Avery Dennison Corporation (AVY) Earnings Call Transcript & Summary

Welcome back, everybody. I'm very happy to be having Avery Dennison for our latest fireside chat. In the audience is John Eble from Investor Relations. If you have any questions, obviously, John, thank you for all you do there. And we have Mitch Butier, Chief Executive Officer of Avery Dennison. Mitch, thanks for being here. As you know, Mitch is Chairman and Chief Executive Officer of the company, who's elected CEO in May of 2016 after being Chief Operating Officer since 2014. Mitch has had a number of senior leadership positions within Avery, and he joined the company in 2000 from PricewaterhouseCoopers. Mitch, thanks for being here.

Great.

I guess maybe to start, you might have some opening comments.

Sure.

And if we could have the slide for Avery, that would be wonderful. Thank you.

Excellent. Well, thank you, George, and thanks for the opportunity to come here and speak with all of you. So yes, just a couple of quick comments, just profile of the company. So we're a $9 billion company focused on branding and information labeling solutions. We're leaders in our 2 primary businesses, which are broken between the Materials Group and the Solutions Group that you can see here. We are exposed to large, diverse and growing end markets, the vast majority of which are in staples. And you can see geographically, we are well split across the globe as well. Now we've got 5 key strategies across the company that have been key to our success of delivering superior returns over time. The first strategy is around driving outsized growth in our higher-value category. So what are higher-value categories? They're areas where markets growing faster. We've got large profit pools, which are important, not just because more profit is better, but it shows a higher points of differentiation and that leverage our core capabilities. And over time, we've been shifting the portfolio mix to being exposed more and more to these higher-value categories. Now the best example of that has been our focus around Intelligent Labels, which we expect to be a $1 billion business this year. This has more than tripled over the last 4 years and been growing 20% organically over the last number of years. We are really focusing on being a leader at the intersection of the physical and digital world, leveraging our capabilities and our market presence in a number of end markets, as you can see, our material science capabilities, our digital capabilities and our process technology. And last and very importantly is our track record. You can see here consistent performance, topline growth and EPS growth. And we've been growing double-digit EPS growth over the last number of years. And these are overriding focus of ours is to drive GDP-plus growth and top quartile returns on capital. That's a recipe for superior value creation over the long run and something we've continued to deliver, and we'll continue to deliver going forward. Now most recently, in the fourth quarter, early part of this year, we commented on, we're seeing some inventory corrections downstream from us. That's causing some near-term disruptions to our financial performance. Overall, as you can see, though, in 2022, we grew our EPS on a constant currency basis. It was up double digit again in 2022. And when we're looking at 2023, we're expecting the second half to be at a run rate of more than $10 a share. So again, continuing that double-digit EPS trajectory. So with that, we'll open up to questions.

Thanks, Mitch. Lots to go through there. To the extent that you can comment, when you've gone through past destocking periods, and I don't remember it happening at this scale for a long time. I think maybe the last time would have been early 2000s after Y2K, and I think this is larger. But from your experience, your observations, maybe smaller destocks that we wouldn't have necessarily seen, how long does it take to get through?

Yes. So the last time we saw it was the financial crisis. So 2009, basically, and so we had seen that. It took 4 quarters to get through, but it was less pronounced than what we are seeing today. And one of the reasons it took 4 quarters is each region was operating a different -- started the impact to each region at a different time horizon. We're seeing both North America and Europe it occurring at the exact same time. And that is due to just the fact that supply chains are more global, and so that's what we're seeing right now. If you look at the cumulative effect of what we've assumed in our guidance and what we experienced in Q4, we're actually -- our guidance assumes a greater impact from inventory reductions, this cycle than we saw in the financial crisis. That's due to 2 reasons. One, we think we started with more inventory in the system at the beginning of the cycle than we did in the financial crisis. We called that a year ago. We said that there was extra inventory in the system, we believe. And that's basically due to when you have a period of scarce supplies, so all the raw material constraints, constant price increases, we were raising prices every couple of months. Customers want to get ahead of that and forward buy. So one of the reasons we -- our guidance assumes more inventory -- correction this cycle is because of that. That's counterbalanced by no one is expecting a recession of the magnitude we had in The Great Recession, if you will.

And would it be fair to say that because in some ways, the destocking cycles are synchronized this time that it may -- you may be able to get out of it more quickly, recognizing no guarantees in life, but...

Yes, that's our expectation. It's more pronounced for a shorter period of time.

And as we think about it, perhaps correctly, perhaps incorrectly, our sense would be there may be more likelihood of the solutions business having a bit slower ramp out of the destocking period just because some of the inventory that might have stocked up last year missed a season, and your customers or their customers will hold it until the next season, whereas materials will be more likely to come in and come out based on just ongoing demand.

Yes. So on the solutions side, it's a little harder to call because the larger piece of that business is tied to apparel. And because that -- the inventory in the system is seasonal, exactly when that will come through is a little bit more of a question mark. Our assumption is like the rest of the business, second half, it will be back at a normalized run rate. That business has 2 seasonal peaks, Q2 and Q4. In Q2, we would see in the coming few weeks what that ramp would look like. And so that is a bit of a question. So that's why when we talked about our guidance overall, we're confident in our ability to deliver the guidance that we provided, but we gave more color on Q1 and the second half. Q2 is going to be somewhere in between.

Got it. Is there anything in the public domain that you would point us to relative to the materials business and the pace of destocking? Again, not trying to get you to get into anything that's forward-looking that you can't comment to.

No, there's not a whole lot of information out there about how much inventory is in the system. What we look at is we know what end markets our products and solutions go into. So we look at end consumption patterns and relative to our own direct demand. And that's where we spotted a year ago. We said we think there's extra inventory in the system. It built up further through the middle of the year, and now the inventory is being pulled back out. So there's nothing specific that we can point to. We do customer surveys, work it through. Again, we said Q1 of this year would look like Q4. And so we basically expect this year to be a bit mirror image of 2022, but obviously, with higher growth in revenue.

I asked this question periodically. Would the pace of the box business give us an indicator for what you might be seeing in the materials business, i.e., if boxes are finally starting to flow again in their shipments, there's some incremental demand? Or is that majority directly, that's right, but that's such a sliver of our market. It's not really indicative?

It's an indicator, but one of many. Our market saw much more inflations, some more supply constraints than other markets. And it's because of that, we had more inventory build than other ones as well.

Got it.

So those are really -- you got to think about why is inventory where it is, and it's those 2 drivers. So we had large paper manufacturer was on strike a year ago. There was some down capacity middle of the year in North America in paper. So those constraints drove customers to want to build inventory as well as our price increases were significant throughout the year to offset the inflation, which we successfully achieved.

At this juncture, the operational constraints, forgetting about demand, those are largely now behind you from what you can see.

Yes, yes. The operational constraints, what George is referring to is with all the demand and some of that was for inventory build when you were basically -- operationally, you had some constraints basically because you're constantly switching over various runs in your manufacturing process because you're running what you can base on available material, and that's all through the system.

We just avoided a long strike in Finland just recently again. So...

A different one, but yes.

Exactly. Exactly. Any questions from the audience to start? Linda is waiting in the back with the microphone. We welcome your questions. If not, we'll keep forging ahead. So in '23, you are up against some challenging organic growth comps, particularly in pricing. Now pricing you had to get through because of the inflation tidal wave that was coming at companies last year and yourselves included. What are you assuming for pricing? What would you have us consider as we continue to refine our models over time?

Yes. So our guidance assumptions, if you look at the high end, 5% organic revenue growth. Majority of that is pricing, and that's carryover pricing. We're not implementing really too many new price increases. That's a carryover, which will impact more at the beginning of the year, and the rest is volume.

And so we've seen this before. I think I know what the answer will be, but I'll ask it nonetheless. So after we -- through a period where there's pricing increases driven by input cost pressure, you start to see the input cost pressure decelerate. Frequently, we see others in the market begin to deal that back. Do you think this cycle will be much different and there's really the hue and cry about whether Avery is losing share or not for a quarter or 2? How do you feel about your ability to maintain and grow share over time through whatever chop we'd get out of that?

Yes. Well, we feel confident in our ability to maintain and grow share. As leaders in our industry, we see an overall focus is the health of the industry, not just the health of our business. So that's being the innovation leader in our space, growing into new markets, new categories as well as obviously growing profitably in our base businesses, leveraging our scale, scale advantages that we have. So your question about what the outlook is, we didn't assume any big shifts around raw material costs in our guidance. We've assumed stabilization overall. If there was deflation, then that would be something that potentially the number of price increases, not potentially -- a number of price increase or surcharges, those would unwind automatically. We're an EVA-focused business, as you know, George, looking at the optimal point of growth, margins and capital intensity. So we're confident in our ability to maintain and further expand profitability across the categories. Your comment about share near term, as the market leader, we are willing to risk share near term for a quarter or 2 quarters to make sure that we are driving profitable growth for ourselves. And we can get that back within a couple of quarters is what we've historically seen. And you don't have to see that just through cycles. That's through just multiple points will happen every few years really when you go through an inflationary or deflationary cycle.

Thanks, Mitch. Any questions from the audience for Mitch? Okay. We'll keep moving ahead. So one thing for you, Mitch. Can you remind us, to the extent possible, what's embedded in your guidance for China in '23 and how it would affect the 2 businesses?

Yes, we expect China demand to start to rebound. So -- and the question is just really when. So it's opening up and everything is what's the ramp curve. And so that's a little bit again the question first half, but we'd expect to see a ramp again in Q2 and then second half. So we expect there to be a rebound there. And the broader question is, what do you think about the macro in general and macro within China? But we have a rebound from comps, to be honest with you.

Remind us, looking at the slide here. So roughly speaking, China, would you say is 10%, 15% of your sales looking at the pie chart? I always think about -- we get the question a lot. Emerging markets are kind of 30-ish percent of materials from what I remember, and China was probably 1/3 plus of that. Is that a good...

It's about 10%, and that's end markets.

Yes.

So for direct markets, it's a bit more because, obviously, a good portion of the apparel industry is serviced out of Asia and China in particular. But relatively small component overall.

Understood. We talked about this already. Is there time in the past when we could look back where we saw materials seeing double-digit declines in volume? Do you have to go back to GFC then for that basically?

Yes. You have to go back to 2009 to see that, and we saw it for a single quarter. Again, the timing across the regions was different. So individual regions would have seen that for a couple of quarters.

And can you remind us what kind of volume run rates you were seeing in both Base and Intelligent Labels and solutions exiting the quarter? Anything that you already commented to already. Again, not trying to get to what you shouldn't, and same thing for materials.

Yes. So the materials was down low double digits we said overall in the fourth quarter. Expect that to continue into Q1 and then rebounding after that. And as far as the Solutions Group, yes, you can see the growth trajectory overall within that business. Intelligent Label, so we do get this -- so that business has been growing 20%, as you can see here on the slide. Over time, that growth can be lumpy because of the timing of deployments of new programs and so forth in individual quarters, which is why we focus on more of the annualized growth rate. In Q4, it grew low single digits. And that was basically because the largest portion of that business is apparels from the destocking going on, apparel was more than offset by growth within new programs.

But you're sold with that slowdown because of the programs and the -- what you know is in the pipeline, you feel comfortable about your target for 2023.

We're expecting more than 20% growth this year. So we had called out the middle of last year. So our target had been 15% to 20% growth within this business organically. And middle of last year, we said we expect for the coming few years a more than 20% growth. So that is because of the adoption of new programs. We've been investing a lot in market development, new technologies to address the big categories of logistics and food, new capabilities within apparel with new woven-in technology. So that's something that we've been investing in and developing, one. And two, we also talked about during COVID that there was accelerating interest in our solutions and technology. And so now you're starting to see that come through as far as the adoption of new programs.

Thanks, Mitch. At this juncture, would it be safe to say that the pipeline is being mostly driven by logistics or mostly driven by food? And I was -- on one of the pie charts that you showed, I think on the last slide deck -- the last quarter slide deck, the pipeline for logistics is relatively smaller. And I was surprised by that because I thought that's where most of the momentum was going. Correct me if I'm wrong on that.

Yes. So the -- if you look at the total addressable market, the largest is in food as far as number of units.

Got it.

And when we laid out our program, our long-term targets through 2025, we said for Intelligent Labels specifically, we said that through that strategic horizon, most of the growth would actually be driven by apparel in dollar terms. Percentage-wise, we'd see much more growth within food and logistics and that we were -- but that was going to be more towards the end of that strategic horizon through '25 and seeding tremendous growth beyond. So what you're seeing now is particularly in logistics, that's been pulled forward. So if you talk about the pipeline chart that you can see in our materials, those are based on programs and so not dollar. We're not sharing dollar revenue. The dollar value of that pipeline is a multiple of our current revenue.

Got it.

And so because the logistics tends to be more concentrated space, you'll have lower numbers within logistics for that reason. It's not representative of the revenue potential.

Understood. Understood. I want to switch gears for a second to materials. And it's nothing that we necessarily can model for. But just curious, what sort of trends are you seeing in terms of technology? What types of adhesives seem to -- or applications are gaining in materials to the extent you can talk, what's not gaining?

The biggest applications that are gaining is, one, within our higher-value categories. So just the continued move towards brands. One, we continue to engage our consumers with micro brands, whether they be craft brands themselves or micro brands within larger brand houses. So just more differentiated label. And you're seeing that in wine, spirits, craft beers and boutique home and personal care products. So that continues to grow. The other area -- another area is really around sustainable products. So renewable materials, being able to reduce just the environmental footprint and enhance the effectiveness of recyclability of the products. This is an area where we started focusing all of our innovation capabilities within materials around increasing the -- just availability of sustainable labeling solutions within our categories. And that has been -- for those who want to look at our ESG objectives, we're making tremendous progress on the circularity of our products as well as reducing the greenhouse gas footprint of the entire enterprise. And we've reduced them by 40% over the last 7 years, our greenhouse gas intensity. And then last is just around e-commerce, so e-commerce labels within materials. So we talk about Intelligent Labels, which is where we're actually managing the data and printing data and largely based on ultra-high-frequency RFID technology where we're the market leader. Within the materials business, we provide base materials and a lot of that is for barcode labels and so forth, which help -- are supported by the large growth within e-commerce.

Mitch, can you sort of dive back into micro brands? And how would -- give me, for instance, in terms of how you're coming into contact with that and what we should be looking for when we see that. And no, it's one of the trends that you're talking to right now.

Yes. So just if you're thinking about spirits, for example, you see a lot of the differentiation is at the shelf, but not just at the shelf, it's a brand that people associate themselves with perhaps. And so the brand imagery, much of what the consumer interacts with is on the actual bottle itself. So it's just people wanting a unique look or feel to what they're providing. And that's something that we will -- that we work directly with the brands as well as with our converter partners to develop.

So the material itself has to be -- able to be utilized efficiently in a shorter run environment and probably absorb inks differently, coatings differently and make a more...

Absolutely. And sometimes, it's more innovation to make it look really old. And sometimes, it's something to make it look very sharp and more modern. So there's lots of different desires. And if you think about the cost of the label and so forth is for the amount of information and brand connectedness it provides is relatively low. So it's something that they invest our time with.

Understood. So can you talk to us about your recession action plan and what's different, what's similar to what you were perhaps doing during the depths of COVID?

Sure. So what's similar basically, so implementing temporary cost reduction actions. That's across the board, one. Two, also when you're in a lower volume environment, it gives you an opportunity, the bandwidth to implement structural cost reductions. And so that's what we're doing. And so that's very similar to what we did during COVID. And even at the time, we had said we're accelerating our restructuring program. So given the low volume environment, particularly in solutions at the time and our more durable categories within materials, we accelerated restructuring programs into that time frame. And so that's what we're doing again on the structural side. That's what we're doing on the temporary side. The temporary cost reductions are lower than what we had called out in the -- during the depths of COVID. And one, because we don't think -- I mean, we're not talking about a major recession here, isn't what we're looking at. And the duration looks like it will be relatively modest overall. So that's what we're working through.

On that latter point, are you basing that based on what the macro's saying, what The Street economists are saying or to the extent that you can share what your customers are kind of saying about that?

It's the macro data. We're seeing the same thing everybody else is. Now our particular business, we've got -- because of the inventory reduction, so we're pulling the belt tighter than we would if we were just going through it like end consumption was. Because our products, as you know, as you can see from the charts here are vastly tied to staples. Our end markets don't move all that much in a recession. During The Great Recession even it was only down a couple points, but it was the inventory where we see inventory reduction through it. And then we call it post-recession bounce. We get a huge surge when people replenish their inventory. So yes, that's what's informing our thinking is just what we're seeing in the macro. And just as you know, we always like to be prepared.

We've seen that over the last decade or so. In terms of the inventory reduction and the stocking up, was it more at the customer level and at retail? Or you also have rolls of material that from your intelligence back in November, December had to have been worked down? Where was more of the inventory that needed to be -- that was in excess from your vantage point?

Our direct customers within materials, so the converter base, but also the consumer packaged goods companies had extra as well.

Okay.

And even we had extra material because when you've got a multi-construction products, you're procuring whatever you can. And so you sometimes have a mismatch of your different categories.

Is there a common point where that roll of material, I know it's going to vary by technology and customer and what have you, degrade with time such that it doesn't really matter that at some point, that roll is no longer usable, and you need to order that next roll?

Not within the time frame we're talking about. The biggest -- it's one of the advantages of our technology is that allows packaged goods, high speeds on high-speed packaging lines but also for you to be able to quickly switch from one brand to the other, just switching a reel. So that's one of the reasons that the cycle time between when our materials are printed and converted to the end CPG, there's not that obsolescence of just printing the wrong material before maybe a new product launch or something else. But no, our products are -- don't have that kind of short shelf life. And the one place you would see is maybe in high environments and so forth. It was more paper, but that's not what we're talking about here.

To the extent that you can comment or remind us, what will be the larger cash uses in '23 in terms of where you're investing? And specifically in IL, is there anything you need to add to build out the product suite or the service offering that you can share that we should be watching for, not dollar by dollar or line item by line item, more categorically.

Yes. So this is a business we are -- we think about capital allocation, we've got a whole spectrum of different businesses, product lines where they fit and within Intelligent Labels is a scenario we are investing and investing ahead of the curve. This is a business that you can see growing 20% and has above-average EBITDA margins. And that's after all the investments in future growth for which we don't have revenue right now. So we continue to invest within Intelligent Labels, and that's both in OpEx. So we commented on $25 million of incremental investments this year. That's OpEx investments. And that vast majority of that is Intelligent Labels around developing new markets, continuing to enhance our innovation capabilities and enhancing our scale. And from a capital perspective, we are also ramping up our pace of investment just as far as manufacturing capacity. And we announced a large investment in a new plant within Mexico. And that's more for growth second half 2024 and beyond. We have enough capacity already for the growth that we're planning on for this year.

Is there much technologically different to the outside observer for an application that would be in logistics versus apparel versus food?

Yes. This is one -- another key area of our strength, similar to what we see across the rest of the company. Our innovation prowess and just leadership enables us to not only innovate the materials but know what innovations are required in each different type of environment. So reading through a shirt is different than reading through a 1-pound stake in a retail store. And understanding what the antenna requirements are, where the label should be placed to get great read rates is paramount to the adoption of the technology. So those are areas, whether it's understanding the antenna design, we have the vast -- tremendous amount of patents around that. If it's understanding -- having RFID-enabled microwave-safe labeling solutions, we have patents around that. If you think about sowing in RFID, which is a newer trend, we've got a new technology where it's basically like a thread, it can just be sown in the garment. And that allows us to expand beyond the traditional use cases of enhancing consumer engagement and managing supply chains for the apparel brands but also moves into electronic article surveillance as well. So yes, there's a tremendous amount of technological innovations here. And one of our key areas of strength is we've actually brought together the scientists from our materials business with our solutions business about 5 years ago to work to develop unique end capabilities because we are uniquely vertically integrated within the space. And with our more than 50% share, we can leverage that scale advantage, not just in production, but in industry know-how, market access and innovation capabilities.

Thanks, Mitch. Somebody was asking us recently where -- what your comments have been about chip supply and how much of a constraint that's been. Is there a need, assuming there was one, two -- or constraint to bring chip manufacturing closer or shortening the supply chain to you. How would you have us think about that relative to what Avery can bring to bear and what Avery is not going to spend capital on?

Yes. So this is -- you can see the resilience of the business. We've had quite a few challenges over the last number of years and the resilience of the business and our numbers. And that's something we provide to our end markets is resilience. And so we leveraged our scale, and we were able to secure chip supply for our ambitions this year and beyond. And so that's something that we are -- we know that once you adopt our technology, each of our customers are dependent upon it. We take that very seriously, and we make sure that we've got the capacity both in terms of raw material supply, including chips, as well as our manufacturing capacity.

Thanks, Mitch. Any questions from the audience for Mitch? Keep -- no questions. Thanks, Linda. Sorry about that. Switching gears a bit -- oh, we have a question in the back. Hang on 1 second.

Just a quick question on the competitive landscape right now. How are you seeing competition with your competitors, market share changes? Kind of speak to that a little bit.

Yes. So overall, in these periods of change, you always have a few pieces moving around. So share perspective within -- and we only have the good information in North America and Europe. And I'm talking about within the materials businesses right now. So share, pretty stable North America. And in Europe, we think we've ceded a little bit of share with all the price increases and so forth. And that's one of the things I commented earlier, willingness to endure that for a couple of quarters to continue to provide the market leadership that we need to. And so we're expecting to recapture that share here in the next couple of quarters, but all within the normal band of what you'd expect.

Thanks for the question. Mitch, I just want to go back. So aside from the fact that you are -- and maybe this is the answer, again, 50% of the market, and you've been the leader in terms of developing RFID and Intelligent Labels for apparel first and now the next markets. Aside from that, what do you do to make sure you have the components and the chips relative to commitments that you keep making, not just for '23, but beyond? Is there anything else that you do to make sure that, that 20% growth curve continues?

It's continuing to innovate, continuing to invest in market development, continue to invest in our capacity. We are investing for the business to be multiples of what it's been, and we see tremendous opportunity. The total addressable market we've laid out is well north of $10 billion. And that's we see -- every place we look, we see opportunities. So we continue to invest in it, and we're excited for all the opportunity that is happening real time.

What are you finding on Vestcom and how that's helping you penetrate food with RFID and IL?

Yes. So the Vestcom acquisition, great stand-alone business, similar to what we had, had in RBIS and the apparel side but more for -- in grocery or retail drugstore, managing data, providing shelf labeling solutions, a great stand-alone business, good growth trajectory, above average margins. When we acquired it, we also saw an option to catalyze growth for Intelligent Labels within food. And they had C-suite access to a number of key retailers in food and drug store and so forth. And so yes, we've got some active pilots going on right now where we're seeing significant opportunity to unlock tremendous value for our customers in those spaces. And it's reducing costs, but not just reducing costs, it's freeing up time of people in the store, employees in the store to engage more with consumers. And it's also enabling a huge unlock for these companies to achieve their own ESG objectives for reducing food waste. So a key objective of ours is to reduce food waste. And if you think about how much bread is thrown away from the fresh bakery section, how much beef and so forth is still thrown away, and you think about the greenhouse gas intensity of beef production, it's quite significant. So this is around, again, improving consumer engagement, reducing costs and reducing the environmental impact of the food supply chain.

Can you remind us within IL overall and perhaps to the extent it may vary across the categories that you're trying to promote, is there much of a service component and data management component to the actual business itself or the component of the business?

Yes. So there's different levels of solution. And so some of the categories within Intelligent Labels are more of a materials play. So if you think about logistics, some of their specialty material handling and so forth, we're providing a solution play around that. But if you think about the vast majority of what you'd get from a logistics company and overnight courier, a lot of that we're providing the base material. So we're providing solution know-how for initiating the program, but the actual revenue model is a little bit more material. Areas like food, it looks a little more like apparel where you're getting data, managing data as well as providing the material. And so there, it's often much more of a solution set. And within apparel, you have more of a controlled supply chain, whereas in food, it's a more fragmented supply chain. So when you look at being able to do track and trace from farm to table and providing that information, that's a key area of opportunity, which is why we've been investing in more and more software and digital capabilities to build on the strength we already have within the apparel and the Vestcom businesses.

And still feel like logistics could be $1 billion plus by 2030 in terms of revenue opportunity for you in IL?

The logistics and others, yes. We...

Logistics and others.

We expect -- well, again, the total addressable market is kind of north of $10 billion. And so you take that and how we're looking to grow, what exactly which product category will be by 2030, but we expect this to be a multibillion dollar business.

So you got 50% share. So we will just take 50% of $10 billion, so 2030, $5 billion?

I didn't say 2030.

I'm kidding. Any last questions for Mitch before we wrap up here? If not, Mitch Butier, thank you very much. Please join me in thanking Mitch for a great presentation on Avery Dennison.

Thank you, George. Thanks, everyone.