Avery Dennison Corporation (AVY) Earnings Call Transcript & Summary

All right. Well, welcome back, everybody. We are delighted to be closing our conference with Avery Dennison. I'm honored that you're here, in person. We have Greg Lovins, Chief Financial Officer for the company; and Mitch Butier, Chairman, President and Chief Executive Officer of Avery. There's been a lot going on. Mitch and Greg, anything that you would have us think about to start? And then we'll get into the Q&A. Any key themes that you're hearing from investors on or that you want to share?

Yes. Well, first of all, George, thank you for the opportunity here to speak. As things have started, I think continuing themes of what we've been talking through is that we've had a successful strategy to continue to deliver GDP-plus growth and top quartile returns, a very balanced strategy for long -- focusing on the long-term success of our shareholders, communities, employees and customers. And so it's just a continuation of that theme, and we're confident we're going to be able to continue to deliver that over the long term and here in the near term. So our guidance for the year shows that, and that that's what we're focused on. It's -- we can talk about ever-increasing challenges that are going on, and we've proven the resilience of the team, and we're continuing to manage through that.

It's funny, 2 years ago, we were just going into COVID or I didn't know we were going into COVID, we knew we were going into something a little bit different, then we did, and you've managed exceedingly well. And the next issue, obviously, that has come up a lot at the conference, it's very unfortunate. And ultimately, our thoughts and prayers are with everybody who's being directly affected by what's happening in the Ukraine. Any sense from your walk around and from your discussions, recognizing it's very early there still in terms of how the impact might be in terms of some of your markets and so on?

Yes. Well, what's happening there is a tragedy, and it's despicable, quite frankly. So we have no operations in the affected countries, and only a handful of team members. So we're focused on their health and well-being and providing them the support that we can. We do have products that sell into Russia ultimately. So it's about 1% of the revenue if you look at it. So that's the historical nature. We're -- it's a fluid situation. We're looking at it every single day. And yes, evaluating exactly how we approach the whole market right now. And I will say also as you would expect the supply chains between Russia and Europe are coming to a halt at the moment.

And does that provide any supply chain issues for you or your business in terms of feedstocks and the like or not directly so?

Not directly so, no.

Yes. I mean it's early, and for that matter, the lead times on Avery Dennison products have always been very, very short cycle. So it's kind of hard to predict out, I would imagine. Anything you're seeing from your discussions with peers, customers, how that conflict might sort of pinwheel into Europe more broadly or at this juncture, just speculation?

It's all speculation. And right now, the discussion is really more on the human front and political front. And for us, the size of the business and the economic matters to us and more broadly are a distant second compared to everything else. So our focus is really around, as you know, as you heard through the pandemic, vast majority of our products are around essential categories, food supplies, pharmaceuticals and so forth. And so we're just making sure that we're continuing to focus on that availability to the broader market. But yes, for us, the economics directly are small, but they're not the primary thing to focus on.

Thanks for that, Mitch. I appreciate that and understand. To the extent that you can comment, can you relay any thoughts on how the first quarter is progressing? Remind us at a minimum of what you were saying coming out of fourth quarter reporting a few weeks ago relative to 1Q.

Yes. So we gave guidance for the full year. We don't give quarterly guidance. The full year guidance was to grow organically 9.5%, as you know, George, and adjusting for currency, again, targeting at the midpoint of our range, double-digit earnings per share growth. So continuing that great trajectory that we've had. And we did say that we expected the year to start off a bit slower overall just as last year ended slower. But largely, things are coming in as expected. We're continuing to see strong ordering patterns, particularly in North America and Europe. We -- pricing is sticking. We are continuing to raise prices. That is sticking and margins are rebounding in LGM as expected in the [ quarter ].

We were chatting earlier, but one of the panels that we hosted at the conference today was around consumer trends and really center of store, but one of the conclusions was that so far, the consumer seems to be relatively unaffected, and that's a very simplified view of it, but nonetheless, unaffected thus far by the inflation, like they're continuing -- the consumers continue to order and buy at the same rate, but we'll see if that continues.

Exactly. Yes. We're -- I mean, the inflation is so broad-based. Previous inflationary cycles we had, sometimes it was more limited to our specific categories, but it's pretty broad-based, I would say, industry at large is just in a mechanism of trying to offset the amount of inflation through productivity like we are and what you can't, passing it through pricing and it's sticking thus far, as you said, at the end consumer level.

So last quarter, a few weeks ago, you made a comment that perhaps the market probably -- or perhaps a market overdid in terms of concern, interest, perhaps we did, like you said that there may be some inventory in the chain that needs to be worked through. So if you can talk a little bit to that because that was certainly a narrative question that we're getting post the earnings call.

Yes. So we -- our approach is put our cards on the table, how we're thinking about things. And quite simply, if you think you're in a raw material constrained environment, which we've been in and price increases coming through every couple of months, we've talked about prebuys ahead of price increases in the past. That's a form of inventory build and also just around the raw material constraints. Yes, we felt -- we don't have hard data around this, but felt we had enough anecdotal data. And when we think about our guidance range, that there's probably some additional inventory in the system, which we see as a good thing. We think our focus is really around growing the end markets. And if you're in this type of environment, you actually want to make sure there's enough surge within the system to be able to handle that end demand.

Well, it's interesting you say that. More than one of the corrugated producers over this -- course of this conference point to the fact that demand would be even better if you didn't have some of the supply chain constraints. So to the extent that you have a little bit of inventory allows your customers to keep fulfilling if that's the only thing that they would have to concern themselves, will. Any questions from the audience in terms of near-term trends? Otherwise, we'll forge ahead in terms of operations and the like. Let's switch gears to Intelligent Labels, a happy topic for Avery over the last number of years. Can you talk a bit, quantify perhaps maybe not, but at least qualitatively, the types of pilots you're working on now versus, say, a year or 2 ago? And how important are collectively transportation and logistics in that?

Yes. So we've talked about the biggest growth driver within Intelligent Labels has been apparel. And within that space, we're still pretty relatively early days, early innings in that space. And so the vast majority of our growth here our 2025 horizon, where we said we're targeting 15% to 20% growth will be -- continue to be in apparel. We've been seeding development in other end markets, and there's quite a few of them we think this technology that we've got, which is a whole solution set as application in many other end markets, the 2 biggest we've been talking through are food and logistics. So if you look at those 2 areas, I'll talk about both and you asked about logistics. I'll start with that. We've talked about a total addressable market, about 60 billion units. So that is specifically around logistics companies, e-commerce companies, using it to increase their speed, lower their labor intensity per unit and lower their costs overall. So that's -- this technology enables that. It's starting off in some areas around special -- areas within their own operations that require special handling, so handling of batteries and everything else. And right now, yes, there's a number of discussions going on about broader adoption. If you think about a lot of companies talking about how to reduce their delivery to customers even further than where they are today, and this technology enables that. And -- if you think about a package going through with bar codes, which is using our material now, there's a lot of -- there's some tunnels they can go through for scans, but there's still a lot of hand scanning. And so this just eliminates all of that, and they can just put an entire rack of items and just have the conveyor belts to feed these items directly on the truck and read real-time with no need for scanning.

Mitch, would there be much, if any, cannibalization of existing LGM revenue into these channels as that becomes increasingly an IL based cell?

It's an enhancement of what's already there. So think about it as right now, there's a label that has base material that we sell out of LGM and also through our Identification Solutions business that then has a barcode printed on it, you'll still have the barcode printed on it, but also then has the inlay with the chip, whether you imprint the data. So it's very much like apparel, where you had the price ticket or the care label and now RFIDs inserted in there. And so it's been a growth driver overall. So this is the incremental elements of revenue we're talking about or the incremental piece, not just the gross amount.

But -- and recognizing ultimately, the more that, that occurs, the more benefit accrues to Avery and its shareholders, but over time, if this gets larger, we'll see, I guess, perhaps some shift of revenue from LGM to RBIS. Would that be fair?

Yes. So we look at this, even within our RFID business today within RBIS, we have a materials play, we're making just the blank inlay. So the chip with the antenna on a laminate. That base materials play business sells to the Solutions businesses that then print the data, manage the data, whether it's in Identification Solutions, Vestcom eventually and Apparel Solutions being the biggest piece. That materials business also sells to the competitors of those businesses. And so that they also buy from LGM. So if you see this as basically, if you think about a vertical stack, our adhesives business, our LGM business, the inlay business and then the solutions business. And for a healthy industry, we see it as we need to have both a materials play, feeding multiple end customers and then a vertical play around solutions.

Would there be a reason why you wouldn't, over time, of the $60 billion unit opportunity in logistics, get your rightful share based on apparel? Or I recognize it's really, really early.

No, we fully expect to be able to continue to keep our -- and we've got more than 50% share now. That's our objective. And this is really around when you're adopting something, you want the leader in the space who has the experience. Of course, we've talked about having the best, most experienced team in the space as well as this is just -- these are channels we already serve. The advantage of already providing the base material for the barcode labels gives you channel access to help these new categories adopt.

And you mentioned $35 million of costs. So I think $10 million incremental versus 2021, is that mostly a marketing and sales-related expenditure relative to Intelligent Labels or what else is that getting?

$35 million of investment.

Yes, correct. And I thought it was a $10 million incremental versus last year in that $35 million.

It's $35 million incremental investment on top of the $25 million we invested in -- sorry. This is part of -- no, thank you for clarifying. It's part of our overall strategy. And we talk about having -- focusing on outsized growth in high-value categories, profitable growth in the base and relentless focus on productivity, it's driving that productivity so you can reinvest in the other business -- in the other businesses, particularly high-value categories. So this is an investment. What are we doing in it? It's market development capabilities. It's innovation capabilities, both digital as well as more sustainability resources. So we're investing on a number of fronts. And this is just something that we called out this year, put it in writing. We've spoken about it in the past. This is exactly why we have a $700 million business growing 15% to 20% with above-average margins because we're investing in these types of spaces. So that's what -- those are what the investments are for.

Understood. Any questions from the audience on operations and the like? If not, we'll keep forging ahead. In terms of the sustainability of your products both in terms of Intelligent Labels and also traditional LGM based domiciled products, what's next in terms of key goals for you? And what's next operationally in terms of what you need to do to make the products more sustainable, everything from the matrix to recovery afterwards?

Yes. So where you started, I think, is an important one to start with is our Intelligent Labels and just our solutions, in general, how they can enable greater recyclability, less waste. So a big focus of the Intelligent Label platform and a big part of the focus of our end customers is reducing waste. If you think about how much food is wasted every year, how much greenhouse gas intensity that there is around baking excess bread throwing away, how much greenhouse gas intensity a pound of beef has. And there's a significant amount thrown away every year. And so that is a big area of focus. So a big part of our focus, how do we use our solutions to enable a much greater impact for improving sustainability, particularly of our food supply chains. We saw it in apparel. There's less materials of customers who adopt that's being incinerated than it was in decades past, and that's what we expect in these other categories. Within LGM, yes. So we've been talking about sustainability. As you know, sustainability is a key element of our overall strategy that we've been driving towards. I'd say early days, we were focused primarily -- the biggest area of focus was reducing the environmental impact of our operations. And we've also enhanced that focus really on the recyclability and how to reduce the content of our products and solutions. So we continue to invest. You've heard us talk about CleanFlake. We're doing next gen of those, moving beyond [ PET-C loop ] solutions, the HDPE, different types of plastics bottling and containers. So that is what our focus is overall, is around just continuing to do all that. And we've -- if you look -- talk about newer innovations, focusing on pulpable adhesives, so part of the recycle -- enhancing recyclability, continuing to improve the sustainability of the sourcing of our papers and so forth. So this is a broad-based strategy. We're actually going to have our integrated report, it is going to go out next week, along with our proxy statement in the 10-K that was issued. We have an integrated report, tells the whole story. We've got aggressive 2025 goals that we set back in 2015. We're well on track to meet or beat those and 2030 goals, ambitious goals around all this and we're going to publish all that information early next week.

Looking forward to download it.

I am as well.

So one last one on ops and then we'll switch to the next topic, paper supply. Usually, we don't talk too much about it. It hasn't been that big of an issue. It's become a bigger factor and certainly, Europe has been a challenge there. And we've had an extension of the strike for at least another month or so. To the extent that you can comment, what are you doing in the meantime to manage your availability? Or it's we're doing just fine. We just have to manage the inflation as you've been doing with raising pricing. So how is that affecting your business, your operations, your supply chain? And what's next?

Yes. So the -- it's clearly having an impact. We have, I'd say, order patterns are strong, but you saw in our guidance and we commented about growth outlook and the material constraints definitely are limiting the -- you said somebody else commented the same thing limiting the amount of output that we can have. So we are just continuing to manage through the situation, making sure we provide, particularly for the essential end markets, prioritize those markets as well as managing the mix as we go through it. So it's the reality we're in. It's across the industry. And the strike of the major paper player that you're talking about, yes, it affects a number of industries. So it's something that we see as near term, we'll get through it. The overall -- it doesn't change the competitive advantages of the overall technology and how we're thinking about it and our ability to grow. Like I said, GDP plus and deliver the top quartile returns over the long term.

Very good. I appreciate the thoughts there, Mitch. Switch to portfolio and strategy and capital allocation for kind of the remaining time here. So you say that acquisitions will be aimed at high-value categories and increasing the speed of innovation and increased sustainability. Are there certain metrics? And if there were, what would you have us think about as you evaluate that next acquisition that would improve your high value, so higher margin or something else, speed of innovation? How do you measure that? What would be a KPI that we would then, next time we do a Vestcom or something else, we can say, "Aha, that fits," or "Not as clear to us,"?

Yes. So one is disproportionately our investments in general and M&A specifically are in high-value categories, as you say. So what defines that? It's businesses that have the capability of growing faster than GDP, so faster than the average where there are large profit pools, which isn't just good because more profits are better, it shows points of differentiation. And then it leverages the core strengths of Avery Dennison. And so that's our simple definition of what a high-value category is. Generally, it means where the market is growing faster than GDP. Sometimes it can be where there's a unique solution to be able to capture share or something. But that's how we think about high-value categories. And as far as innovation, it's really around from an innovation perspective, where we see we have a unique capability that we can acquire. So we just did a very small acquisition of TexTrace. That's basically an external innovation, and it's an RFID inlay that can be woven into the garment directly. So we think about something where somebody else has innovated something or has an innovation capability that we can bring on. Smartrac is another great example. R&D was one of the -- one of the factors that we looked at and said, okay, they've got a great R&D team. And our own organic strategy had a significant investment in innovation capability. So it was kind of a make or buy, just looking at it through that lens. So that's what shapes our thinking overall around all of this.

Mitch, remind us, what is Avery's strategy? And how does it vary by region or product line? And in turn, at your core, if you're meeting a new investor, what do you always relay as the key competitive advantage that Avery has in fitting that strategy and the decisions in turn that you have to make for strategy to be strategy?

Yes. So overall, the broad strategy, we've got the 5 strategic pillars, which you know well, but it starts off with what markets are you in. So we're in large growing markets and then what's your position? We are the largest player in our 2 primary businesses in industries where scale matters. So we've got scale advantage, which isn't just everybody goes straight to lower cost. Yes, scale advantage comes out in margins, but it's also ability to innovate more, serve your customers better. You have a better distribution networks. So those are our position, if you will, and you start with that. And the strategy is quite simply, so drive outsized growth in the high-value categories I just talked about, grow profitably in the base of those first 2 or a simple moniker for saying, segment our business. And there's much more segmentation that goes on than that. But you heard me talk about 6, 7 years ago, we were managing maybe a little too much to the average and really segmenting markets, customers, everything. And that's been a huge part of our margin expansion over the years of doing simply that segmentation. Third strategy, relentless focus on productivity, and that's freeing up all the capital to be able to reinvest in the first 2, particularly high-value categories that we've been doing and still expand margins. And then effective capital allocation is a fourth and then being socially responsible is the fifth so -- and environmentally responsible. So those are the 5 strategies, and that's how we think about it. That's a strategic theme across all of the businesses. But that starts with your market and your position and the last thing I'd say is our competitive advantages beyond scale is really around material science and process technology know-how.

So when we look at Vestcom, it seems like that is really driven by growing in the higher value-added category. Doesn't really leverage your material science per se, or maybe it does. Help me understand that. And in turn, recognizing you've owned it for a little while, how is it performing relative to your goals?

Yes, I'll start with the second part of that question. So it's hitting all the performance objectives we've laid out, one. And if you recall, when we invested, we said great business on its own, near adjacency to RBIS. I'll come back to that in a moment, but it also gives us the option, the upside around Intelligent Labels that they had channel access and products that we thought mirroring up with our Intelligent Label capability we could get into grocery, dollar stores where we didn't have a significant presence. And it's very early days, but the early signs of that are quite positive. The level of engagement that we've had with the C-suite and a number of large stores is quite positive. So as far as how does it meet that, yes, the business is growing well. They have a differentiated solution that gives clear measurable ROI to their customers. It's a solutions-based business. They don't sell by the product. They basically figure out what the opportunity is and price according to what the return is overall within that space in that particular program. So that's what that business is, and it's a near adjacency to RBIS. It manages data and it provides a physical salute product for branding and promotional and pricing both base as well as promotional labels for grocery at the shelf edge as opposed to just apparel. So it was actually a very natural adjacency within RBIS in general, and we see the opportunity to leverage it to go into IL just like we leverage the base business in RBIS for apparel into Intelligent Labels as well.

And to the extent that grocery trends move progressively more online in terms of where that initial purchase decision is made, how does Vestcom fit into an environment like that?

Yes, that enhances it further same as we saw with apparel when you move more to omni-channel because things aren't generally pure e-commerce or pure brick-and-mortar, it's actually a blend. And so grocery stores or the distribution centers for e-commerce for -- so huge opportunity because what do you need more than ever when you have that, accurate information, real-time data and speed. And that's what the technology enables.

Thanks, Mitch. That's a great rundown. IHM showed progress in 2021. How pleased were you with it? Its margins moved up modestly. You saw earnings move up, I think, around $20 million. It's still not quite though performing at sort of LGM-like margins. It's more industrial, has some -- clearly some headwinds in auto and elsewhere. Help us understand what the path in IHM is going to be to get into where you want it.

Yes. So this business actually is in a number of markets where we see good growth trends. The conversion of mechanical fasteners, so nails and screws and the like to tapes and adhesives. There's quite a few categories. If you look at automotive, you look at building and construction, a number of tailwinds in that space. And so we've basically been spending the last number of years. We've been in this business for a long period of time, and they were kind of run off to the side, basically reconnected all the operations and are connecting the R&D capabilities with LGM. So how -- to leverage the scale and prowess of LGM but in these faster-growing markets where we have a smaller presence. So we've been rewiring a lot of the business. As you said, we're making progress. We're not where we wanted to be from a margin perspective. It's a small part of the company overall, around 10%, but yes, we see a tremendous amount of potential. And the reality is that category, if you think about automotive and so forth, the end market is not where we expect it to be either, but we expect here that things to start ramping up across a number of categories here. So yes, we're still confident in the long-term prospects of the business, not exactly where we want to be, but very confident where it's going to go.

Maybe a question for you, Greg. In terms of capital allocation at this juncture to the extent that you can comment because you're never going to get ahead of what you're going to do in terms of buyback or acquisition or the like, for the average M&A candidate that you might be looking at or growth investments that you're looking at relative to value return, which of those 3 buckets seem to offer the best return to the Avery shareholder at this juncture? And obviously, a question in here that you -- if you can share, we'd appreciate it. With Avery's stock having come in quite a bit over the last number of months, obviously, the intrinsic value gap is probably greater. How is that sort of rolling into your allocation -- capital allocation run through on a day-to-day basis?

Sure. Yes. So overall, I think it's -- start with our balance sheet is very strong. So we ended last year after the Vestcom acquisition, still at a debt ratio of about 2.2%, below our target range. And that's with only 3 or 4 months of Vestcom's profit in that number. So we expect that to even come down barring other investments in 2022. So we're starting with a very strong position that enables us to continue investing in the business. We've talked about increasing pace of CapEx and OpEx in -- organically in the business. We talked about M&A a lot here in the last few minutes, and certainly, we have ample capacity for that and capacity to continue returning cash to shareholders. So our focus on those allocation priorities is -- continues to be the same as it's always been. In periods like now where you would see the stock taking a little bit of a decrease, we would typically be accelerating our pace of share buybacks, and that's what we would be doing in this type of environment now as well. So that's been our playbook over many years, and we're continuing to execute down that same path.

And we are doing.

We appreciate that, Mitch. So -- any other last questions for Avery before we wrap? Any last thoughts, gentlemen?

No. Thank you for the time, and we continue to be confident in the position and prospects of the company. Very thankful to the team. The team has done a phenomenal job through a very challenging set of circumstances. And as we highlighted, circumstances are changing, but not getting easier and -- but we're just as confident as we have always been.

Mitch, there are not many companies that I've covered over the years that have as good of a track record as Avery Dennison. So we look forward to the continued progress and we thank you both, Greg and Mitch, for being here in person. Please join me, everybody, in thanking Avery Dennison for a great presentation.

Thank you.

Thank you.