Masco Corporation (MAS) Earnings Call Transcript & Summary

Good morning. I'm Sam Darkatsh. And on behalf of Raymond James, I'd like to welcome you to the Masco Corporation presentation, ticker MAS. With us today from Masco is Vice President, CFO, John Sznewajs. For reference, Masco is a global leader in the design, production and distribution of branded home improvement and building products, including Behr paint; Delta and Hansgrohe faucets, bath and shower fixtures; Kichler decorative and outdoor lighting and HotSpring spots. The format of today's presentation will be as follows. The company will have perhaps 10 minutes or so of prepared introductory remarks, followed by a fireside chat Q&A session, which I will host. [Operator Instructions] With that, John, thank you for joining us today, and the floor is yours.

Sam, good morning. Thanks for having us again today. It's hard to believe it was a year ago, we were live, and it was actually my last business trip. Yes. Because now goes the ankle taps and all that. So it's good to be back with you. Let me just -- I'm going to share a couple of slides here, Sam. So let me just get that going. I hope you can see that. Sam, give me the thumbs up, can you see my slides? Good. Thank you. So yes good morning, everyone. Ans let me just -- here we go. So many of you might be familiar with Masco's history, as Sam just walked you through, but might not be current with the company's transformation in the last 6 years. And there's been a purposeful transformation, but the intent to create a significantly simpler and more focused portfolio of low ticket, repair and model products that are market leaders with strong brands, broad distribution and higher margins that generate really strong cash flow and are more resilient to the economic cycle. We complement this unparalleled portfolio with a consistent and balanced capital allocation strategy. So when comparing our portfolio today versus the portfolio when Keith Allman became CEO in 2014, we've made some significant changes. We've reduced our segments from 5 to 2 initially through the spin-off of TopBuild back in 2015, and then also the divestitures of our Windows business in 2019 and our cabinet business early in 2020. In doing so, we have reduced the cyclicality as approximately 90% of our revenue is now generated by repair/remodel products, and we're really within purpose of deliberately diminishing our exposure to new home construction. At the same time, our margins have expanded more than 650 basis points and we've deployed our strong free cash flow generation and the proceeds from our dispositions to repurchase approximately 25% of our outstanding shares. We have done all this while strengthening the balance sheet, by paying down more than $650 million of debt and improving our credit metrics. Our portfolio consists of 2 strong segments. Let's start with the $4 billion Plumbing segment. We believe we are the largest manufacturer of plumbing fixtures in the world. As Sam mentioned, we have 2 very strong faucet and shower companies with Delta Faucet here in the United States. And 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 channeled partners, including the home centers, plumbing wholesalers, showrooms and e-commerce partners. In addition to Delta and Hansgrohe, we have several other companies in this segment, including Watkins, the world's leading outdoor spa business, and BrassCraft, which manufactures brass valves is well-known by plumbers. Turning to the $3 billion decorative architectural segment. Behr is the largest company in this segment, which makes paint, stains and other coatings for both DIY consumers and professional painters. In addition to Behr, we make KILZ, the leading primer brand in North America. We have 2 other businesses in this segment: one is Liberty Hardware, which is the leading retail cabinet and builders hardware company in the United States; and finally, we have Kichler, which is one of the top brands in the lighting industry that serves broad distribution. Together, these 2 segments give us one of the strongest portfolios in the industry, as we have transformed into a company of lower ticket, repair and remodel products that will perform well through the cycle. We leverage our scale, consumer insights and strong channel relationships and our Masco operating system to make our businesses better together. We have delivered exceptional financial results with the strong portfolio of companies. Since 2016, sales increased 6% while EPS has grown at a 24% compounded annual growth rate. What makes our portfolio so strong? There are 3 critical components to our success. It all starts with having the best brands that are covered by our channel partners, professional installers, and most importantly, consumers. We arguably have the strongest portfolio of brands in the building products industry with Delta, Hansgrohe and Axor in the plumbing industry, Behr and KILZ in paint and primers and Kichler in lighting. Next, we couple our strong brands with the legacy and heritage of innovation. Approximately 30% of our sales in 2020 came from products introduced in the last 3 years. We know that customer-backed innovation drives consumers to our websites, to seek inspiration for their projects as well as to our channel partners, stores, showrooms and websites to purchase products. Finally, we are everywhere consumers want to shop. This means we are not only in all channels of distribution, including retail, wholesale, e-commerce and specialty dealers, but we are also accessible at all price points. As we have a good, better, best offering in each of our major product categories. Coming off at an incredibly strong 2020, the fundamentals of the repair and remodel industry remains solid. The 2 principal drivers of demand for our products, our home price appreciation and existing home sales. The most recent data on each of these has been very strong. Another factor that we are particularly excited about is that it appears as if the pandemic has caused the 90 million person millennial generation to engage in housing. We believe this will provide support for the remodeling industry for years to come. On our recent fourth quarter earnings call, we provided our outlook for 2021. We are expecting overall top line growth of 7% to 11%, with operating margins of approximately 17%. Breaking this down in a little bit more detail, we expect organic growth in the range of 2% to 6%, which is slightly above our expectations for market growth. We also expect that our 3 recent acquisitions will add an additional 3% to growth and another 2% will come from foreign currency translation. Margins will be slightly lower than 2020 due to the acquisitions and acquisition accounting, as well as reinvestment back in the business as compared to 2020. We expect this reinvestment back into the business to be at a more normalized level in '21 since we implemented significant cost containment measures during the pandemic in 2020. We also expect that our EPS will be in the range of $3.25 to $3.45. And since our earnings call in early February, we completed a significant bond refinancing. In this transaction, we called our 2022, our 2025 and our 2026 debt maturities and refinance these with a combination of new 7-year, 10-year and 30-year notes. This refinancing accomplished really 2 things. First, it lowers our interest expense. And secondly, it extends the duration of our maturities. From an interest perspective, the net effect is a $30 million annualized interest savings compared to the $135 million of interest expense in 2020. Due to the timing of this transaction, interest expense will be approximately $115 million compared to our previous guidance of $135 million for 2021. And in 2022, interest expense will be approximately $100 million. From a maturity perspective, this transaction also means that we've taken out nearly all of our near-term maturities. And our next debt maturity is not until 2027. Masco's most significant attribute is our ability to generate a tremendous amount of free cash flow. We use this cash to execute our disciplined and balanced capital allocation strategy. The 4 elements of the strategy remain unchanged for 2027 -- or 2021, I should say. Our top priority is still always reinvest in the business to drive organic growth. Fortunately, our products are not capital-intense and CapEx as a percent of sales runs between 2% and 2.25%. And we are very efficient with working capital as working capital as a percent of sales to approximately 16%. Second, we want to maintain an investment-grade rating. And for us, that translates into gross debt-to-EBITDA of less than 2.5x. We finished 2020 with this metric at less than 2x, so the balance sheet is in great shape. Third, we look to maintain a relevant dividend. We recently announced that our Board intends to increase our annual dividend at $0.94 per share, representing a 68% increase. This move takes our payout ratio to approximately 30%, and we expect to maintain it at that level. And finally, we use the remainder of our free cash flow for share repurchases or acquisitions. We recently announced a new $2 billion share repurchase authorization, made our intention to deploy approximately $800 million in share repurchases, subject to market conditions and acquisitions. Finally, we also recently announced our views and our new long-term growth algorithm. It's a pretty simple formula that we believe will deliver significant shareholder value. It starts with above-market growth of our businesses. We believe the repair/remodel industry grows at roughly GDP plus 1% or 2%. We expect our businesses to outpace this market growth. We look to supplement this organic growth with acquisitions that will add 1% to 3% to our organic growth. Through the execution of our Masco operating system, we look to drive operating margin expansion to cost productivity and volume leverage. Now this will likely be in the tens of basis points of margin expansion, not hundreds of basis points. And we will continue to execute our capital allocation strategy of repurchasing shares and increasing our dividend. We believe all these actions will drive annual EPS growth of approximately 10%. Add to that roughly 1% to 2% dividend and dividend yield, and that leads to shareholder returns of 11% to 12%. We believe this is a compelling and powerful model. Thank you for your interest in Masco. Sam, this concludes my prepared remarks. I'm happy to answer any questions.

Terrific. Home Depot last week noted that it expects its comps this year to be basically flat, maybe mildly up. Lowe's indicated that optimally, it would be down maybe 4% or so based on what both are seeing with respect to current demand activity and pricing. This is obviously in contrast to your guidance you just talked about for overall organic sales growth of 2% to 6%, with plumbing up 4% to 7% and deco at flat to up 5%. Obviously, the home centers do not represent all of your business. And there's also a lot of other things going on, for example, channel refill or what have you. But generally speaking, what accounts for the difference between their sales growth expectations for the year and yours? How much of it might be expected channel refill? How much of it is the categories you're in, growing maybe more so than their fleet average? How much maybe new products, share gains, other factors? Just talk about your expectations for growth this year vis-à-vis the home centers?

Yes, Sam. Great question. A lot of questions in there. Hopefully, I can respond to most of them. So just to remind, to your point, Sam, we do have a lot of focus on the home centers, both Home Depot, probably more significantly than Lowe's. But I'd remind you that we're not just a DIY business, we're not just a retail business. As we look at things, starting with the home centers, to your point, they've got their overall comp store growth that they're focusing on. And we do believe some of the product categories that we are in, while pace the overall growth of -- the comp growth of the base site. As we look at we're hearing from contractors out in the marketplace, we're hearing that 2020 was a year where there was a lot of DIY projects that were done. But a lot of the more significant projects were postponed because consumers were less willing to have contractors come into their house. And so with these big R&R projects postponed, we do believe that the growth in paint and plumbing will be quite good in 2020 -- or 2021, I should say. The other thing I would point out, Sam, is there are a couple of our businesses that were also struggled in 2020. I think we've been very open about the challenges that our spa business has had in '21. It was effectively shut down for 2 months in 2020. And we are expecting double-digit growth out of that business in 2021. Europe for a much -- had a much more stringent lockdown than much of the U.S. did in 2020. And so we're expecting better growth in Europe than in 2021. So that's going to be a component of it. So there's a lot of different things that go into it. But we feel confident about the growth forecast that we outlined in our earnings call in which you just -- I just reaffirmed and you just articulated it.

Any color on the first quarter trends so far, including the weather effects, and I'll add just one more question to that as opposed to the litany of questions you heard earlier. You mentioned the Spa business. That's usually a real good leading indicator for activity. It's just such a big ticket discretionary item? What sorts of order trends are you seeing there, too?

Yes. Maybe I'll start with that one, Sam, and then we can touch on the other question. Demand for spas continues to be good. We've got the largest backlog that we've ever had in that business. And it's not just us in the industry having that backlog, it's the entire industry. So it's not as if our capacity limitations are driving share to somebody else, the entire industry is in the same position. And so we feel really good about how that tees up. The other thing that we're keeping a close eye on, Sam, that we think it's going to have a significant impact on demand is the stimulus bill that's in front of Congress right now. I mean if you get $1.9 trillion in consumers' hands, our experience has been -- the U.S. consumer is a hard time holding on to that money. Somehow it makes its way back into the economy. And from our perspective, part of that will end up back in houses, as we think about our business. This is -- the vaccines are rolling out and we start to think about return to work. We're going to probably be more flexible in our work environment going forward, which means that consumers will be staying in their houses longer. And so that probably will lead to continued investment is companies like ours and companies different than ours will continue to have their workers work from home. In terms of what we're seeing in the first part of the year, we don't like to give too much out in terms of the intra-quarter stuff. But I would tell you that the winter weather that moved through did impact sales a little bit. And we do think that, that was more of a creative demand deferral as opposed to demand destruction. So if there's a little bit of softness here in the first quarter, we do think that will be made up in subsequent quarters. We don't think it's -- as a matter of fact, given some of the -- what we're hearing out of Texas, there actually may be a little bit of demand creation because we [ did it on the distance to homes ]. And so I think it's all relatively short term in nature and that we'll move through it here relatively quickly.

It appears -- regarding paint, it appears, Lowe's has been doing much better of late within its paint department. They comped over 30% in the fourth quarter, which looks like it well surpassed that of Home Depot where you're clearly tied to. First, what do you largely attribute this recent outgrowth at DIY retail somewhat away from Behr? And do you imagine that the reaction of Home Depot might be to get a bit more promotional in paint this year, especially given that Lowe's is moving towards an EDLP strategy.

Yes, Sam. In terms of RV in the paint market, we don't think we or Home Depot lost any share as a result in -- from that perspective, there's a lot of moving parts. Recall that a year ago, we were talking about a significant $20 million sales pull forward in our sales. And so we think that had a factor in it. In terms of the retailers' comps or performance, from my perspective, I think that's best for the retailers to address. And to your question on retail and the promotional strategy. For those on the call, many of you may have known -- may know that Home Depot pulled back significantly on their promotional strategy in 2020 because they were purposely and rightly trying not to drive too many consumers to their stores during the height of the pandemic. We do expect them to go back to a more normalized promotional cadence. I don't think it's going to be anything more intense than that we've seen in the past. This all said, Sam, we don't control the promotional environment. This is controlled by Home Depot. So now could this change? That's going to be subject to discussions with Home Depot down the road.

What are your updated thoughts on fiscal '21 gross raw material headwinds? Where are you seeing the most inflation and how are you responding? And I'll include within that labor, shipping costs and insurance, too.

Sure. You're right. There is a lot of inflation that's out there now, Sam. And maybe just to ground everyone as to what we said before. In our fourth quarter earnings call a couple of weeks ago, we said that we thought the overall inflation basket for raw materials would be in the low single digits, and we could be in kind of the mid-single-digit range for our paint raws. And obviously, since that time, we've seen even greater inflation. And so we're doing the things that we would typically do, Sam, to try to mitigate the inflation, while obviously, negotiating hard with our suppliers. We continue to try to drive productivity within our facilities, but then at the right time, we'll have to put price into the marketplace. And depending on how things go. As we've done in the past, we're not afraid to put multiple price increases in if there is an extraordinary amount of inflation. So we're keeping an eye on things. And we'll see how that plays out. I would remind everyone that as they think about inflation, there's a couple of things to consider. In our Plumbing segment, because of the lengths of our supply chain, any raw material inflation takes about 2 quarters or so before it flows through and hits our P&L. It's a little bit shorter than that in our Decorative Architectural segment, it's about 90 to 120 days. And so what may happen is we don't always necessarily perfectly match pricing in raw material inflation. So you may see a quarter or 2 of margin contraction before we put through pricing, and then you see margins expand. And what I got you to think about is, over the long term, our margins have been extraordinarily consistent. We may have a quarter or 2 deviation here or there. But we had very good ability to get price over time. And so we're -- we will handle it. And like we've always done, Sam. It's constantly moving a battle, but the teams are on top of it. I can tell you that.

Is there either a target or an expectation for how much of the inflation would be offset with price? And how much of it from either cost takeout or productivity or other measures?

Yes, Sam, we don't necessarily break that down because it's always hard to tell based on the amount of inflation and how your pricing discussions go with your suppliers. So we probably won't go into that level of detail on this call.

How low do you figure channel inventories are right now versus normal? And by channel, I'm mostly talking about retail, but really throughout the whole supply chain. And at what point do you anticipate either you or other channel participants being able to replenish those inventories?

Yes, Sam. So I should think about kind of, let's call it, the last 6 to 9 months. I'd say the channel inventories are lighter than where they were a year ago. The much better than they were 6, 8 months ago, right? So over the course of the last 6 to 9 months, we've really -- the teams and we have worked hard with our channel partners, both in retail and on the wholesale side to improve channel inventories. That said, as you mentioned earlier, there's tightness in a variety of things, including transportation and logistics. And that leads to some -- still a lot lighter inventories. But we're working hard to rebuild our inventories as we go into the spring selling season. And there's still room for channel fill, but it's not that significant at this point.

And you talked about spas, but what -- this is related, but what are your lead times generally speaking right now versus normal in your primary segments?

So spas are extended. So the spas, our lead times, typical lead times would be in the kind of 2- to 4-week range depending on the spa that you ordered. Lead times now are in the 50-week range. I mean that's how much demand is out there for spas. In terms of our other product categories, the lead times aren't far off, they're typical lead times because we call most of -- unlike when we had cabinets and windows, which were made to order, and their lead times were much more critical because most of our other SKUs are now stacking SKUS. Lead times are less relevant for those because we got really good distribution and logistics functions.

You just completed 3 bolt-on acquisitions. Talk about what each of them bring to the table, how they came about, the status of their integration and the financial effects for this year. And then relatedly, what does the pipeline of M&A look like going forward? I know you mentioned 1% to 3% being a long-term goal for sales contribution. But that can come in fits and starts or big chunks or little chunks, give a sense of what we should be anticipating from an M&A activity.

No, absolutely, Sam. So let's talk about the first 3 small transactions we've just done, and then we'll talk about the pipeline. So you're right. Each of these 3 businesses relatively small, but each complementary to our 3 largest companies, quite frankly. They were all internally generated, right? So this was part of our cultivation exercise that we've been doing over the course of the years. And all 3 came through that mode. So starting with Kraus, which is the leading digitally native brand for plumbing products. And digitally native means the fact that they grew up selling online. They didn't really sell to traditional wholesalers or to the big box retailers. And so what that brings to us is the opportunity to continue to extend our leadership position in the e-commerce channel, but also brings a great opportunity to learn, right? I mean they have been serving online customers and gives us another brand to play with and online channel, which is something that we think is important for us is consumers look to move their shopping patterns more online. The other acquisition in the plumbing segment was Easy Sanitary Solutions. This was one that was completed by Hansgrohe. And ESS manufacturers are those highly stylized, linear shower drains. So if you think of shower drains in the United States, typically, they're square around showers in the center of your shower floor. These are much more high style you typically find at higher-end hotels, little trough drains, things like that. And the beauty of this one is that the principal markets are Germany, the Netherlands. And as you know, Hansgrohe sells into more than 140 countries around the world. And so it's -- and with every shower, the water has got to go out of drain. And so the ability to take the product to Hansgrohe is access to distribution across the world. It's something we can do. Now we're going to start in Europe, where it's close. But ultimately, we'll expand that. And then the final one that we just did is a company down -- in your neck of the wood, Sam, down in Florida called Work Tools International. They make paint applicators. So think rollers, brushes and mini rollers. We go into the brand name Whizz. And it's just a nice complement to both the Behr and the KILZ line that we have. All of our -- our paint has to go on with an applicator, and so it's a nice synergy there. So 3 really good transactions. To your second -- that we think are very synergistic with our 3 largest businesses. To your second question about this status of the pipeline, you're right. I mean this thing go and fits and starts because you can never control when a seller wants to sell. But we're actively continuing our cultivation and think of companies similar to the 3 that I just described, things that are close to the core. In plumbing and paint, that would be complementary to the things that our biggest businesses are doing. As we get better and better at this, Sam, could we extend that to some of our other businesses? Yes. But we want to stick to most businesses that have the strong management teams and the wherewithal to integrate the businesses.

You're a significant repurchaser of your own stock. Should we then assume that pretty much any and all deals would be at multiples less than where the stock will be trading at, generally speaking?

Yes. Generally speaking, Sam, that's the way we like to look at things, right? We like to -- we don't like a premium to our multiple for infra companies that we go out and buy. And generally, markets are a little bit less efficient at the lower end of the price point range. And so we do think there's more value to be had there.

What's the latest with the health and improvements that you've been working on at Kichler, and how would you define success for Kichler, both this year and next?

Yes, Sam. This has been a real success story for us. As we laid out in our 2019 Investor Day, 2020 was going to be a year of hard work and turnaround and 2021 was going to be the year where Kichler pivoted the growth. And quite honestly -- I mean the team down at Kichler done a great job of executing the plan. They've taken out some of the -- one of their distribution facilities, they rightsized the business. They really focused on innovation during the course of 2020, and we started to see some of that benefit. On our fourth quarter earnings call, we remarked that Kichler return to growth in the fourth quarter of 2020 which is right on schedule for the Teron plan that we planned on. And so they're on plan, we do expect to see improved both top line and bottom line performance in 2021. So that's a really positive story for what they've been able to execute on.

And how would you define success for Kichler this year? I mean is it a growth driver? Is it a fleet average.

No, it would be a growth driver, Sam, sorry, yes, I missed that question. Yes, it'd be a growth driver and both on top and the bottom line.

Are there any policy discussions, either positive or negative, that you're watching closely under the new federal administration. And then also, I guess, remind us your current exposure to tariff costs. How much price you pass-through in order to offset those segments?

Yes. So we are watching, obviously, a lot going on in Washington right now with the new administration. There's nothing in particular in terms of things that are being proposed that will directly impact the paint or the plumbing markets that we serve. The one thing that we're obviously watching -- the 2 things , obviously, we're watching very close. One is the stimulus plan because that could have a huge impact on demand. The second thing is the discussion around taxes, and that's been relatively quiet. There's a lot of, I think, other priorities of the administration had here initially. But we're going to keep our ear to the ground as that ultimately rolls out. In terms of your second question...

The tariffs.

The tariffs. yes. With respect to tariffs. Our exposure to tariffs from a dollar basis, about $150 million of tariff headwinds that we're facing the company in, call it, '19 and the first part of 2020. To your part of your question, the pricing is long but put in. We put that pricing in 2019 and the first part of 2020. So we feel like there's not much more to do there for us to the extent that the new administration makes moves on tariffs, obviously, we'll have to react to whatever those might be.

You and your organization do a lot of macro analysis, what drives the consumer, what drives the homeowner, what drives DIY activity. Obviously, interest rates, especially in the tenure has moved pretty meaningfully higher over the past few weeks and couple of months or so. Historically speaking, or is there a good rule of thumb, John, where -- how much of a move in interest rates would it take for it to actually spook consumer or home improvement, and where would you tend to see it first? Would you see it first in the builder channel? Would you see it first in spas? Or what's the canary in the coal mine, so to speak?

Yes, Sam, good question. A couple of things that are going on there. And there are -- to your point, there are a lot of variables that are moving on right now, particularly with the tenure. But as we look at things, the consumers' balance sheets are in pretty good shape. And as the 10-year moves, mortgage interest rates move, that has probably a bigger impact on our -- the new construction portion of the business. But as we mentioned, as roughly 10% of the business. So we're much more focused on R&R. And what we're seeing on the R&R side is that for the most part, consumers to date are using financing for that, right? They're doing that with cash off their balance sheet. So between home price appreciation and their balance sheets, there hasn't been a big factor for us. If you consider the fact that on the repair and remodel side, things that are driving our business, existing home turnover, which has been good, though there's low inventory, which drives on price appreciation. The tick up in rates, as a result, could actually maybe cause more R&R activity because people are more likely to stay in their home. And that could be a good thing. And the other thing that we've been talking about a little bit is if this stimulus package goes through, that could be a driver of demand as well for our own activity. And so we do believe that people will continue to be spending a fair amount of time in their homes, as I mentioned, return to work is going to look very different. I don't know exactly how Raymond James is thinking about it, and we're going to be a much more flexible model than we had been previously. And so I think consumers will be putting money back in their homes for quite a while. We do think that's going to be a good run in R&R for the next several years.

We have a question from the field. When you said that inflation has gotten worse since the call, what specifically are you referring to? And from a margin perspective, will that show up more as a pinch in 1Q or 2Q? Does this put segment margin guidance at risk for either segment?

Yes. So if you look at the broad-based combines , both copper and zinc have continued to inflate since early February as well as some of the inputs to paint. As I mentioned in my earlier remarks, it takes about 2 quarters for any kind of inflation to flow through and hit our Plumbing segment, and just over a quarter for our Decorative Architectural segment. So I don't think there's going to be any near-term impact to Q1 as a result of raw material inflation. That would be later in the year, be a second half of the year impact.

And with that, I think we are out of time. So thank you. John, thank you so much, again, for joining us at the conference. And good Lord willing and the creek don't rise, it will be in person again. Next year, but definitely be well, stay safe and enjoy the rest of the conference and the conversations with our investors.

Great. Thanks, Sam. Thanks for having us. Thanks, everyone.

Thank you, John. Be good. Stay well.

You, too.