Avery Dennison Corporation (AVY) Earnings Call Transcript & Summary

We'll go ahead and get started. Thank you again for joining us, everyone. My name is Ghansham Panjabi. I'm the Packaging & Coatings equity research analyst at Baird. Welcome again to our conference in-person in Chicago. The next presenter is Avery Dennison. We had a slight change. Mitch Butier was supposed to be here, but he had a conflict come up last minute. And so we have, Greg. Greg has been with the company since 1998. Is that correct?

'94.

'94. '94. okay, even longer. He's been CFO since 2017. This is going to be a pretty standard presentation with the fireside format. Please e-mail your questions in or you could just simply raise your hand in the small room. With that, let me introduce Greg Lovins.

All right. Thank you, Ghansham. Appreciate the opportunity to be here today. I'll just give a very brief introduction. Just have 1 slide to talk about here, just very high level, and then we'll jump straight into your questions. So first of all, Avery Dennison is about a $9 billion revenue company now, making branding information, functional label solutions for our customers. Our 2 largest segments are Label and Graphic Materials and RBIS. LGM is about 2/3 of the company, RBS about another 1/4 of the company. Those segments or those businesses are both by far the leaders in their industries, in their spaces. And overall, when you look across the top 2 pie charts there, you'll see we have broad exposure to diverse markets, both from a product perspective as well as a geographic perspective. Our -- most of our portfolio is in Staples with a lot of that in nondurable consumer goods, areas like food labeling, household and personal care items, pharmaceutical labeling, et cetera. So a lot of our products going into those nondurable consumer goods. And we've done -- most of our focus over time is on long term -- or all of our focus is on long-term value creation. And that's really targeting our goals of GDP plus growth over time, plus top quartile returns, which we think together combined to create superior value creation over time. And that's been our playbook, and that's where we've driven significant EVA and value growth over the last many years. When you look at overall, part of our focus is around growing in these higher-value categories, you can see that on the bottom left. High-value categories are becoming a bigger and bigger portion of our portfolio. And these are areas where generally strong growth opportunities, markets that are growing faster than our average, areas where we have variable margins above our average and areas where we, as a company, have strong competitive advantages to win. So these are spaces we're significantly investing and to grow. The biggest one of those is Intelligent Labels, as I'm sure you're all aware. This is an area we've been growing over the last number of years, about 20%. Our expectations for the next couple of years are more than 20% growth. So continuing to see a significant opportunities here, and we're investing to capture that. So we're by far the leader in this space. We're continuing to invest ahead of the curve to make sure that we're helping create these markets and capture the opportunities there. When we look at the far right, you can see we also have a strong track record. We delivered double-digit earnings per share growth over a multiple year periods and continuing to deliver that and expect that over time. So this combination of our strength of our markets that we're in, our leadership positions in those markets, the strategies that we're delivering against and executing against as well as our people. Our people have done a fantastic job over the last number of years, really delivering against a pretty difficult set of challenges that we've worked through over the last many years. So very confident going forward and ability to continue delivering superior value. So with that, I'll Just jump over to questions.

Okay. Just as a reminder, please e-mail your questions in or simply raise your hand. So Greg, if -- John, maybe we can go back to the pie charts, yes. So if we look at this chart, you have a fair amount of consumer exposure and the investment community looks at the consumer and sees a lot of stress associated with inflation. You have a lot of multinational exposure, foreign exchange. You have a lot of Chinese exposure, literally that countries had all sorts of issues from a growth standpoint. How did you accomplish what you have this year in context of all those headwinds that so many other companies have been tripped up by?

Sure. So I think, first of all, we've been largely prepared for it, right? So we came into this year -- well, really, I'd go back a couple of years, really, in 2020, we started doing more in-depth scenario planning, really looking forward multiple years and under multiple scenarios, how will we react in different scenarios. What will our businesses do and what will that playbook be to execute across our portfolio. And that's something we've been very focused on and continue to focus on and certainly coming into this year. We saw some challenges heading into this year. We talked about that earlier in the year with potential inventory buildup in the system, et cetera. And we really had a playbook to continue executing against that. We've got, as I talked about, Intelligent Labels a really strong growth driver, helping us grow through this environment, accelerating the pace of growth there. We made a large acquisition last year in a company called Vestcom, it's contributing significantly there. not just in terms of contributing financially, but also helping us engage more in those environments that they compete in, in grocery and drug in areas like that. And how do we help pool Intelligent Label revenue into that in the future as well. So really, the portfolio is very strong given the breadth of that. You mentioned geographically. Again, you can see on the pie chart, our largest region is the U.S. China has become a bit smaller portion of the company given some of the acquisitions we've done that are largely in the Western parts of the world. So -- but continuing to manage and China is still a good sized business for us that delivers strong margins and strong returns. So been a little bit more challenging lately, but continuing to deliver there also.

As we think about the various issues that we've kind of dealt with this year from a price cost standpoint, maybe you could just give us an update there in terms of what's progressed over the last few quarters? And what do you see evolving next couple?

Sure. So yes, I mean we've continued to see inflationary pressures in raw materials, certainly in energy, particularly in Europe, in freights, particularly late last year, early this year. And we've continued increasing prices to manage that across the businesses. In LGM, in the back half of this year in Q3, in particular, we grew about 20%. Most of that was driven by price. So a significant amount of pricing going in over the last number of quarters to manage the amount of inflation that we've been seeing. But we've done a good job managing that. I think I mentioned in our last call in our LGM business, over the past 4 years, we've had a volume compound growth rate or annual growth rate around 4%. And we've grown our EBITDA dollars compound growth rate there, about 10% or almost 10% in that same time period. So our business has done a great job managing through those inflationary pressures. Getting the pricing where needed, leveraging our productivity capabilities, not just pricing, but how do we take material costs out of our products as well. So leveraging all those buckets in our portfolio to help make sure we can offset the inflationary pressures.

Greg, one thing we've been doing is looking at the baseline of earnings for companies 2019 versus 2022 as an example, right? You started off at $6.62 in 2019, almost 50% higher is where we have you for 2022. A lot of folks that we talk about, talk about maybe the company having been advantaged through the course of COVID. How would you sort of address that?

Yes. I think -- well, yes, we built advantages, I guess, is how I think about that in terms of our strategies, in terms of how we position the portfolio, how we've continued to invest to capture the -- or to increase the share of our business in the higher value segments like Intelligent Labels, of course. And our base business in the core Label and Graphic Materials segment, is really, again, serving these strong consumer Staples. So throughout 2020, we saw strong growth still or strong opportunities in our core label business, as people are still continuing to consume food, of course, in health care and beauty products, all those types of things. And we've continued to use those opportunities to accelerate our investments and accelerate our growth in a number of these high-value categories.

In terms of supply chain challenges, anything residual you'd want to highlight. Paper supply was a big issue a year ago?

Yes. Paper supply coming into this year is a challenge we've continued to have off and on different challenges across the course of the year. but continue to work through those fairly well, and I feel pretty good about where we are right now from that perspective. We've closed a lot of the -- I would say, open order book we had in our Label and Graphic Materials that got built over the last year, while we were managing through or what the whole macro was managing through these supply chain challenges. We've closed a lot of that and back closer to normal lead times at this point.

Your company has done a pretty consistent sort of Analyst Day on a rolling basis. Maybe you can just kind of tie in to what the targets are at this point, if there's anything you'd want to highlight for the audience?

Yes. Our expectation is we continue to grow above GDP. We continue to deliver double-digit earnings per share growth. And that's been our focus, and that's our target, and we'll continue to deliver top quartile returns. So nothing necessarily changing from that target. I think next year, we're potentially have another Analyst Day, talk about how the company has progressed since the last one that we had in early 2021 as well.

Okay. Maybe we can jump into the segments. Start off with RBIS. Let's start with the base sort of business and then we'll keep RFID in -- separate that because there are questions coming in on that.

Sure.

So what are you seeing from an operating environment standpoint? Obviously, all sorts of data points out of many big customers about inventory drawdowns and too much inventory and so on and so forth. How's that impacted your business?

Sure. So I think that's the area we talked about in our earnings call a couple of weeks ago that we're seeing some inventory drawdowns and some softness of orders in the month of October are largely due to what we expect largely due to some of that inventory drawdown. And as you said, it's not secret to us. I mean, the big retailers we're talking about in Q2 and Q3, bringing inventories down already. We managed very well through that, and then we have more retailers and brands bringing inventories down Q3 into Q4. We have seen that continue here in November. So we continue to see orders a little bit soft as we've entered the first week or so in November and expect that to, again, just be driven by continued inventory drawdown. So right now, we look at that mostly in RBIS, there is some of that in LGM as well, and we anticipated that coming into the year also. But we'll probably look at that having an impact, of course, on our top line in the quarter and making it less likely we deliver our earnings guidance in the top end of our earnings guidance range. We've got a pretty narrow range already, but certainly, with volumes coming down a little bit, expected less likely to be in the top end of that range.

On the base business for RBIS, where are you seeing incremental weakness relative to what we saw last quarter? Was it any different?

No. I think last quarter was really the value channel. So a lot of the big mass market retailers bringing inventories down. We've seen that expand now into a little bit broader retail view, especially performance apparel and things like that, talking about inventory. So that will be a little bit of what's happening, I think, in the fourth quarter. But again, I think this is somewhat temporary in terms of inventories getting back down. You already saw some big mass market retailers talking a couple of weeks ago that they've got their inventories back now in the place they expect them to be. So we feel like this is somewhat temporary in terms of that, in terms of bringing the inventories down, and then we'll move forward from there.

And LGM in terms of incremental weakness, where are you seeing it?

Yes, I think we had -- as we talked about last quarter, we had very strong growth in Europe, Western Europe, in particular, last quarter. We were up, I think, 40% overall on revenue and mid-teens volume growth and the rest of that being price. And I think we closed a significant portion of our order book that had been extended due to the supply chain challenges in Q3. And I think that's led to some inventory in the channel, and that's starting to come out a little bit in the fourth quarter after a very, very strong third quarter. So I think that's largely where we've seen it. We still had some more supply challenges in North America versus Europe. So I haven't seen as much of that in North America, but Europe is where we've seen it slow down a little bit after the very strong Q3.

So many of the quarterly earnings notes that we wrote had Europe and China as it relates to weakness. As you kind of progress into next year, is the U.S. also going to join in that in terms of incremental weakness, you think? And you have great visibility across your businesses from a just the variety of different end markets you sell into. Do you see any change that would support a weakening in the U.S. as well?

Yes. Hard to call on the macro. I guess from our particular business, we had, I think, less supply challenges if you put kind of energy and things aside in Europe than we had in North America this year. So I don't think North America had as strong volumes in the first part of this year as Europe did. So we wouldn't expect such a correction, I don't think, in North America. Now what the macro does in the various regions and how that plays out is a different impact in that we'll try to call that right now. So...

Okay. Let's go into the fun stuff. Intelligent Labels. Maybe just kind of deep dive because some of us are newer to the story than others. In terms of what your platform has evolved into at Avery Dennison, apart from just years ago, it was just RFID was sort of the call log versus broader Intelligent Labels. Let's start there.

Sure. So we look broadly at Intelligent Labels. So how do we deliver solutions that help our customers meet a number of their goals. So whether that be starting out in retail apparel, which is obviously the biggest space that RFID started out in. Looking at how do we help them improve their revenue. And they do that by having the right product at the right place where the consumer wants it. As we've seen a bigger and bigger shift to omnichannel retailing that requires even more accurate inventory to be able to serve that well, whether it's buy online and picking up in the store knowing the item you bought online is going to actually be at the store. So that requires a lot of inventory accuracy that didn't exist prior to RFID. That's helped shift accuracy in those inventories to closer to the high 90s percent from the 60s before. So that's been a significant shift. In addition to just giving more revenue, it's helped bring more automation to their operations where they have less need for as much labor. They don't have as much time taking inventories throughout their stores. So that's brought some automation there as well and also help them reduce waste. So having the right products at the right place, knowing where that inventory is, allows them not to over order or not to have more products than they need as well. So eliminating waste, and you can look at how that plays into other verticals as well. So we've talked a lot about both logistics and food segments. Food, in particular, obviously, has a challenge with eliminating waste. So that's an area we're focused on as well. And how can RFID help better manage freshness of food, so you can turn your food faster, whether that be in a grocery store or a quick service restaurant. How do you use less of the food, turn that faster and reduce a lot of the waste in the channel. At the same time, also, again, using less time of the people you have in a quick service restaurant taking inventory in the back and receiving trucks and things like that, making that more efficient so those people can serve customers. So that plays very well, the same strengths that help drive apparel, plays very well into food. And then you look at logistics and it's somewhat similar as well there. how do you help automate their operations? How do you help them reduce the number of miss ships they have? How do you help reduce or eliminate the needs to scan every box that's coming through a logistics channel? Make that automated, make that much quicker, ensure you're getting the right products on the right truck to the customer. So I think that all the things that drive apparel, most of them really play and deliver well into food and logistics and the other verticals we're looking at.

Where do you see the most momentum outside of apparel?

I think it's both those areas, logistics and food. So obviously, large logistics players are talking about RFID and how that can benefit them really from an automation perspective, as I talked about a minute ago. And then in food, we're seeing opportunities, as I said, in grocery as well as quick service, fast food type of restaurants and around not just freshness, as I mentioned, but also how do you get more traceability, to be able to trace your food back to the farm from the restaurant. So those are all initiatives that we've got a number of pilots in play with both grocery channels and quick service restaurant channels.

There's a question from the audience on RFID/Intelligent Labels. The 20% growth rate that you highlight, can you just kind of break it down into industry growth versus market share gains?

Yes. So we've had a leading market share position really back to that chart goes to 2019, but prior to that. So we've continued to strengthen our share over that time. So a lot of that is industry growth. And then I think we've added share on top of that. I don't have a specific split of the number, but it's certainly a combination. I think we are by far the market leader in this space, pretty much every significant rollout of RFID, we've been heavily involved in those rollouts, helping enable those, helping make them successful. So from that perspective, we continue to gain scale there that market leadership help to ensure that we're also heavily involved in new big rollouts as they come as well.

The 20% that you sort of annualized, is there a reason it's not faster just given food is huge and logistics is massive. Is it a resource issue on your end?

Not necessarily in our end. We're continuing to invest ahead of the curve. And I think we've been talking out for a number of years and from both an operational capacity perspective as well as business development and helping enabling these other markets to go. We're investing ahead of the curve. And what we're investing this year is for 1.5 years or 2 years from now to make sure that those markets and that we can deliver those in those markets. There is -- it takes some time to integrate RFID into an operation, whether that be a logistics operation, a grocery operation, a fast food type of business. You have to integrate that with your systems, you need to upgrade your equipment and get readers and things like that. So it's really about just time and continuing to build that. And as we saw with apparel, once we saw some big retailers go, we saw that accelerate. And we think with some of these other verticals, we'll see that accelerate as big operators go in those different verticals as well.

Conversely, do you see risk to that 20% growth, just given some of the weakness that we're talking about on the consumer side globally?

Well, I think we see -- if there's a macro slowdown, I think that more than anything, helps accelerate some of the adoption of Intelligent Labels. So whether that be looking for more ways to automate your operation, more ways to reduce your inventory, reduce the waste in your operation. As I talked about a few minutes ago, RFID helps enable all of that. So while in the middle of a downturn, you may have some impacts, obviously, if apparel still our biggest segment of that decline, you may have some impacts or you may get some very short-term delays in new programs. But overall, we think coming out of a downturn just as we saw coming out of 2020, it starts to accelerate adoption across different verticals, different customers within the same verticals as well.

There's a follow-up question from the audience on the competitive landscape. I mean, clearly, this is a low-growth industry for the most part when you see this type of growth with the margins that you've been delivering, the risk of new capacity coming on, CCL, for example, as a competitor.

Well, CCL is a large customer, generally, not so much a competitor. Are you talking IL in particular?

Both. Both. Yes.

I think overall, we continue to -- as I said, invest ahead of the curve. We've got the strongest teams, the strongest capabilities in the industry and certainly is from an Intelligent Labels perspective, given the opportunities there. It's not as though we expect no competition to be there. So we're investing, we're building there. We feel great about our capabilities and know that we can win. And we know there will be competition that's natural in a growing space that delivers strong returns like we have. So we're confident, though, in our ability to continue winning there.

Maybe we can switch to Vestcom. What that's added to your portfolio? Maybe you can update us on any commercial synergies the business has generated?

Yes. So Vestcom is largely -- just to back up a second, Vestcom creates price labels for retail, largely in grocery, in drugstores and dollar store type of environments. So they're really managing a significant amount of price changes. So every week in a grocery store, for instance, about, I think, generally 30% -- 25% to 30% of the prices change. So Vestcom is delivering real-time price updates to each store in a sequence that they can walk through the store and quickly relabel their pricing. So they've opened a lot of channels there. They deliver, as we've talked about when we made that deal strong EBITDA margins above our average, and they didn't want to do that because they add a lot of value to their customers. They don't just create a price ticket and sell it to you. They create a price ticket that allows you to very quickly and more efficiently change prices in your store. And that's allowing us to really think differently about how we approach some of our business as well and think more about the value we're creating for our customers. In particular, we're leveraging some of their know-how and insights into the grocery channel as we think about Intelligent Labels and grocery and how can we help ensure, help customers in the grocery side again, manage the freshness of the products, turn their produce or their baked goods more quickly and things like that. So really, the insights there. We've really integrated very well with our Identification Solutions business, which is part of RBIS as well and really leveraging those together quite effectively now.

Okay. In terms of the capital allocation portion, let's talk about your balance sheet strength. Obviously, we're in a very different environment in terms of interest rates versus what we've been used to in terms of buybacks with low cost of financing across the markets and so on. How do you sort of plan to adjust your capital allocation, if at all?

Yes. So broadly speaking, our capital allocation strategy isn't changing. We feel very good about the strength of our balance sheet, where we are now. We've got ample capacity to continue investing in the business organically, as I talked about that we've already been doing. Continuing to look for M&A opportunities. We just talked about Vestcom from a year ago, which was the largest deal we've done in a long time. Our balance sheet is very strong to continue looking at opportunities to keep growing that high-value segment portion of our business. And that's really where all of our M&A dollars have been going over the last many years. At the same time, we continue to have capacity to return cash to shareholders, continue growing our dividend, continue looking at buybacks. And you know from history that we look at buybacks is generating a return. So when we see a period where the share price is decelerating, maybe we'll be more aggressive on buybacks and vice versa in a period where it may be accelerating. But for us, we'll continue to deliver a return through our buybacks, and that's how we would think about that. So nothing changing from our strategy, how the macro plays out and how that shifts may shift where we allocate our capital in the near term, but our strategy stays the same over time.

Maybe you can touch on some of the variances for 2023 as it relates to FX and interest expense and so on.

Sure. So yes, just where the dollar has gone over the last I guess, quarter and half year so, certainly see some headwinds from a currency perspective. I want to say that's about $0.50 next year, a little bit of headwind from interest, as you just talked about. And but we still have strong opportunities. We've talked a little bit about Intelligent Labels. We expect that to grow in the coming years in the 20% plus range. Continue to feel good about the business. We get through this cycle of some inventory reduction now. And I think that puts us in a good footing as we head into 2023. Where the macro go in 2023, we'll see how that plays out. But we feel like we'll be in a really strong position to weather a downturn, just as we've shown in the past and come out much stronger or to continue growing if we don't see much of a downturn. So we feel good about just where we are there from that perspective and our ability to grow through multiple cycles next year.

In terms of what you and Mitchell talked about in the past in terms of scenario planning, right? Clearly, we're in a more uncertain macroeconomic backdrop. You've also had a tight labor market that everybody has had to cycle through. Labor is scarce for a lot of different businesses. How would you manage through a downturn?

Yes. So I think we showed in 2020 the playbook that we have there, and we -- in the short term, we had a few number of -- or a few buckets of actions, I would say. One is around volume. So if we see volumes come down, our biggest labor-intensive business is our apparel business. If we see volume come down there, we'll look at short-term actions, whether that be reducing overtime, temporary labor, those kind of short-term labor actions. We use these opportunities if volume comes down to also just as we did in 2020, accelerate some footprint actions. So we accelerated a number of actions we had on the table into 2002. If we see a scenario like that now, we'll look to accelerate some actions we've maybe been drawing up for the future as well. At the same time then, just as we did in 2020, we'll look at belt-tightening type of actions we'd call it as well. And then, of course, incentive compensation and things like that shake out in that type of an environment. So there's a number of areas in 2020. I think we pulled out about $135 million of short-term cost to manage in that environment. And our playbook is pretty similar going forward. And we'll continue to work that depending on where we see the macro go over the next couple of quarters.

In terms of anything you'd want to highlight from a sustainability aspect across your portfolio, a lot of these customers have made all these grant proclamations over time and so on and...

Sure. I mean a big part of our focus from an innovation perspective is around sustainability, particularly -- I'll hit IL again very quickly. But when you look at waste reduction. That's a big focus of how our Intelligent Label Solutions can help reduce waste across a number of different markets, whether that be food, as we talked about, reducing excess apparel garments, eliminating extra trips and things like that from a logistics perspective, whatever it may be, reducing waste is a big part of how our products can help enable sustainability. At the same time, within our LGM business, a lot of our innovation effort is going around how do we help enable sustainability of packaging, help enable recyclability of packaging, help use less material and packaging, et cetera. So that's where a lot of our innovation focus is going, particularly on the LGM side. And then on the RBS side, really about enabling waste reduction as well.

And in the context of maybe the consumer trading down across your purchase patterns and so on, just generically, how would that impact your business?

Yes. I think over time, you may see that in certain spaces, but I think that nothing different happening in the near term that I would say, versus what's happened with that over the past. And our focus, again, is on shifting the portfolio towards these higher-value areas. So areas where we think we have more growth opportunities, areas with generally higher variable margins as well. So as our portfolio has gotten more into those areas, I think we see less of that impact in the near term as well.

Okay. Great. Maybe just to kind of close this out in the interest of time and the bad microphone optics we have here. Just give us the audience the pitch. I mean, what is -- what are they buying when they buy Avery Dennison. As you kind of think about the next 5 years, you've been in the role about 5 years and there's a lot of momentum across the various categories and so on. But maybe just close us out with the pitch.

Yes. So I'd say a number of things. So one, we compete in strong markets, markets that are growing, markets where we have a strong leadership position. So our position is by far, a market leader in each of our key markets that we're playing in, those markets are growing. We're investing in those markets to continue growing those. We've got strong strategies. We've been executing against those strategies over the last many years. You've heard us talk about them, whether it be growing in high-value segments, continuing to drive productivity, et cetera. So we're continuing to execute very well against those strategies and continue to evolve our strategies where we need to continue driving in the future. We've got a great track record. You can look at what we've delivered over the last many years throughout different challenges in the macro, we've continued to deliver and continue to come out stronger. And we've got this great balance sheet to continue investing throughout a downturn as well. And then we've got great people. Certainly, our people have been a big reason why we've been able to deliver through so many challenges over the last couple of years. So really great markets that we're in. We have strong leadership positions in those markets. We've got the right strategies, and we're executing well against those and we've got a great team. So I think all those things together will help us lead to really being confident in our ability to deliver value creation in the future.

Okay. We will close that out here. The breakout session will be on Salon A on this floor and the next presenter here will be SiteOne Landscape company.

All right.

So thank you so much.