Avery Dennison Corporation (AVY) Earnings Call Transcript & Summary

Good day, and welcome, everyone, to the Avery Dennison Corporation date cohosted by UBS. My name is Shandor and I'll be your operator today. [Operator Instructions] I would like to advise all participants, the call is being recorded for replay purposes. And with that now, I would like to hand over to Josh Spector. Please go ahead, sir.

Yes. Great. Thanks, and hi, everyone. Thanks, everyone, for joining us today. My name is Josh Spector, chemicals and packaging analyst with UBS. And I'm joined on the call today by Mitch Butier, Chairman, President and CEO of Avery Dennison. Mitch has been with Avery Dennison since about 2000, serving in a variety of roles, including CFO and COO prior to becoming Chief Executive in 2016. This call will be entirely Q&A format, so for anyone on the line, if you have questions, feel free to e-mail me. My e-mail is [email protected], and I'll do my best to try to work those questions in. So with that, thanks, Mitch, for joining us today.

Thank you, Josh. Thanks for the opportunity.

Great. So to start, I was wondering if you can give us an update on what you've been seeing quarter-to-date by business and by region.

Yes, sure. So overall, the quarter is tracking better than we projected on our earnings call that we had back in October on both the top and bottom lines. On a quarter-to-date basis, total revenue is up around 3% on an organic basis. With LGM, is up a little less than 3%. RBIS is up a little more than 4%, and that includes Intelligent Labels and RFID being up again roughly 20% in the quarter so far. And IHM showing a modest level of growth, roughly flat, though. So overall, quarter is coming in better than we had projected. We're again, proving our resilience of our business, while our priorities in these compounding crises remain on, first and foremost, the health and safety of our teams and continuing to deliver for our customers.

That's helpful. I guess just to be clear. So when you talk about revenues up 3% on an organic basis, you have that benefit of an extra week this quarter. That would be excluding that extra week, correct?

Yes, that excludes the extra week and excludes the impact of acquisitions as well, specifically Smartrac.

Great. So then -- okay, that makes sense. I think, overall, it's been impressive RBIS maintaining positive growth here, given what we've seen in terms of COVID cases and retail sales. I was wondering if we could dig into that a little bit. RFID, now about 30% or so of your RBIS sales, growth recovering nicely here in 3Q, it appears similarly strong trends in 4Q as well. I guess I mean, if you're talking about 20% growth in RFID, would you say you're significantly above that quarter-to-date? Or around that mark? And I guess, trying to think about what that implies for the rest of the retail business overall.

Yes. So Josh, if you're asking how much RFID is up, RFID is up around 20% this -- so far this quarter comparable to what we saw in the last quarter. And overall, our long-term projection is 15% to 20% long-term growth within RFID going forward. So that's what we're continuing to see. We continue to see a ramp up of new activity along -- throughout the entire pipeline, both at the pilot level, business case level as well as obviously in rollouts and full adoption, so continue to see that evolve well there.

And I mean, have you seen any difference in terms of where the rollouts are taking place? So I know apparel, retail, a big majority of your RFID sales, would you say the growth more near term is acceleration there? Or more acceleration in some of the other markets?

We're actually seeing it across the board. And so yes, apparel is around 90% of our revenue today. We've -- that's where we're driving most of our revenue as well as, obviously, from a dollar growth perspective, most of our dollar growth as well. And as far as pipeline, we're seeing it across the board. We actually saw a rejuvenation of pipeline for particularly early-stage pipeline growth in the apparel space as well. I think the COVID has further reinforced what we already knew, a strong business case for RFID. And we're continuing to see, particularly in the areas of food, logistics and beauty, quite a bit of early-stage activity number of pilots going on. So a lot of activity across the pipeline.

I guess so I mean if apparel retail is around 90% of your current sales, what would you say the mix is of your pipeline? Is it representative of your current sales? Or is it significantly different?

No. It -- apparel will be less than that just because you have so much more early-stage pipeline development in other sectors. But when we quote the pipeline, it's more to comment about level of activity. You've got some programs in there that might be $5 million and some of that could be 10x that. So there's quite a mix of different programs in the pipeline. So it's more to measure overall activity, not one-for-one correlative to dollar growth.

Okay. All right. That's helpful. How about pharma? I mean I know some pharma producers are using RFID for tracking. I guess explicitly, does the COVID vaccine have any potential for RFID tracking? And more broadly, are there opportunities for higher growth in that market in general?

Yes, we haven't called that out. We do see some opportunities within medical applications and pharma. It's still relatively early stage and even earlier stage than some of the other ones that I called out. Clearly, with what's going on with the vaccines for COVID-19, that's increased our level of engagement, looking at the specific use cases around RFID and so forth. So there are some applications, as you note, Josh, relatively limited right now. We think there's a huge opportunity, eventually in the broader medical space and so forth. But it's even earlier than what I commented around food and logistics and beauty right now.

Okay. All right. That makes sense. And just thinking about RBIS segment mix. Looking past 2020, perhaps there's still some near-term pressure next year. RFID is a big contributor of RBIS organic growth. But trying to think about the margin level overall and thinking about the incremental dollar margin on an RFID sale relative to the rest of RBIS. Is that a driver of increased margin leverage over the next few years as that growth rate continues?

Yes. So the RFID business has above-average EBITDA margins for the segment and for the company. And that's been consistent over the last number of years. And that's after considering how much we're investing in future growth for these areas, like I mentioned, around food, logistics and so forth. We're investing a lot in innovation as well as market development so we're able to have the above-average margins, and that's including the increased investments that we've talked about.

Okay. So maybe shifting within RBIS to the base tags and labels business within there. So I guess the -- you talk about 6% growth or so for the segment. That kind of implies the rest is roughly flat. That seems pretty far ahead of what I think you expect [ each ] might have been. What's the biggest driver behind that?

Yes. So RBIS, the segment for the quarter is up a little more than 4% so far this quarter, which is coming off of a decline that we saw, mid-single digits in Q3 and an even more significant decline in Q2. So overall, if you look at the trends, we saw a pretty big lift within the month of October, and this was across the board. It was RFID as well as the base. And a lot of that was due to catch up. And so a lot of the retailers did not have brands, did not have enough inventory basically going into holiday. And so we saw a pretty good surge of activity, especially on a sequential basis from what we had seen previously. And so the big question, as we've said, is what is happening in the holiday period. And we're really going to need the next 4, 5 weeks to play out to see what that does for a retailer sentiment. Overall, we can see that the impact, particularly with the COVID cases rising again in a broader society, more limited capability for retailing and so forth. But even that included, some of the sentiment we're hearing from some of our customers that retail is, while down, better than people had expected on the margin.

Okay. All right. No, I appreciate that. So I guess, yes, you say you still need a few more weeks for that to play out. And I guess, as we think about mix, I mean, from what I've seen from other UBS retail, apparel analysts, in-store is down pretty good amount, online up, kind of balancing out to a certain extent. So does that mix matter much to Avery in the base tag business?

Well, it matters significantly in the fact that when you look at our global capabilities, as retailers and brands have had to move some of their sourcing around the different countries, we're in a position that we can capture that migration, if you will, and be partners to our end customers. So that absolutely has a big impact across all product lines, the base business as well as the higher value segments. And the other element here, when you're the go-to player for RFID, clearly, we're bringing in a full suite of product lines and categories that we're working with our retailer and brand customers, from design all the way through to delivery. So absolutely, we're seeing an impact across all product lines.

Okay. No, I guess I understand the RFID being a supportive strength through an omnichannel-type strategy. I guess if you were to sell -- customer sells a shirt online versus in store, does that change the actual tag element in terms of the potential for you to have products on that garment?

No, it does not because they don't have multiple channels for -- and multiple inventory stocks for the different channels. So they will have -- basically, use their retail outlets as well as their warehouses as virtual warehouses for online ordering. So it does not have an impact on the other levels of tickets and tags, if you will, on the garment.

Okay. That's helpful. I guess if I look at what you said at the start of this call versus what you said about a month ago, a month ago, quarter-to-date was plus 4%. Now you're saying plus 3%. Where is the biggest change taking place versus that prior update?

Yes, it's really within RBIS. So if you recall, when we commented that it was up 4% about 4 weeks ago, that was -- we'd said that RBIS was coming in better than that, a bit better than that, and that we expected there'd be some moderation. And so that is proving out right now. So RBIS was up mid-single digits in October and up low single digits in the month of November. Now again, some of that October was, again, the catch-up, if you will. And for us, the biggest thing, again, is really just what is -- what's going on month-to-month and so forth is less impactful for right now other than what retailer confidence is going to be coming out of the holiday period.

Okay. Got it. And maybe shifting gears a bit back to the LGM side of the story. You gave an update on the segment as a whole. Can you comment by region what you're seeing, and maybe if there's anything that you're seeing that you would characterize as perhaps temporary from COVID, either rising cases in Europe, U.S. or elsewhere?

Sure. It's tough to tease out exactly what the impacts are of COVID, but I'll share some of the regional numbers and give some commentary on that. So overall, LGM, as I said, is up a little less than 3% for the quarter so far. That compares to being down roughly 2.5% in Q3. And if you look, LGM is Labels and Graphics Materials. If you separate those 2, we are seeing that LPM up -- LPM, so Labels and Packaging Materials, is up low to mid-single digits, whereas the graphics business is down mid-single digits, which is a significant improvement from where we've been in previous quarters, as you know, particularly Q2. So focusing on LPM, so Labels and Packaging Materials, at the volume level, because I know that's where a lot of the focus is. If you look at North America, North America, in this business, was up mid-single digits in Q2, and that was when we had a lot of the inventory build. It was then up low single digits in Q3, and now it is up, from a volumes perspective, up high single digits. Now within North America, particularly what's going on with the resurgence, we do think there's -- resurgence of the confirmed cases, we do believe there may be some inventory build in that. This is above the historical growth rate of that business, particularly in the Q4. If you look at within Europe, here, this business is growing low single digits, which is an improvement from what we had seen in the previous quarter, and this is growing roughly at or even slightly less than what we had seen in Europe, what we see over the long term within this business. So we think that is healthy and sustainable. But again, some choppiness between October and November within Europe. So the mature regions seeing an increase in growth at the volume level with North America ahead of Europe. And I would say North America, a little bit better than the headlines of what you read in the macro. In Europe, maybe on par with what you're reading in the headlines, maybe slightly better. And then if you look in the emerging regions, our Latin American business is up in volumes, high single digits and as is our Asia Pacific businesses, with China being in high single digits and India as well. So that's a little bit of the color by region.

And just with Europe where you talk about the choppiness, can you remind us where growth was in October and where it went to in November, so how choppy it actually was?

Sure. So this business was up high single -- I'm going to go back to Q2, Q3 because the story is important here. So it was up high single digits in Q2. It was down mid-single digits in Q3. And now it's up low single digits. And October was actually flat. And November, what we saw was up mid-single digits. So a recent improvement in the trend of what we're seeing in November as well as the first week of December.

Okay. And I mean, obviously the...

Again, Josh, I think -- the one thing I'd highlight in LGM is just the month-to-month choppiness, and it's one of the reasons we don't always go out with these numbers. It's just you can have some variability month-to-month. So for me, the key is just tracking it over time. And if you look at within LPM Europe, across this entire cycle, it's still growing a little bit less than what we historically have seen in Europe, which basically, if you look at what's going on with the broader economy, it makes sense. And in North America, we're growing a bit above what we've historically seen. And that's still holding out, I guess, to what I'd say, very similar stories to what we talked about in the last earnings call.

Okay. No, that makes sense. Yes. That's what I was actually going to ask about is how much of this monthly choppiness is normal, and we just don't normally talk about it and how much of it is abnormal with everything else going on. So I think that helps to answer that. I think within -- if you look at the base, you talked about the LPM business relative to the specialties, graphics, reflectives, I mean, the recovery there has been pretty strong. I guess do you think where you're at now, at the minus 5% or so, is that kind of a level that holds kind of as we move our way towards a recovery at some point? Or does that change very much versus what we've seen over the past couple of months?

It's been getting sequentially better each quarter from where we were in Q2. So if you're asking going forward, we would expect this business to return to growth and have strong growth characteristics overall. And if you look going into next year, particularly having an easy comp in Q2, specifically. So I'm not sure exactly what you're asking, but when you say hold, we -- it's been improving sequentially since Q2, particularly the graphics business, and we would expect it to continue to do so.

Yes. I guess where I was going towards is more -- so as we think about 1Q and if things maybe don't get much worse, but don't get much better, it's kind of down mid-single digits reasonable. Or is there any -- I mean, obviously, 2Q was down a lot. So it's still a big question of how much of this latter demand is catch-up versus more normalized, in line with what you say is end-market demand.

Yes, I'm not going to get into specific product line forecasting. But I guess the biggest thing is just what are your assumptions around what's going to happen with the macro and the outlook on COVID. The Graphics business is more related -- more durable categories. So that's why it's more economically sensitive. So we go into -- still have 1 more quarter, Q1, of somewhat tougher comps because the full impact of recession had not hit yet, and much easier comps in Q2. So quarter-by-quarter, tough read, but that's a little bit of color for you.

Okay. I appreciate that. I guess maybe moving to LGM margins, have been quite strong throughout 2020, and it's been a mix of permanent productivity, temporary cost actions, some lower raw materials. Obviously, volumes at points have been better than expected. At the overall company level, you talked about margins being flattish year-over-year into next level with -- next year, sorry, with some volume improvement. Are you able to provide any early thoughts around how you're thinking about LGM margins at this point into next year?

Well, I just want to reiterate what you said. So as we look into 2021, because I know that's where a lot of eyes are focused on right now, we said we -- if you look at where we are the first 3 quarters of this year, we've delivered EBITDA margins of 14.9% for the total company, which is up 80 basis points, despite volume being down. And going into 2021, we expect to be able to hold on to our margins at a total company level, maintain the margins is what we're targeting from the 2020 levels into 2021, assuming modest level of growth, as you've said. If you look at the individual segments, I'm not going to give color overall. Our focus has been continuing to find the optimal point of gross margin and capital efficiency. Our LGM business is a high-return business that we continue to invest in and continue to expect healthy margins. So I'm not going to get into specific color, though, outlook for next year by segment, Josh.

All right. It's worth a shot. So I guess in terms of some of the longer-term growth within LGM, I mean, you guys typically talk about the higher value categories in emerging markets. And just thinking about the emerging markets growth story and kind of related with [ LGM ] around margins, I'm trying to think about your margin structure for LGM products in developed versus emerging markets. And with LGM margins with that -- where they are today, will emerging market growth be accretive to margins overall in the future?

So Josh, your question, are emerging markets higher than mature -- emerging markets margins higher than mature markets?

Yes. Just how -- if they are, what you do differently, since I assume the business mix within those 2 markets is different. And if emerging markets are growing, just trying to think about how we look at that from an incremental margin standpoint.

Yes. The margins overall are relatively comparable. It used to be, years back, we would talk about the margins being higher in the emerging markets. We've narrowed that gap largely by bringing up the margins, particularly in Europe, to a higher degree, higher level. So there is a bit of margins being higher in some of our emerging markets. But overall, the regional mix isn't that significant at the EBIT level.

Okay. That makes sense. And I guess not to leave IHM out of the conversations altogether. Can you maybe provide some context of what you're seeing in some of the different markets there, specifically around health care, auto, industrial and kind of how much is maybe some catch-up demand versus more sustainable in your view?

Yes, so overall, I think the -- a lot of what we've been talking about continue to be the case. If you look within the industrial market, so automotive, China has come back sooner than anywhere else. But we have been seeing sequential rebound everywhere. China, in particular, which, by the way, slowed first, coming back stronger. And then in health care, basically, got a -- within that business, a lot of it is tied to elective surgeries. And elective surgeries, as we all know, are down right now. So that's a bit of a pressure. So kind of the business is sequentially improving quite a bit from where it had been in Q2 and then Q3. This business is roughly flat in Q4. And I'd say Asia is doing better than what we're seeing elsewhere. And that roughly flat is, compared to being down in Q3, mid to high single digits.

Okay. And maybe the last question I have to kind of round things out, just looking at capital allocation and leverage, despite a challenging 2020 for most companies, you're sitting here well below your leverage targets. And I guess, 2 questions around this. First, when you get more comfortable deploying meaningful capital again, and second, what should we think about in terms of the main uses of that capital?

Yes. So nothing's changed as far as our intent and strategy around capital allocation. And we've laid that out about what we expect, 20% of our available capital to dividends, around 5% or less to restructuring. And then you've got the amount for share buyback and M&A being a fungible bucket of roughly 50%. So that's still our capital allocation strategy. As you know, we are below our targeted leverage, we have been for a few years now. And when we did have that, our intent was across economic cycles, there'd be a market dislocation in M&A or otherwise that would last for a couple of years like we've seen in past downturns. So we'd be in a position to lean forward as others pull back. So we're still in that position of strength. We intend to use our capital, both for M&A and share buyback. And that's our intent, as I said on the earnings call, going forward. So recognize, we just got to demonstrate that for everybody to see it, but that is our intent right now.

Okay. And maybe just one more around similar topic, just in terms of where you look at M&A. You guys have a pretty high share in RFID, a largely growing market. Is that an interesting area for you to deploy more cash, specifically in RFID? Or would you look at maybe tangential technologies that offer you more opportunities to capture kind of similar themes, secular growth around infrastructure, logistics, tracking, et cetera?

We're looking across the portfolio for opportunities, but absolutely, the high value segments. Our focus on the M&A strategy is to really just accelerate our overall company strategy, which is driving outsized growth in the high-value segments and profitable growth in our base. So specifically, your question of RFID, we had our acquisition of Smartrac earlier this year, which significantly expanded our capabilities and reach and further cemented us as a UHF RFID leader and gave us access to additional technologies. We've been -- if you look at our venture program, we've been investing in start-ups, such as PragmatIC and Wiliot. And so we are making investments in multiple levels, M&A ventures and, obviously, organically. And something -- it's impressive with the large -- significant margin expansion we've had over the years within RBIS. I'd point out, that we've highlighted a number of times that we've invested significantly in organic growth within RFID, deploying $30 million of additional operating expense investments over the last 3 years, and so $10 million incremental each year. So that -- we're definitely focusing our capital allocation, including M&A and ventures, particularly around high-value segments. And that's first and foremost, RFID, as you point out, Josh.

All right. Great. And with that, we're at top of the hour. Thanks for joining us, Mitch.

Thank you, Josh. Appreciate the opportunity. Again, we look forward to speaking to everybody again in late January to talk about our quarterly results and our outlook for 2021. Thank you all for joining us.

Thank you, everyone. That concludes your conference call for today. You may now disconnect. Thank you for joining and enjoy the rest of your day.