CCL Industries Inc. (CCLB) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen. Welcome to CCL Industries' Second Quarter Investor Update. [Operator Instructions] The moderator for today is Mr. Geoff Martin, President and Chief Executive Officer; and joining him is Mr. Sean Washchuk, Senior Vice President and Chief Financial Officer. Please go ahead, gentlemen.

Good morning. This is Sean Washchuk here. I'd like to thank everyone for joining us on our second quarter investor update. We're having some challenges with the website right now. So, in order to view the slide, everyone will have to go to our website, cclind.com and go to investors, drop down menu and then to investor presentations and download our second quarter investor update presentation. And from there, I'll guide you along through our deck today. So, moving to our Slide 2, our disclaimer regarding forward-looking information. I'll remind everyone that our business faces known and unknown risks and opportunities. For further details of these key risks, please take a look at our 2021 Annual MD&A, particularly this section risks and uncertainties. You can also refer to our second quarter report for updated risks and uncertainties. Our annual and quarterly reports can be found online at the company's website, cclind.com or on sedar.com. Moving to Slide 3, our financial summary for the 3 and 6 months. For the second quarter of 2022, sales increased 14.9% with organic growth of 10.9%, acquisition-related growth of 4.8%, partially offset by almost 1% negative impact from foreign currency translation, resulting in sales of $1.62 billion compared to $1.41 billion in the second quarter of 2021. Operating income was $247.8 million for the 2022 second quarter compared to $235.5 million for the second quarter of 2021, a 6% increase, excluding the impact of foreign currency translation. Included in this figure is a $3.5 million noncash acquisition accounting adjustment to fair value inventory for the acquisition of Adelbras in the quarter. Excluding this adjustment, operating income improved 7% excluding currency translation. Geoff will expand on the segmented operating results of our CCL, Avery, Checkpoint and Innovia segments momentarily. Corporate expenses were up for the quarter, principally due to higher expense for long-term variable compensation versus the prior year quarter. Consolidated EBITDA for the 2022 second quarter, excluding the impact of foreign currency translation, increased 7.3% compared to the same period in 2021. Net finance expense was $15.4 million in the second quarter of 2022 compared to $14.1 million in the 2021 second quarter due to an increase in total debt outstanding this year versus last year. The overall effective tax rate was 24.4% for the 2022 second quarter compared to an effective rate of 25.5% recorded for the second quarter of 2021, primarily reflecting a higher portion of taxable income earned in lower tax jurisdictions as well as a U.K. tax legislation that was enacted in the second quarter of 2021 that increased the prior year tax rate. This effected tax rate may change in future periods depending on the proportion of taxable income earned in different tax jurisdictions with different rates. Net earnings for the 2022 second quarter were $163.4 million, up 8%, excluding foreign currency translation compared to the 2021 second quarter. For the 6-month period, sales increased 16%, operating income increased 5%, net earnings increased 6% compared to the 6-month period in 2021. 2022 included results from 12 acquisitions completed since January 1, 2021, delivering acquisition-related sales growth for the period of 4.7%, organic sales growth of 10.8% and foreign currency translation was a headwind of 1.7% to sales. Moving to Slide 4, our earnings per share. Basic earnings per Class B share were $0.91 for the second quarter of 2022 compared to $0.86 for the second quarter of 2021. Adjusted basic earnings per Class B share were $0.94 for the second quarter, a record -- quarterly record compared to adjusted basic earnings per Class B share of $0.89 for the second quarter of 2021. The change in adjusted EPS to $0.94 was primarily attributable to an $0.08 advance in operating income, $0.01 increase from equity contribution from our joint ventures, partially offset by $0.02 negative currency translation, $0.01 from increased finance costs, an additional $0.01 from our adjusted tax expense year-over-year. Moving to Slide 5, free cash flow from operations. For the second quarter of 2022, free cash flow from operations was $115.1 million compared to $94.7 million in the 2021 second quarter, reflecting an improvement from cash flow from operations of almost $42 million, partially offset by an increase in net capital expenditures for the comparable periods. In the 12 months ended June 30, 2022, free cash flow from operations decreased $165 million compared to the 12 months ended June 30, 2021. This decline is attributable to an increase in net working capital, coupled with an increase in net capital spending for the period. Moving to Slide 6, dollars returned to shareholders. During the second quarter, the company renewed a normal course issuer bid or a share buyback program to the buyback program that expired in May of this year. Under this new bid, the company may purchase up to 9.9% of its public float of Class B floating shares up until May 24, 2023. This is all subject to the normal restrictions of the TSX. During the first 6 months of 2022, the company repurchased almost 3.4 million shares at an average price of $58.95, for total proceeds of $200 million. Including the 14.3% increase in the 2022 annual dividend in February of this year, dividends year-to-date have amounted to $85.4 million, representing 26.7% dividend payout ratio. Moving to Slide 7, our cash and debt summary. Net debt as of June 30, 2022, was $1.76 billion, an increase of approximately $515 million compared to December 31, 2021. The increase is principally a result of new borrowings to finance the company's acquisitions during the first 6 months of this year and dollars needed to repurchase shares under the aforementioned buyback program. Although the company's net debt increased, the balance sheet closed the quarter in a strong position. Our balance sheet leverage ratio was approximately 1.47x, increasing from 1.06x at December 31, 2021. Liquidity is still robust with $634.3 million of cash on hand and USD 0.8 billion of available undrawn credit capacity on our revolving credit facilities. The company's overall finance rate was largely unchanged at approximately 2.43% at June 30, 2022, compared to 2.42% at December 31, 2021. The company's balance sheet continues to be well positioned as we move through fiscal 2022. Geoff, over to you.

Thank you, Sean, and good morning, everybody. Hope you all are managing to follow slide. Sorry about the webcast [ issue ] this morning. Now I'm on Slide 8, to kind of look at capital spending for the year so far, $190 million net in disposals, [ exactly half ] what we planned for the year, $380 million. Slide 9, highlights for the CCL segment, a very good quarter in this part of the company. 10.9% organic sales growth, largely price-led. Some -- a little bit of volume growth but largely pricing. North America up high single-digit, Europe up double-digit, Asia Pacific up mid-single digit and Latin America up more than 30%. Very strong quarter in our Home & Personal Care business and Healthcare & Specialty, offset tough comps at CCL Secure. And in CCL Design, our sales were up but profits are still impacted by lockdowns in China and soft demand in the electronics sector. Sales were up at the Food & Beverage business. The profitability gains, they were held a little bit by inflation. Slide 10 highlights our Joint Ventures. Very good quarter, an excellent quarter, in fact. So, we're pretty pleased to see that. Slide 11 highlights the results of Avery. Strong trajectory in this business continues, especially in North America, where we've seen a big recovery in name badges. Not quite yet a full recovery because we're still seeing some slowness in the convention space, but sports events and other forms of events are back to normal. Noncash acquisition accounting affected the Avery result as Sean already mentioned, to the tune of $3.5 million [indiscernible]. Raw materials inflation and elevated freight/component costs from China pass-through was successfully implemented with supply availability in this business is still challenging. Slide 12, highlights for Checkpoint. The MAS business had a tough quarter actually. We saw declines in all regions, except Latin America, but both at a very strong prior year and our profits were impacted by China freight and component inflation and lockdowns in the country, which affected our large supply farm that's based in Cana. The Apparel Labeling business on the other hand, had another exceptional quarter, exceeding expectation, 25% organic growth driven by RFID and augmented by the Uniter and Tecnoblu acquisitions. So, 1 soft story at MAS and 1 strong story at ALS. Slide 13, Innovia. 2 stories again here. Volume was up in the Americas, but down in Europe and the sales gain was largely price pass-through to inflation. The down story was really all in Europe, where we had higher-than-expected energy and freight inflation and the cost of the new line start-up in Poland, all 3 of which impacted profitability in the quarter and accounted for all the decline in the quarter. Profitability did increase in the Americas. This was held by the revaluation of inventories as resin declined and we also saw higher freight costs in North America. Slide 14, our outlook comment for the coming quarter. Final price pass-through initiatives is now being implemented to benefit the core CCL Label business where we had some lag and that will definitely benefit the second half of the year and the orders picture remains very solid. CCL Design outlook is still dependent on the chip availability recovery, especially in [indiscernible] and consumer demand holding up in the electronics space, where it's been a little bit soft recently. Recent acquisitions are additive. Comps at CCL Secure ease significantly to the second half. Avery volume should continue to improve and augmented by recent acquisitions. Checkpoint RFID growth at ALS is also expected to continue with the softer MAS picture in broad retail may well continue in the second half. We'll have to just wait and see. Innovia sales likely to decline on lower resins, so resins been dropping in the last 3 months of today's purchase prices. And we have to balance the freight and energy in Europe to match the second half of '21 profitability. We are working on both of those things. Company-wide, our China operations are back to near normal. The demand in the country overall remains soft. Okay, operator, with that, we'd like to open the call for questions.

[Operator Instructions] And the first question today is coming from Mark Neville from Scotiabank.

Maybe first, just on prices, just so I'm clear. For all the freight increases that you intend to do sort of, for now?

There's a little bit of lag in a couple of parts of the businesses. So, there the 3 areas of lag you can think about, Food & Beverage in the CCL space. We've got some lagging contracts there that we can now fix. So, we'll have benefit of that in the second half. Tecnoblu MAS, the freight and component cost inflation increases going through particularly in Europe in the second half. So, we've got some energy, energy and freight transportation, [indiscernible] pick up in Europe, but they are not terribly material. I would say we passed on 85%, 90% of the inflation we've received.

Maybe just on the regional differences that you're seeing in the CCL segment, is that more to do with sort of rate inflation in terms of geographies and the mix?

Well, the Latin American situation is really about share gain in some part of the business. So, that's one of -- is high it is. I think in Europe, it's definitely -- inflation in Europe has been running at a higher clip than it has in the U.S. So, that's probably comment about the contrast in Europe versus the U.S. for sure. And also in Asia, where it is running at a much lower curve.

In terms of sort of volumes and demand picture, I was just curious how that differs regionally? If there's a marked difference between sort of what you see in Europe and sort of North America and in Asia? I guess, it feels with the economic data [indiscernible]?

Yes, I would say the strongest region right now for us in North America. Europe is actually in pass and Asia is actually in pass, especially in China. So, it pretty much mirrors what most of our customers are saying. The North America has held up pretty well, some bothersome data coming out of Europe and also from parts of Asia.

I know that's helpful. Just it gets blurred by the price. But that's super helpful. Maybe just one last one for me then. Maybe just on NCIB, I just ask on from sort of mid-50s to mid-60s. I'm just curious if you intend to be as active.

We'll have to wait and see.

The next question is coming from Stephen MacLeod from BMO.

Just on the CCL segment, you had really nice EBIT performance there. And given the fact that most of the growth was from price, I would have thought you'd see a little bit of EBIT margin pressure. So, I'm just curious if you can talk about some of the drivers on EBIT in the CCL business in Q2?

Well, 2 of our bigger businesses in there, HPC and Healthcare & Specialty did particularly well. And I would say, they've done particularly in North America, done probably the best job of the price pass-through. So, very little lagging inflation in those 2 parts of the businesses. So CCL Design is more of a mixed story because we recently had the impact of the chip problem. Demand was soft in automotive, demand was soft in electronics and in food and beverage, we had some contracts where we had inflation lag. And then at CCL Secure, we had a very strong EBIT quarter last year with very high margins. We had higher sales this quarter but mix was very challenging and sort of above the average for the company that -- is going to be versus last year.

So, mostly, sounds like mostly mix and price related. On the MAS business in Checkpoint, it sounds like you expect some of the softer resale impact to continue in H2. I'm just curious, do you expect it to worsen? Is your sort of your guidance based on what you're seeing today?

What we're seeing today. I mean, it's broad retail. So, we sell it to all kinds of store operators in the MAS business. So grocery, pharmacy chains, all those changes you see in the mall, but it's really broad based retail. And we're certainly seeing some slowdown in sales globally and North America, not the largest reason in that business, so -- Europe is. So, some softness in Europe and some softness in Asia, partly due to the lockdowns in China.

And then just finally on Innovia, obviously, with revenues lowering, you're talking about sales being impacted. Would you expect the back half EBIT to be flat given what you see right now? Or are you sort of guiding to it potentially being lower at this point?

I think it depends on how well we do with the energy and freight situation in Europe. That was the main problem this past quarter. I mean we still got the startup cost of the line in Poland. That wasn't terribly material but the freight and energy catch up on that, making sure we've got enough recovery on that -- in that pricing is important in the second half. If we do that, I think we'll be okay. If we don't do, we'll have a repeatable of what happened this last quarter, but we're working on it. I would expect to see some sequential improvement, maybe doing as well as we did this time last year and the squeeze inventory we're going to have, might be difficult.

And the next question is coming from Walter Spracklin from RBC.

This is [ Louis ] on for Walter. I know we ask you this every quarter, but any change to the M&A line state? Is market volatility prompting any new sellers? Are valuations still elevated?

No change.

This one is on CCL. So, organic growth in CCL Core segment has been solid and your outlook sounds optimistic. How far would you say you have visibility on demand? And any view as to sustainability beyond that direct line of sight?

Well, it's a short lead time business and in large file. And you know, we have visibility for about 6 weeks. But we don't see any anecdotal change in circumstance. So, [indiscernible] is still very much focused on supply availability than anything else. So, supply chain issue is still remaining in many areas of packaging and customers are more focused on making sure they dominate when they need it. That's the biggest issue right now.

The next question is coming from Adam Josephson from KeyBanc.

Geoff, you just, in response to the last question, you just talked about how supply chain problems are leading packaging buyers to keep their stocks up yet in the earnings release, you talked about supply chain problems easing globally. So, can you help me square those 2 things?

Well, the supply chain is still relative. So, it's not as bad as it was but it's still terrible compared to how it was a year ago. So, is it better than you -- is it looking like it's improving? Yes, it is? How is it compared to a year ago, terrible? So, our key raw materials, precious raw materials technically needs to wait with 3 days to get an SKU raw material from the supplier and then you wait 6 to 8 weeks. [indiscernible] But it has some of the pain points we are experiencing, the UBM strong, particularly, obviously over with some of the pain points are easing but compared to how it was in what the last time we call it normal, is still pretty difficult.

But do you see that -- I'm sorry go ahead Geoff.

No, go ahead.

Do you see that easing further in the weeks and months ahead? I mean there's no other event like the [indiscernible] right? So is there anything that sticks out to you that would suggest to you that these problems will significantly further ease in short order?

Well, yes, I would say, but we're certainly seeing some signs of easing. And also you're seeing that in deflation rather than inflation, resins and aluminum. And so -- and things are a little bit easier than they were. But I think paper is a big question. So, paper supply industry in the U.S. and all these conversion to box board, paper supply in the U.S. has become challenging just in general.

When we look at your CCL segment organic growth and try to compare it to historical when we've been in recessionary periods, it's fluctuated anywhere from, call it, flat to up 5% to 6%. But this time, it's distorted with all the price increases related to all the inflation. How would you characterize your volume trends now compared to what you've seen in past recessions? I think you said your volume was slightly up in the second quarter and I assume you're expecting something similar in the third quarter. Can you just frame what the volume trends you experienced are compared to years past and recessions past?

Well, it's a very different economic outlook compared to how it was in the last one where we had -- the last big one was the global financial crisis of '08 and '09, which was a real recession, unemployment and all the rest of it. So this time, we have a technical recession and GDP decline of 2 quarters in a row. But you still can't find people and unemployment is at record levels. So, it's an unusual -- an unusual situation. And on top of that you've got supply chain constraints that you didn't have in the last recession. So, it's very hard to read what's actually going on underneath it all. But if you look at the results of our customers, most of the sales increases that we saw were exceptions, but a lot of them were price-led rather than volume-led. So, we look at that quite closely and following quite closely. And the outlook is probably like it's been this quarter. Could be a little bit of volume growth, yes, but not much.

And on the price pass-through initiatives that you talked about earlier, how much inflation did you actually recover in your CCL business in the first half? Just trying to understand how much more growth one should reasonably expect year-over-year in profitability given whatever additional price recovery you will have had along with all the other benefits, the easier comps in CCL Secure, the acquisitions in CCL Design, et cetera?

It's very hard to measure -- to measure that in the label business, because it's millions of transactions with all shapes and sizes. So, you can only really intuitively guess, really Adam. So, it's very, very hard to answer that numerically. All I can say is volume is up slightly in the last quarter and we got healthy volume situation unlikely to change for the second half of the year.

But for the -- presumably, the price cost relationship will be more favorable in the second half than it was in the first half?

Yes, yes. But don't forget, we got a little pass-through arrangements and the things that are really dropping like aluminum will be passed on pretty much real time. So, it's kind of a loss on the bottom line really.

And just one last one, Geoff, on RFID. Can you talk about what -- from your seat, what the penetration is in apparel and other markets compared to what it was, say, a year ago? And has your thinking or outlook changed with respect to the long-term opportunity you have in RFID?

Well, most of us like everybody in the industry today are in apparel. And apparel has been -- is the 100-pound gorilla in the room of RFID and it's still continuing to grow. And the technology is still continuing to develop. So, the full factor of RFID is also beginning to change. So, not just the rollout of RFID, it's the form factor that's using. So more use of [indiscernible] specifically. And so we still think we are in the early to mid-stages of RFID growth and I haven't seen a lot of change in that comment since last quarter. We are getting quite excited about opportunities outside of apparel, but they're all in niches and there's lots of them. So, the challenge there is to finding out, making sure you've got the last mile of the business development and sales and marketing activities and the products properly priced to make a real profit in that part of the business. But we are excited about it.

And the next question is coming from Ahmed Abdullah from National Bank of Canada.

You managed to deliver strong result of about 11% organic growth in the first and second quarters of this year. Given where you stand and all the moving pieces and how passes have gone and inflationary pressures, can you be thinking about a similar level of organic growth in the back half of the year?

We have to wait and see. I mean we've got some resin and aluminum are both dropping quite significantly. So we definitely won't see the same rate of growth in -- at Innovia in the second half of the year because resins are dropping. And where we've got pass-through arrangements like in our aluminum can business, this also have been dropping, we're going to see impacts there. So, the bottom answer is no, I don't think we'll see the same rate of organic growth because I don't think we'll have as much inflation in the second half. What the number will be, I wouldn't like to say it.

And at Avery, you highlighted that you saw a bit of pull forward as the back-to-school season is on earlier than usual start this year. Can you perhaps quantify how much of a pull forward that may have been? I mean will we still see a bigger third quarter in the year for this segment?

Well, typically, the big month is the big month for the back-to-school shipments is July, but this year, it was in June. The pull forward was really from June into May. So, first time, I'm going to remember back-to-school shipments beginning in May. So, they started in May, accelerated in June, July was below what it was for July last year. So, we're expecting to see some pickup in August because the reorders are much more organized this year. The retail industry had a calamities back-to-school industry last year in all retail. So, retail, they're much better organized this year. So over the season, if we look at it over the season, we're expecting sales to be up. But I think there'll be more in Q2 this year than was this time last year and less in Q3 than this time last year.

And on the Innovia, the sales decline, given the lower resin prices, are you thinking more sequentially or versus last year as well?

Sequentially.

Sequentially. Okay.

I think the outlook is last year but we'll have to wait and see.

The next question is coming from Michael Glen from Raymond James.

Just to start, if we're looking at CCL Design and we're thinking of the automotive business there, can you give some sense as to how much below trend or how much opportunity for upside there might exist there?

Well, it's about 300 -- little over $300 million in sales. The [indiscernible] added a fair chunk to it. And it's still difficult in automotive. So, there's still got lots of problems with OEMs, rescheduling production, past availability. So, that's the big challenge in automotive. And it's disrupting our operations everywhere, particularly in the U.S. and not very big in China, but particularly in the U.S. Europe seems to be better. So, Europe is performing better than North America. That's probably the best color I can give you.

And is the bigger exposure for that business overall, is it in -- it's in North America versus Europe?

Well, no, we have the [indiscernible]. No, no, Europe is the biggest in automotive.

And then for the MAS, there's -- the stories we read about increase -- you talked about the grocery and the pharma broad exposure and then we read stories about increased use of security products by expanding line of items. Are you seeing any of that come through in your results?

We see that in the CCL space not in, not in Checkpoint or MAS. If a pharmaceutical company wants to use RFID, those revenues would appear in the CCL segment on the Checkpoint.

By putting -- like we read these articles about people putting security products around meat and stuff like that. Are you...