operating Officer for 2 years prior, and many different roles, including CFO at the company, and he's been with the company since 2000. And Cindy Guenther in the background as well. Cindy has been with the company over 25 years, much of that in Investor Relations. Cindy is also retiring, and we just want to wish her the very best in retirement. And obviously, she's been a huge resource to many of us, including, I'm sure, many in the audience. So with that, Mitch and Cindy, welcome, and thanks for joining us.

Great. Thanks, Ghansham, and hello, everyone. I appreciate the opportunity to share a bit of our story here today. I will start with a brief overview of the company, and then we'll jump back into Q&A here with Ghansham. So before jumping in, I first encourage you to read our disclosures about our forward-looking statements and use of non-GAAP financial measures that are here on Slide 2. So overall, at Avery Dennison, our overriding objective is creating superior long-term value for all of our stakeholders, our customers, our employees, our communities, which includes reducing environmental impact of our products and businesses and, of course, our shareholders. We're extremely well positioned in our primary businesses. We're the #1 player in our 2 primary businesses, leveraging strong competitive advantages around innovation, material science capabilities, process technology, commitment to excellence in operational excellence, and we are serving large, diverse and growing end markets. We've consistently been driving strong organic growth over the years as we have 2 key catalysts for driving GDP plus growth. These are the emerging markets. We have a good exposure to emerging market trends. And that is not just China that is broad-based across all the emerging markets as well as our focus on higher-value categories. So we've had a key strategy over the years to drive outsized growth in higher-value categories. And these are categories where there are market tailwinds with above GDP growth in the marketplace and that have good profit pools and so clear signs of differentiation. We've been successfully executing our strategies, leveraging our great position in these growing diverse markets. And that is, as I said, driving outsized growth in our high-value categories that I just explained while also growing profitably in our base businesses. These are 2 of our overriding strategies that we continue to drive, leveraging our innovation, productivity, excellence throughout the company. In addition to our long-term financial objectives, we laid out back in 2015, a series of sustainability goals focused on 2025, both to reduce the environmental impact of our business on the environment as well as to make our products more recyclable and enabling a circular economy. We are well on track to achieving those goals and even ahead of our previously planned objectives already here. So looking at the portfolio. So as you can see here, we have 3 primary components to our portfolio. Labels and Graphics Materials is our largest business. It's about 2/3 of the overall company. And here, the focus is really 2 areas. One is labels, creating pressure-sensitive base material for decoration labels. So those are labels for household and personal care products; think of shampoo bottles, wines and spirits and so forth. So that's decoration labels, and the other is around variable information labels. So think of barcode labels for e-commerce and what you would see in your deli at the local grocery market. Our next biggest business is Retail Branding and Information Solutions. That's roughly 1/4 of the total company. This business provides branded products and information solutions, largely focused on retail apparel, and here, we -- the biggest growth driver within the company is embedded largely within RBIS, and that is RFID, Radio Frequency Identification. We are the market leader in providing UHF RFID solutions. This is now a more than a $500 million business and the single-biggest growth driver within the company, delivering 15% to 20% growth over the long term. So a lot of exciting things going on there. And our key focus is continuing to leverage the advantages we have to continue to grow within the apparel market for RFID as well as we've been seeding investments over the last couple of years to identify significant growth opportunities outside of apparel with RFID as we build out our intelligent label platform. And last is, definitely not least, 10% of the portfolio is Industrial Healthcare Materials. It's the group of businesses focused on functional materials, that are leveraging the strength of LGM around pressure-sensitive materials and material sciences to target various categories around fastening and tape industries. Really, what we're doing there is capturing the market tailwinds and broader trends of migration from mechanical fasteners into adhesives and tapes. So we talked about our strong position in our markets that are continuing to grow and very diverse. To me -- to us, the key is looking at the track record. We have, right now, a long-term sort of objectives that we used to set back in 2017 using 2016 as a baseline that we laid out through 2021. This is our third set of long-term objectives, and we have executed against and achieved our previous objectives, and we're well on track to achieving our objectives through this current cycle as well. Just a couple of call-outs here. If you look at the sales growth, so we laid out an objective of growing 5% ex currency from '17 to '21. We are above that target and essentially just shy of our organic growth target and hitting 3.9% through the first 3 years of this objective. If you look at operating margin, our objective was to achieve 11% in 2021. This was up a couple of points from where we were back in 2016. And as you can see in 2019 already, we achieved 10.9%, and that's on a GAAP basis. When you consider all the charges that we took last year related to restructuring as well as the pension retirement. On an adjusted basis, we achieved 11.7%. So on a GAAP basis, we've essentially already achieved our 2021 targets. And then going down to return on total capital. You can see here, we set an objective of 17% plus by 2021. And we have, if you exclude the pension settlement last year, we've already exceeded that target. Our overriding objective of these targets is to continue to deliver GDP-plus growth and top quartile returns on total capital that has a recipe for superior value creation, continues to be a drive for us, and we've been able to successfully be delivering against that ever since. The last thing to call here is just our leverage position. So we established leverage target of 2.3 to 2.6. We've been below the low end of our target for a few years now. It gives us a very strong balance sheet as we've gone through the COVID and economic challenges of 2020. We are extremely well positioned and leveraging our balance sheet, using our balance sheet as a position of strength as we move forward. So overall, very strong track record, and we will be setting new targets through beyond 2021 through 2025, sometime early next year. We've been leveraging the strength of our long-term position in our growing markets and the strength of our strategies to continue to deliver strong execution in this challenging environment this year. Now our priority, first and foremost, we've been consistent on this is the safety and well-being of our employees. That is our top priority. We're a safety-first culture in general. And we quickly deployed best practices around the globe when the pandemic first began. Immediately after, protecting the health and well-being of our teams is delivering for our customers. This is an opportunity for us to demonstrate our strength within the industry and continue to serve our customers in a very effective way. And we're proud of how we've been performing on both of those fronts. Now if you look at the quarterly earnings for Q3, touch on them briefly, we had a strong earnings growth versus the prior year. Margins were up significantly, and we have seen sequential improvement in growth trends from the trough that we had seen in Q2. Overall, year-to-date, our margins are up. Our adjusted EBITDA margins are up about 70 basis points for the first 3 quarters of the year. We continue to have a strong balance sheet. And once again, we are proving the resilience of our cash flow. We are now targeting, expect more than $500 million for the year. That is something across economic cycles that has been quite strong, and we have been pointing out is the resilience of our cash flow, and it is proving once again. Through this time, our strategic priorities have not changed. We've been clear on that. We continue to focus on driving outsized growth in our high-value segments. We continue to drive profitable growth in our base, and we're going to continue to allocate capital investing in our business, ring-fencing our investments in RFID and innovation and continue to make sure we're driving success for all of our stakeholders over the long term. That is our overriding priority here, long-term success for all of our stakeholders. And how we do things is just important as what we accomplish in the track record and what we've laid out here. We're a value-based company with value-based leadership with uncompromised and commitment to integrity and excellence. With that, Ghansham, I'll hand it back to you for Q&A.

Thank you, Mitch. Everybody, I forgot to mention, just use the portal to send questions, and some of you have already sent them in, and I promise I will get through all of them. Maybe, Mitch, first off, if we just start off with 2020, what your plans were going in, the impact of COVID on your specific businesses, 1Q, 2Q, what you saw in 3Q? And also, what are you seeing so far in 4Q? I think you guided towards core sales for 4Q being similar or slightly better or better than 3Q, which was down 4%?

Yes. So overall, the -- when the pandemic hit and then the economic challenges right after that, we did see a -- the biggest impact specifically in Q2, when we were down in the low teens on an organic basis in the second quarter. Principally being in 2 of our businesses, the biggest one being the apparel business of RBIS, and RBIS was down more than 30% within the quarter. Since Q2, things have been quickly tracking back. We were down in Q2 overall, like I said, low teens. We were down in Q3 about 3.5% on an organic basis. And in Q4, so far, this is -- the biggest part of Q4 is still ahead of us, but it's trending quite well. We're actually seeing all the businesses showing continued sequential improvement here in the fourth quarter. Each of the businesses and regions showing sequential improvement from where we were in Q3 and overall, we're trending at roughly 4% organic growth in the quarter, where we were expecting to be down modestly, a trend similar to what we saw in Q3, we are now seeing good growth now. I have to call out that the December is a big question, specifically around holiday for the retail branding business, what happens there. There's always a few commenters. But we're now halfway through the quarter, and we're seeing, yes, good strength and the resiliency of our markets and of our position within our markets is coming through overall as we expected and a little sooner than we expected as far as the return to growth here. So good to see there. And then the other key element here is we've said that we're, in this low-growth environment, going to protect our margins. As I said, despite -- in the first 3 quarters, volumes being down, we've been able to protect our margins both through accelerating some restructuring actions as well as quite a bit of belt-tightening and temporary cost actions. And so far, we've had, like I said, the good margin expansion. We're expecting to be able to hold on to that going into next year as well as we've commented on.

Great. And building on that, Mitch, I mean, we're seeing, obviously, real-time shutdowns in Europe, obviously, cases were up here in the U.S., et cetera. Are you seeing any deviation in trend? Are you seeing any parallels with the pantry stocking that we saw in the early part of the onset of the pandemic in maybe Europe, as an example, just because it's [ far and center ] at this point. And then related to that, how do you think the lockdown part 2, if you will, how would that impact you differently relative to the first lockdown, if at all, differently?

Yes. So we are obviously seeing everything that you're reading the headlines as far as what's going on as far as lockdowns and impacts. Within Europe, we have seen sequential improvement, like I mentioned, across all of our regions there, we've seen a slightly better sequential improvement, and we think it is because of perhaps some additional pantry loading, but very modest. And our expectation overall is you won't have the panic buying like you had in the first wave of the pandemic at the consumer level nor throughout various levels of the supply chain. So we think it will be more orderly. And I think the resiliency of supply chains, in general, not just ours, but more broadly, proved themselves out in the first wave, and people know how to deal with it now. So we see that as a good thing. Having big spikes and troughs is not the most efficient way to run a business in the industry. So we expect maybe a little bit of that, but at a much more modest level. Overall, Ghansham, our businesses are tied to consumables and growth. And so we feel very confident that resilience of our various end markets that we play in and that we're going to continue to see good growth drivers in the marketplace and we're obviously well positioned within that.

And then just one final one on that aspect, specific to Europe, is just the stores being shut down in some countries or reduced hours, et cetera. Is that a risk factor that we should consider for RBIS as you kind of go into the holiday season, et cetera?

Yes -- I think overall, the question on RBIS, you've got it -- whatever your assumptions are broadly about consumption end markets is a key thing to focus on. For us, we've been consistent. There's a lockdown aspect, but it's just holiday is the biggest question. And what -- how much -- how strong holiday is will have be a big factor on what retailer confidence is going into the subsequent seasons, one. Two, the other thing we've called out is that the apparel garments that were manufactured late Q4 last year and early Q1, those -- a lot of those garments were for the spring season, and that's when we were in the most extreme elements of the lockdowns at the retail level. Some retailers were able to sell that through because spring garments look a lot like summer garments. As for others, stored some of those garments away and we'll bring them out in the spring. So I think combination of what holiday sales do and what that does to retailer confidence as well as letting that last bit of inventory that may be in the system to run its course. But again, that's maybe some near-term volatility and the demand of apparel for the next couple of quarters. But when we look at the apparel market overall and our position in it, we feel good about it.

Great. There's a question from the audience, and we'll just -- we're in a [indiscernible] opinions. And there was one that wasn't necessarily flattering that was put out this morning on your name, and the question is on strong claims pertaining to accounting measures. And maybe you could just give very specific about that aspect of -- if you have an opinion on that aspect at this point?

Yes. So let me just start by saying we adhere to the highest standards of accounting, disclosure and governance. And yes, I find these claims without a completely unsubstantiated, very unfortunate and I will just say that we are committed -- have the highest degrees of commitment, like I said, to integrity and excellence, and that includes our accounting and reporting. And for us, in addition to all the normal reporting that we do as being a publicly traded company, try to provide transparency through our various ways of analyzing the business and the results. So those are -- we categorically just reject the comments that call in the question and all that. And some of them are, yes, quite interesting saying, we're not disclosing research and development expense anymore by quarter, which that was a SEC statement saying that trying to simplify quarterly reporting requirements for companies that we stopped disclosing it quarterly. Our R&D spending. We've ring-fenced that through this environment. We're -- we did not cut back at all, and we continue to expand our R&D investments, and we'll continue to do so. So any -- all the -- everything that was insinuated or explicitly stated that's -- on this front, we just categorically reject.

Okay. Makes sense. If we jump into the segment, LGM; 1Q, up 4%; 2Q, down 4%; 3Q, down 3% from a volume standpoint, is like the way just parsing out some of your comments from before. How would you have us think about underlying demand? And then related to that, you called out a faster-than-expected improvement in the high-value category-specific to that segment out of 3Q. Just give us a sense as to the sustainability of that improvement in high-value versus just a big decline previously and just some sort of normalization?

I'm sorry, Ghansham, I missed. Are you talking about LGM?

LGM.

Yes. So in LGM, in general, yes, we continue to see sequential improvement both in the high-value categories and in the base categories across the board. We continue to see opportunities, particularly within specialty labels and durable labels, which are more of the specialty categories within the labels business and within the graphics segment of that segment, that we saw a decline in Q2. That was the second business in addition to apparel we saw a significant decline. We've since seen significant improvement each quarter sequentially building on, and that's continuing into the fourth quarter here.

Okay. Great. If we jump into RBIS, there's a couple of questions from the audience too. Maybe just step back, Mitch, and take us through where we are on -- the major retailers implementing RFID for the -- for your largest category. And then there's a question about the nonapparel portion of the RFID, which we'll get to you after that. What inning are we in, in terms of the adoption in apparel within...

Yes. So adoption of apparel, we've described it a bit of 1/3 penetrated. So maybe top of the 1/4 as far as what inning we are in. I will say that I think the game is going to go extra innings because as the technology continues to demonstrate its success in helping companies accelerate their supply chains, reduce their inventory and really create more sell-through to their end consumers, we think the portion of the market is addressable will likely increase over time. But using your analogy, I'd say, top of the 1/4 is where we are specifically with the apparel.