Masco Corporation (MAS) Earnings Call Transcript & Summary

Good morning. Thanks for joining us. My name is Mike Rehaut. I'm the Senior Analyst for the Homebuilding & Building Products franchise for JPMorgan. We're pleased to continue our morning, second day of our 13th Annual Virtual Homebuilding & Building Products Conference. We have with us John Sznewajs, CFO of Masco Corporation. Masco, a leading building products company, undergone through some transformation over the last few years, now with 2 core segments anchoring the portfolio in plumbing with its core Delta brand as well as Decorative Architectural where it's anchored by the Behr paint brand, the exclusive brand of Home Depot as well as having Kichler Lighting and Liberty Hardware, among other smaller companies. John has provided -- Masco has provided some slides that he'll walk through. Following which, I'll ask some questions to the company. And we also have, as a feature of the conference, our Ask a Question function. So we invite people in the audience to type in their questions, and I'll be able to relate those and convey those questions to management as well. So without any further ado, John, floor is yours.

Thank you, Mike, and good morning, everyone. There is a -- an accompanying slide deck, as Mike mentioned. And so I'll start my comments on the third slide. So as Mike mentioned, many of you may be aware of Masco and our history but not particularly familiar with the transformation the company has gone through in the last 5 or 6 years. So what I thought I would do is start with a little bit of a discussion on the transformation that we've gone through and then get on to the business that we're seeing today. So the transformation has been a purposeful one, with the intent to create a significantly simpler and more focused portfolio of low-ticket repair/remodel companies that are market leaders with strong brands, broad distributions at higher margins that generate strong free cash flow and tend to be more resilient through the economic cycle. We complement this unparalleled portfolio with a consistent and balanced capital allocation strategy. So when you compare the portfolio today versus the portfolio when Keith Allman became CEO in 2014, you can see some remarkable changes to the company. As Mike mentioned, we have reduced our segments from 5 to 2 through the spin-off of TopBuild back in 2015 and then the recent divestitures of our windows and our cabinets businesses. We have reduced the cyclicality of our business by reducing our exposure to new home construction as now approximately 90% of our revenue is generated by repair and remodeling products. We have enjoyed 650 basis points of margin expansion in the portfolio reshaping activity that we've completed. And we have redeployed our strong free cash flow generations and proceeds from the dispositions to repurchase approximately 20% of our outstanding shares, while at the same time, we have strengthened the balance sheet by paying down over $650 million of debt. So turning to Slide 4. Here's a great snapshot of how the portfolio looks today by reporting segment with a good breakout of both our end market and geographic exposures. Starting with plumbing, we believe we are one of, if not the largest manufacturer of plumbing fixtures in the world. We have 2 very strong faucet and shower companies with Delta Faucet here domestically, with Hansgrohe, our global brand that is headquartered in Germany. We lead with these companies through their strong brands and robust innovation capabilities, both of which provide each company the must-have position with their channel partners, including the home centers, plumbing wholesalers, and showrooms and with our e-commerce partners. In addition to Delta and Hansgrohe, we have several other companies in this segment, including Watkins, the world's leading outdoor hot tub and spa business, and BrassCraft, which manufactures brass valves and is well-known by plumbers. Turning to our Decorative Architectural segment. The largest company in this segment is Behr, which Mike mentioned is a supplier to Home Depot, which makes paints, stains and other coatings. In addition to Behr, we also have the KILZ brand, which is a leading primer brand in North America. And one of the things that we've been doing over the course of the last several years, historically, we have been very focused on the DIY consumer through our partnership with The Home Depot. But more recently, in the last 7 or 8 years, we have partnered with The Home Depot to expand our relationship with Pro painting contractors. So those contractors that come into Home Depot to buy their paint. We have taken that business to over a half a billion dollar business at the end of 2019. So we've seen some very significant growth on the Pro side of our -- of the business in conjunction with the -- our channel partner, The Home Depot. So let's turn to Slide 5 and talk a little bit about our response to the COVID-19 issues that we're facing. So first and foremost, our top priority is the safety and well-being of our employees during this unprecedented time. In early March, we formed a cross-functional COVID-19 task force to coordinate our response across the enterprise. We have employed some of the best practices and followed the guidelines from the World Health Organization and the Centers for Disease Control and Prevention, including when work remotely, staggering our shifts, modifying work areas to ensure proper social distancing, enhancing our cleaning practices and taking measures to ensure that sick employees stay home. We have also been focused on community outreach. Supporting the communities in which we live and work has always been part of our culture here at Masco. And several Masco businesses had assisted local charities and frontline health care professionals by purchasing and donating protective equipment, such as masks and sanitizers and by making in kind product donations. In addition, we as an organization have committed $1 million to nonprofit organizations that are helping to meet the urgent needs of the communities near our business units. Yes. So we're extremely proud of the employee -- our employees. They've worked hard to keep each other safe and to serve our communities. The second big priority that we've been focused on is to ensure that we're meeting the needs of our customers and the end consumers during this difficult time while maintaining the highest levels of employee safety. And our businesses continue to provide essential products, though, as we mentioned on our first quarter earnings call, certain facilities had been shut down during the month of April and continue to be shut down, to some extent, here in the month of May. Additionally, we've seen a number of our big-box retail customers place restrictions on the number of customers in their stores. We've seen restrictions on the sale of certain product categories in various states and closures of distribution outlets, all of which will impact our sales in the second quarter. It didn't have much of an impact on our first quarter results. So now let's take a look at how we are approaching the current environment and how it impacts our outlook. So I'm now on Slide 6. From a business standpoint, in addition to our commitment to the safety of our employees, we're really focused on 2 things. First is maintaining our strong liquidity. And secondly, we are ensuring that we are well positioned to win in the recovery. Our liquidity remains strong. And at the end of the second quarter -- or in the first quarter, I should say, we made a liquidity of about $1.8 billion. That includes the full availability of our $1 billion revolver. But at the same time, we're actively reducing our costs and conserving liquidity by cutting our discretionary spend. We've implemented both a hiring and a wage freeze across the enterprise. We delayed discretionary capital expenditures, and we have announced the suspension of our share repurchase activity indefinitely. Our goal here in the near term is to ensure that we're able to support our customers in any scenario the most cost-efficient way possible. While we are focused on the short-term cost control measures during this time of the pandemic, that said, we remain committed to driving long-term growth, and we'll continue to invest in our brands, in innovation and service to ensure that when the recovery comes, that we are in a position to win. So let's turn to Slide 7. Without a doubt, we are in dynamic and uncertain times and accurately predicting the depth and duration of the impact of this pandemic is very challenging. Based on what we have seen since our Q1 earnings call in late April, I'd like to update you on how we are currently thinking about the second quarter. So the plumbing business in Q2 is on track with our expectations. Our facilities that were closed are starting to come back online in the timeframe that we had anticipated. So we continue to expect Q2 sales in the plumbing segment will be down 30% to 35% compared to the second quarter of 2019. And this does not represent a change to what we communicated on our Q1 earnings call. However, in the Decorative Architectural segment, we continue to experience strong demand for paint. We now expect paint sales -- or the Decorative Architectural sales in Q2 will be approximately flat to last year. Now this is better than what we communicated in our Q1 earnings call when we expected Q2 Decorative Architectural sales to be down in that range of 5% to 10%. So for the total company, we now expect sales in the second quarter to be down between 15% and 20% from the prior year. Previously, on our Q1 earnings call, we said that Q2 sales will be down in the range of 20% to 25%. So you can see an improvement there. Further, we now expect decremental margins for the second quarter will be in the range of 35% to 40% as compared to the decremental margin range of 40% to 45% for the second quarter we communicated on our Q1 earnings call. Again, an improvement upon where -- on our decremental margins compared to where we were just several weeks ago. So Mike, some good news that we're seeing here in the month of May, thought I'd share that with everyone. And that will conclude my prepared remarks, we can turn it over for Q&A now, Mike.

Great. Thanks so much, John. Appreciate the update, and you took away my first 2 or 3 questions I was going to be hitting on. So -- and certainly, some good news and consistent to a degree with what we've been hearing, obviously, around the continued strength in North American retail. So that's very encouraging. I was hoping to maybe press my luck or press our luck with, as always, with Wall Street, you give us a number, we ask for 5 more numbers. So I think the comments around some of the updated sales trends are very encouraging, very positive, very helpful. Just to try to get a sense of maybe talking a little bit more about plumbing and then paint. Certainly, North American retail, as alluded to before, continuing to do pretty well, particularly in the big-box. What you're seeing in paint suggests continued strength or perhaps even improvement as we go into May. What type of trends -- if you could kind of give us a sense either by POS in April versus May, what you're seeing so far in paint. And then to contrast that to plumbing where you're still seeing kind of more of a similar trend that has resulted in you more reaffirming or reconfirming your expectation for down 30% to 35%.

Yes, Mike. So a couple of things there. In terms of -- I'll leave it to our channel partners to comment on POS. I mean I don't think that we're in a position that we should be commenting on that too much. That said, recall that on our Q2 earnings call, when we gave our Q2 sales guidance for the Decorative Architectural segment, we did say that we were up against a tough comp just given the nature of the load in that we experienced in the Q2 of last year. So we thought that would be a little bit of a headwind. Obviously, we're seeing good sell-through, and so that gives us the confidence to increase the Q2 sales views that we gave earlier. It's obviously stronger than what we were experiencing and we thought we've experienced when we had earnings call several weeks ago. So we feel good about how we're positioned as it -- I don't think we were ready to give out specific numbers yet in terms of percentages, increases that we're experiencing at this point.

Okay. No. I appreciate that. I guess, though, maybe zeroing in on plumbing, as I said earlier, I mean, we have started to see some sequential improvement from early April -- late March, early April, into the second half of April and even further into May. Now the plumbing business, there are a lot of moving parts of that business. You've had the spa business, which has kind of dragged down results because of the facility closures. You talked about North American retail actually performing a little bit better or your North American plumbing -- core plumbing business with Delta doing perhaps more in the 20% to 25% range down. Obviously, there's a European component as well. But what have been the factors that have maybe resulted in that down -- overall down 30% to 35% staying on course as opposed to showing a little bit of improvement like you're talking about in paint? And we just heard earlier in the morning from Stanley Black & Decker, they're being a little bit more optimistic kind of raising that sales outlook. You were able to do it in Decorative. What are the factors that are kind of holding back and creating the down 30% to 35% to be reiterated?

Yes. I think there's a couple of things, Mike. As I mentioned in -- as we work through the slides, as we consider our hot tub business, the $100 million sales decline that we talked about on our Q1 earnings call, it looks like that's going to be the case. I mean we -- the facilities that had been shut down are slowly starting to come back up online but exactly on the timeline that we kind of had anticipated. So that has not changed our view whatsoever. And then as we look -- as you mentioned earlier, about 40% of the segment sales are in Europe, are non-North America. And some of the larger markets there have been -- were depressed when we talked on our Q1 earnings call a couple of weeks ago and continue to be slow to come out of the blocks. If you consider, Germany has been okay for us, but some of the other large markets in Europe, think France, think the U.K. and obviously, even some of the smaller markets for us, like Spain and Italy, all of which have experienced pretty significant sales declines because many of them are still shut down. And so that really -- those guideposts really haven't changed, Mike, at all. And so if you take our spa business and our European business as are playing out just as we expected, and our North American core Delta business is continuing to play out as expected, that leads us to not change the top line guidance for plumbing at this point.

No. I appreciate that. Maybe just to take a step back. I kind of alluded to it in my opening remarks and was one of your first slides around the transformation of the business, pretty dramatic. Obviously, played out very well during this most recent downturn. I mean your relative performance from a stock and valuation perspective speaks for itself. How do you think about the portfolio? Because at the same time, I want to say it's now 18 months ago, perhaps, you made your first acquisition kind of in a new category in Kichler Lighting. How do you think about the portfolio going forward from an M&A perspective? In other words, is -- you kind of had slimmed down from 5 segments to 2. At the same time, you bought a new product category. How are you thinking about the business from an M&A perspective in terms of could you go back to a third segment or the different categories that you're looking at from an M&A standpoint, how should we be thinking about the future of Masco from that portfolio management standpoint?

Yes, Mike, I think as you consider the near term, and for those of you have known Masco a long time, M&A has played a significant role in our history, but the way we're currently thinking about it over the next several years is we would be open to M&A without a doubt. But the focus of that M&A would be very tight. It would be on our core paint and plumbing offerings. And so if you consider, Mike, a couple of the bigger businesses that we have in the portfolio, we've got very strong and capable management teams at each of Delta, Hansgrohe and Behr. And so would we like to support those management teams with their inorganic growth ambitions through M&A? Yes, absolutely, that's something we would consider. But the overriding or overarching criteria that we would follow is we've got to have the right strategic fit and generate the right returns. And I'd say that the M&A environment, just prior to the pandemic hitting, things were -- multiples were quite expansive, and that's probably -- environmentally, we may or may not would have played it. So that's -- as we look forward, those are the 2 or 3 businesses that we'd really support with M&A, mostly tuck-in in nature, but tuck-in because these are sizable businesses, could be north of $100 million. You mentioned Kichler. At this point, Kichler, I think a lot of people know, has had some challenges with its performance. We've done a lot of things to correct those challenges, including doing some of the rationalization there by knocking out one of our distribution centers here early in 2020. At this point, we would not look to add a third leg to our portfolio. Kichler has been a good acquisition, but -- for us, but we need to get it better positioned and immediately focus on their own operational metrics first. And so we have not given them the license to look at M&A at this time. And looking at other product categories, there's nothing that I would consider that we were looking at, at least in the near future, Mike, to be that third leg of the stool for us.

Great. No, that's helpful. And maybe just kind of expanding on this topic for a moment because it was one of my questions that I laid out in our question bank that we published ahead of the conference, you alluded to tuck-in acquisitions and supporting the core businesses. During your first quarter call, you announced the acquisition of a small technology company in the plumbing segment that makes an interconnected shower system, monitors the temperature and flow of water. And the interesting part of the description was around this company from my point of view was that you noted it was adaptable to a wide range of showering products. So to me, that kind of sounds like there's the potential to really expand this across a broader portfolio potentially. So just trying to get a sense for how we should think about this acquisition over the next year or 2, that this is something that is more of a complementary feature that could be added on over time to a select set of products? Or is it something perhaps that could have even a more substantial impact in the marketplace?

Yes. So Mike, as you mentioned, this was a relatively small acquisition for us. And as we think about this business specifically, if you consider technology-enabled products, particularly the ones like this, the main company that they're working with us now on is Hansgrohe. Hansgrohe is more of a premium price point offering. And as you consider electronically or digitally controlled shower systems, they generally are at higher price points. And what we've seen -- what we expect to happen over time is that, that technology gets refined and improved that price points will start to come down. So initially, this company will be very much focused on the more premium price point showers. But to your commentary, we do think, longer term, as consumers want to get their home more digitally enabled, companies like this will enable -- will be able to participate in a more mid and lower price point offerings that we have in our line, but that's probably not going to happen in the next year or 2. That will be a little bit more down the road.

Okay. No, that's helpful. I guess another area that we focused on a little bit is mix in the business. As of the last couple of weeks, you had a pretty negative CPI number that came out, probably the biggest drop, it was reported in the data series history. And over the last year or 2, there has been a little bit of a negative mix shift across a variety of building product sectors to the extent that repair/remodel demand has slowed a little bit at points. Home price appreciation has slowed a little bit at points as well. You've had a millennial buyer come back into the market. Entry-level housing has gained a lot of strength and momentum. So I was curious about how you view mix for the current year if they're -- if you're seeing any negative product mix this year and if COVID-19 has accelerated that given that oftentimes in periods of more economic softness, consumers will shift a little bit to a lower price point as well.

So Mike, if you consider the nature of our products, there's not been a huge amount of mix, partly because we generally offer pretty low-ticket products in terms of the price points. We have seen mix impact us over time. It really started back in 2019 for us over in Europe. As the economy was softening over there last year, we saw a trade down from our best and better products to more of our better and good products. And we've seen that trend continue here in the first part of 2020. As you look across our North American product mix, we haven't really seen any significant mix changes. Even our highest price point products right now, Mike, which are our outdoor hot tubs, we've seen consistent mix there from our spas and can cost upwards of $10,000 to our opening price point spas, which are, call it, several thousand dollars. That mix hasn't changed even through the first several months of 2020. And we are selling spas through the end of March. So -- and the demand that we've seen -- we commented this on our Q1 earnings call with respect to hot tubs. So we've seen -- continue to see good robust demand for those products. And so that mix hasn't changed much there either. So -- and that was a bit of a surprise for us. We thought that we'd see a little bit of mix, but at least to this point, we haven't seen much of a negative mix other than the European mix I mentioned a minute ago.

Right. Right. That's interesting. I guess just last question for me is just kind of returning to capital allocation. Again, one of your first slides talking about reducing the share count. Over the last few years, you've had a significant reduction and significant increase in share buyback activity. And that's been part of the portfolio transformation as well as you've received funds to reduce the share count, return the proceeds to shareholders. As we look past some of the current softness, how should we think about capital allocation going forward? Obviously, I presume that we're still not out of the woods yet. But at some point, things will return to some resemblance -- semblance of normalcy. What should we think about in terms of capital allocation kind of a return to before or might you be more conservative, share repurchase?

Mike, from our perspective, obviously, to be determined yet because we don't know what the shape or the slope of the recovery looks like. But to your point, if we get back to "normal environment," whatever that looks like, and we're continuing our strong free cash flow generation, now our free cash flow conversion of 100% of net income, if we continue that process, I would guide you to think about more of our traditional capital allocation approach, which is fund the capital needs of the business is our #1 priority to continue our organic growth of our existing businesses. But as you know, and you've followed us for some time, that's a relatively small amount of money. We're -- even this year, we were guiding kind of that $140 million, $150 million range. Initially, we've toggled that down to $120 million as a result of paring back some of the capital as a result of the pandemic. We'll have a little bit of a dividend. And obviously, that's at the discretion of the Board, but we think there's an appropriate dividend. And we laid that out at our Investor Day last September that we think about it in terms of a payout ratio in the range of 20% or so. And so I think that would be something that we would consider. And then the balance of that, our excess free cash flow, we look to allocate to either M&A, or to your point, to share repurchase. And in the absence of good M&A, and good M&A being those same 2 principles I mentioned earlier, right strategic fit, right returns. If we can't find anything, are we afraid to buy back our own shares? No, we wouldn't be. And so I think that will be our approach going forward. So I think it's that simple. And well, we've been very consistent in our approach, and I think you'll see that same consistency when things revert back to being normal.

Great. Great. Thank you, John. I think that really does it for me. We're a few minutes early, but just about half an hour through. So majority of the session, and I don't see any incoming questions from the audience, and I asked all of my key questions. So we'll cut it here. Just 3, 4 minutes before the end. So appreciate the time, John. I appreciate the update on the quarterly trends, of course, and the business update. Thanks, again, for Masco, for your participation in the conference. Always welcome and always appreciated being one of the anchors of the building product sector. So it's not a building products conference without Masco. We will resume the conference at 11 a.m. Eastern Time with PulteGroup as followed by D.R. Horton to finish out the afternoon session and then -- finish out the morning session, followed by an afternoon session of Century Communities, Forestar and Jeld-Wen. That's it for me. We'll see you back at 11. Thanks again, John.

Thanks for having me, Mike.

Have a great rest of the day.

Thanks. You too.