Masco Corporation (MAS) Earnings Call Transcript & Summary

Good afternoon. Thanks for joining us with the afternoon session of our second day of our 14th Annual JPMorgan Homebuilding and Building Products Conference. My name is Mike Rehaut. I'm the senior analyst covering the sector for the firm. And we're excited to have with us Masco Corporation and CFO, John Sznewajs. We have a presentation and slides available on our website that John will walk through. That will be followed by some questions by myself as well as the ability to field questions from the audience. [Operator Instructions] You can submit a question that way, and I'd be happy to pass that along to John. So John, I want to thank you and Masco for participating once again. We always appreciate it, and the floor is yours.

Thanks, Mike, and good to see you again, and thanks for having us at the conference. It's always been a terrific conference for us. So good afternoon, everyone, and thanks for your interest in Masco. What I'd like to do is, like Mike said, I've got a short slide presentation that I'll walk through. So let's turn to Slide 3. And as you can see on the slide, our portfolio consists of 2 strong segments. And let's start with the $4 billion plumbing segment that's on the left side of the page. And we believe we are the largest manufacturer of plumbing fixtures in the world. 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 a must-have position with their channel partners, including the home centers, plumbing wholesalers, showrooms and e-commerce partners. In addition to Delta and Hansgrohe, we have several other companies in the segment, including Watkins, world's leading outdoor spa business, which has seen really strong demand since the pandemic; and BrassCraft, which manufactures brass valves and is well known by plumbers. Turning to the $3 billion Decorative Architectural segment on the right side of the page. Behr is the largest company in this segment, which makes paint stains and other coatings for both DIY consumers as well as professional painters, and we've had a strong initiative to drive our professional painters growth in conjunction with our channel partner, The Home Depot, over the last several years. And in addition to making Behr-branded paint, we also make KILZ, the leading primer brand in North America. We have 2 other businesses in the 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 Masco over the years into a company of lower-ticket, repair-and-remodel products that will perform well through the cycle. And we leverage our scale, consumer insights and strong channel relationships and our Masco operating system to make our businesses better together. Now let's take a look at Slide 4. We have delivered exceptional financial results with a strong portfolio of companies. Since 2016, sales have increased 6%, while EPS has grown at a 24% compounded annual growth rate. What makes these businesses so strong? There are 3 critical components to our success, the first of which is on Slide 5. 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 and in paints and primers; and Kichler in lighting. Next, on Slide 6. We support our strong brands with investment in innovation that results in approximately 30% of our sales in 2020 coming 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 channels, partners, stores, showrooms and websites to purchase our products. As you can see from the slide, innovation can take many forms, including new products such as Hansgrohe's Rainfinity shower and Behr's new spray paint offering or feature benefits such as Behr's simple pour lid and Delta's voice-controlled kitchen faucet. And turning to Slide 7. Our products are found everywhere consumers want to shop. This means we are not only in all channels of distribution, including retail, wholesale and e-commerce and specialty dealers, but we are also accessible in all price points as we have a good, better, best offering in all of our major product categories. Turning to Slide 8. Coming off an incredibly strong 2020, the fundamentals of the repair/remodel industry remains solid. The 2 principal drivers of demand for our products are home price appreciation in existing home sales. The most recent data on each of these has been very strong. The other factor 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. And Mike, as you know, we've been waiting for this to happen for many years. We believe this will support the remodeling industry for years to come. Turning to Slide 9. On our recent first quarter earnings call, we updated and increased our outlook for 2021. We are expecting overall top line growth of 10% to 14%, up from our original expectations of 7% to 11% with operating margins of approximately 17%. Breaking this down into a little bit more detail, we expect organic growth of approximately 7% to 11%, which is above our expectations for market growth. We also expect the 3 recent acquisitions we completed at the end of 2020 will have an additional approximately 2.5% to our growth, and another 1% will come from foreign currency translation. Margins will be slightly lower than in 2020 due to the acquisitions and acquisition accounting as well as reinvestment back into the business as compared to 2020. We expect this reinvestment back into the business to be at a more normalized rate during 2021 since we implemented significant cost-containment measures during the pandemic in 2020. And finally, we now expect our 2021 EPS will be in the range of $3.50 and $3.70, up from our original estimate of $3.25 to $3.45. Now turning to Slide 10. 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 have remained unchanged here in 2021. Our top priority is always to reinvest in our business to drive organic growth. Fortunately, our products are not capital intensive, and CapEx as a percent of sales runs between 2% and 2.25%. And we are also very efficient with working capital as working capital as a percent of sales generally runs around 16%. Second, we want to maintain an investment-grade rating for us, and for us, that translates into gross debt-to-EBITDA at less than 2.5x. We finished Q1 2021 with this metric at less than 2x. The balance sheet is in great shape. Third, we look to maintain a relevant dividend, and we recently announced that our Board of Directors increased our annual dividend to $0.94 per share, representing a 68% increase. This increase takes our payout ratio to approximately 30%, and we expect it to maintain it at that level going forward. And then finally, we use the remainder of our significant free cash flow for share repurchases or acquisitions. We announced a new $2 billion share repurchase authorization in the first quarter and repurchased approximately $300 million in shares in Q1. Now I'd like to update you on our view on share repurchase activity for 2021. We recently received approximately $160 million in cash for our preferred instrument in cabinet works. As a result, we now expect to deploy approximately $960 million to share repurchases, subject to market conditions and acquisitions for the full year 2021, up from our prior expectation of approximately $800 million. Finally, given the strength and resiliency of the portfolio in a low-ticket repair/remodel focus, coupled with our strong brands and strong cash flow, we introduced our long-term growth algorithm earlier this year. It's a pretty simple formula that we believe will deliver significant shareholder value. It all starts with above-market growth of our business. We believe the repair/remodel industry grows at roughly GDP plus 1% or 2%, and we expect our businesses to outpace market growth. We look to supplement this organic growth with acquisitions that will add between 1% and 3% to our organic growth. Through the execution of our Masco Operating System, we look to drive operating margin expansion through 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 these actions will drive annual -- average annual EPS growth of approximately 10%. Add to that roughly 1% to 2% in dividend yield, and that leads to shareholder returns of 11% to 12%. We believe this is a compelling and powerful model. So I want to thank you for your interest in Masco. Mike, that concludes my prepared remarks. I'm happy to take any questions.

Great. I'm going to, like I said, ask some questions, and then we're also happy to have questions from the audience. [Operator Instructions] I'd like to start with some of the comments towards the end of the presentation, John, around some of the long-term goals. You mentioned margins, perhaps, in the tens of basis points of annual expansion. This is actually an improvement from an outlook a year or 2 ago from your last Analyst Day where you talked about maybe margins being at your long-term goals and the difference really behind the improved outlook being more around the fact that you see a better market growth backdrop today. I was hoping you could kind of review where you see the incremental margins in each of your 2 businesses. And to the extent that those incremental margins are more meaningfully above where the current margins are, I would suppose the difference in that, not necessarily flowing through all the way, would be your view around incremental investment and supporting the top line. So I was hoping you could walk through some of the puts and takes to that, the incremental margins in the businesses and how that flows through.

Sure. Sure, Mike. So as we think about incremental margins, and I always think about incremental margins on volume. It probably breaks down a little bit differently by segment. So if you think about the plumbing segment, I'd say those incremental margins are probably in the 30%-or-so range. And then on the Decorative Architectural segment, it was probably closer to the 25% range. And so if you blend the 2, just given the different sizes of the business, we're probably in the high 20s in terms of our incremental margins. And to your point, that's -- to my earlier point as well, that's on volume. And so that's not always going to drop all the way through to the bottom line because you do need to make some investments to support that growth. And as you well know, following the company for as long as you have, we've been making investments in a variety of places across the enterprise to continue that growth, some of which is easily identified in terms of the growth we've seen in the pro plumbing, pro paint initiative that we've had with Home Depot where we've been investing heavily in head count to drive the growth of that business. And now as you know, we have about $0.5 billion business as a result of the investments we've made. But then the market is changing. We've seen some changes in the consumer demand and where they are shopping, and we've seen some more -- a significant uptick in e-commerce given the pandemic. And so we've made some investments in technology, in people, in analytics and even in the back-office side of things in order to get product out the door on a onesie-twosie basis, whereby we have our distribution logistics better honed to serve individual consumers. So all that investment has been required to react to the change in the way consumers are shopping. So those investments will continue. Don't know -- I can't foresee exactly what they all look like, but those are the types of investments we continue to make to grow the business.

I'd also like to hit on acquisitions as one of the components of your top line formula. And you recently completed 3 bolt-ons over the last quarter or 2, those being Kraus easy sanitary solutions and Work Tools International, expect to contribute about 2.5% to the top line, net of the HUPPE divestiture. I was wondering if you could give us an update on how those are progressing. And as you look to the future, do you see similar types of bolt-on opportunities across your businesses of this type of size? Or are there even medium to larger-sized opportunities?

Yes. Mike, so the 3 -- a couple of questions in there. The 3 transactions we completed, Kraus, just to give a little bit of background. Kraus is the leading digitally native brand in faucets and sinks in the online category. So digitally native meaning, they've never sold through any other distribution other than online. Easy sanitary solution is a high style drain business over in Europe. It complements very much the Hansgrohe brand. And then Work Tools International is a paint applicator business that complements both the Behr and the KILZ offering. And so those transactions, Mike, to your first question, they're on plan. It's early days, obviously. We're about quarter -- just over 1.5 quarters into them. But they're right on the business cases that we outlined for them when we made the acquisitions. And so we like how the businesses are performing. The integrations are going very well. And so those are -- we feel really good about how those are performing. In terms of how we're looking at the acquisitions going forward, right now, given the way the market conditions are, and I would guide you to think to -- that we would continue to pursue acquisitions similar to what you just saw. So smaller, closer to the core, very strategically aligned acquisitions that we can either integrate into one of our businesses or potentially might be standalone. Because, right now, Mike, the way we see things, the valuations in the upper part of the market are quite rich right now. Obviously, the debt markets are very good. Private equity has got a lot of money. And so it's tougher to get the good returns as you'd like to see with the larger transactions. And so I think in the near term, which you'll see us focus on these smaller transactions where we see, one, better value; and two, better opportunity to create value through the integration that we're able to do.

Great. Great. No, that's helpful. Maybe just sticking on the topic of acquisitions. You mentioned Kichler earlier as part of the Decorative Architectural segment. That's a business that was kind of more of a new business for you when you acquired it a few years ago, I believe, about, I want to say, 2, 2.5 years ago now. It's gone through some change, and I think most recently, you've kind of highlighted that it's been more hitting its stride, contributing to top line growth. So I was hoping maybe if you could give a kind of a quick review of what's occurred with that business, maybe some of the earlier headwinds and challenges that it had, where you feel it is now and how you see that business as part of the portfolio going forward. And to the extent that it continues to demonstrate momentum, could there be add-ons to this business as well?

Sure. Sure, Mike. So just for everyone's background, we acquired Kichler back in March of 2018. And we ran into some headwinds really in 2019 with the tariffs that were coming out of China because I think many people know that most of the lighting sold in the United States is manufactured in China. So we bore the brunt of that, and that created significant headwinds for the company as we had to put through some significant price in order to offset some of that. On top of that, we took a hard look at the footprint that we had. And as a result of some of the headwinds, we did some footprint consolidation, which we completed in the first part of 2020. We shut one of our facilities and consolidated that activity into one of our existing operations. And then the team down there also took a hard look at people and processes and really doing a lot of revamp there, taking a delayering of the management team down there. And then they started to invest back into the product, which is what we would like to do at Masco is make sure we've got relevant and innovative product in the marketplace. And so the products that the company has recently come out with have resonated well with your channel partners, both on the retail side as well as in the traditional lighting side. And so in our Investor Day, Analyst Day in 2019, we laid out a path whereby 2020 would be the year of turnaround for this business, and then 2021 would be the year that it pivots back to growth. And we're effectively on that plan. We perhaps started to see the growth a little bit earlier than we anticipated in that the company grew in the fourth quarter of 2020 and then saw additional growth in 2021. So we like how the company is positioned. There's still work to do there, like we're not done. And so as a result of the work not being yet complete, we're not ready to declare that we're ready to add on to this company yet through acquisition. We want to see them complete the work, get the company on solid footing and get it executing well before we burden the management team with a new acquisition.

Okay. Great. One of the channels you highlighted was the e-commerce channel. And I know that's kind of been an increased area of focus by yourself and your peers and broadly in the building products space with most of the companies we follow. I actually -- I thought I saw it in your slides that it said it represented about 9% of your sales. I actually had 12% in my notes. I actually believe that's 12% of plumbing in 2020. So maybe you could kind of review, just for the people here, your positioning in the channel across both plumbing and paint, how you see e-commerce continuing and where that percent might be for plumbing and, to the extent it's possible, for paint over the next few years.

Yes. Mike, so maybe a little bit of context here. So if you're able to take back to 2019, e-commerce represented about 5% of total company sales. And to your point, it's now 9% of total company sales in 2020. And as you suggested, it's a little bit higher than that. It's 12% in the Plumbing Products segment, and that's because it's an easier product to shop and ship as compared to paint. Yes. So we've seen nice growth in there. And we actually -- through the Kraus acquisition, we added to our e-commerce sales. That's not really included in our 2020 figures because we acquired that business at the very tail end of 2020. And so before we acquired Kraus, before the pandemic, we were quite certain that Delta was the leading online faucet company. The sales were quite strong. And based on the data that we had, we were outpacing our competition. And obviously, we're adding to that through the acquisition of Kraus. We feel like we really are well positioned in the online e-commerce channel because we've got strong brands that we can use such as Delta, but then we also have the digitally native brand in Kraus. And so we think that, that will continue. We're continuing to invest in there. As I mentioned in my prepared remarks, we have to invest in technology. We have to invest in people and analytics, but we also have to invest in our operations to ensure that we can ship small packages one at a time as opposed to the way we traditionally would ship product pallets in the way. So that investment will continue because we do expect the consumer behavior that we've seen through the pandemic to continue to seek inspiration, shop and then ultimately transact online. On the paint side, to your point, Mike, it's been a little bit less of an impact on the paint business. Consumers are still a little bit leery to select color online. And the way we've gone after that, Mike, is we are now offering 8-ounce samples that you can buy online. And so if you've narrowed your color selection to 1 or 2, maybe 3 colors, we can send you the 3 8-ounce samples. You can apply a small portion of them to the wall or whatever room you might -- you're painting, and then finalize your color selection and either shop online, and we'll send the paint to you. Or if you choose, you can go to the local Home Depot to pick up the paint.

Great. Great. And is that ability of the samples and the online portion of Behr, is that through a Home Depot website? Or is that a Behr website in and of itself?

So you can either purchase the samples and order paint either through the Behr website or the Home Depot website. What ultimately happens, as you know, we're closely integrated with The Home Depot. And the transaction page is actually a single website, Home Depot site. But through our website, you can end up on that transaction page. So that's how integrated we are with Home Depot on the paint side.

Right. Right. Maybe taking a step back now in terms of broader industry question around just demand trends post-COVID. I'd love to hit on that. Before I do, let me just remind the people that have joined us that -- we only have one question here in the queue. But happy to -- and we'll pass this along. It actually kind of looks around my demand question. But for anyone else, again, just a reminder, we have about roughly 10 minutes left to this presentation session or fireside chat session. If you'd like to ask a question, feel free to click on the Ask a Question button. So yes, I believe -- I'll just ask the question that I see on the screen. It's very similar to mine. It's around repair and remodel spending. You talk about the market growing 100 to 200 bps above GDP on average. The crisis obviously driven significant outperformance. How do you plan for this business on the other side of the crisis? In other words, once we kind of get out of this very strong period, obviously, you raised your 2021 organic growth outlook to 7% to 11%, I believe. So how should we think about this going forward? Should we kind of revert back to that baseline type of growth? Or by contrast, has this crisis kind of created more of a stronger level of demand and stronger level of growth that might continue in '22 and '23?

Yes. So Mike, we think that the demand is strong, and I know it should remain strong and for a couple of reasons. One is the fact that as we look at the underlying drivers of our revenue, it really comes from 2 main macroeconomic factors. One is existing home sales, and then the second is home price appreciation. And as you know, Mike, both of those have been very strong over the course of the last couple of years. But home price is up high single to low double digits and depending on the measurement periods you're looking at. And then existing home sales continue to be strong, even though they may have pulled back in the last month a little bit, but they're running at a rate that's $1 million plus higher than we've seen over the course of the last several years ago. It's approaching $6.5 million, $6.6 million existing home sales in the United States. And that bodes well for us because we know when a consumer transacts, buys a home, one of the first things they do is they paint a home. And so that gives us the confidence that there should be good demand for our products. The other thing that we're seeing, Mike, and I mentioned in my prepared remarks a little bit, and I think you and I have been around this industry long enough, we can both attest to it, is we've been waiting for the millennials to engage in housing for some time. It seems like the pandemic, the thing that finally caused them to get engaged, moved out of the city centers, moving out more into single-family homes. And as we look at that 90 million cohort coming through the system, it's really just been the front end of them that have engaged in housing. And so we think that, that in and of itself will create sustainable demand for years to come. So we've got -- great. The one time my dog barks. Yes, we think that creates sustainable demand for a long period of time. And the only thing we've seen out of the millennials is that they are becoming more engaged in DIY projects. We saw that during the pandemic last year. We did some work that we saw about 30% of the painters last year were first-time painters. And all that, half were millennials. And so we think -- and the other thing we've learned is once someone engages in a project, they're much more likely to engage in a second DIY project because they've gained that confidence that they can actually execute on these projects. And so we feel really good about how demand is shaping up for both the near term as well as the next several years.

So in that context, the other part of the question was you're not necessarily seeing the person kind of framed it as 3 or 4 years of growth all rolled into one and that there might be a hangover effect in '22. You're kind of saying by contrast, what a lot of people are saying, not just yourselves, in the industry is that they're kind of viewing 2021 as a new starting point and growing off of that level rather than any kind of mean reversion or kind of working below the long-term curve for a little bit.

Yes. Mike, I would tell you, as we looked at our demand over the course of the last couple of years or last year or so, a lot of the activity that was done last year were smaller DIY projects because the consumers were pretty like contractors in their homes. And so they took on those projects themselves. What we're hearing from the field is that there's a fair amount of backlog of larger-ticket projects that are backed up, either bathroom remodels or kitchen remodels or home -- whole-home renovations. And maybe give you a little anecdote here. I was talking to my neighbor who wanted to just bump out his kitchen a little bit. Had a contractor come over and said, "Hey, look, I'm hopeful we can get this work done before the snow flies in Michigan. But if not, we'll get this done starting in April of next year." We're sitting here, that's 11 months out. And so if contractors in Michigan are that backed up, I got to imagine that the similar things that are playing out across the country.

Right. Great. No, that's fair. We actually got another question from the audience around comps. Home center comps maybe slowing a little bit, still obviously extremely high, extremely robust. But the question here is that paint was called out by both Depot and Lowe's, I guess, as a -- somewhat of a category that was slowing even to a greater rate. And the question is, is this an area where we might see promotions return? Obviously, in a lot of different areas, pricing power has been very strong, and promotions and discounts. Another example has been appliances that have been almost nonexistent on the retail front. As things moderate, would this be an area where promotions might revert to the mean?

Yes. That's, Mike, really up for the retailers to decide. Well, we participate in the promotions, and we partner with Home Depot on their promotions. They are the ones that really set the promotional cadence. That said, last year, they pulled back on it for all the right reasons. They did not want to drive large volumes of consumers while the pandemic was developing into their stores. And so we fully supported them and their decisions to not to promote paint during that challenging time. As things start to open up and things relax, I'm certain they will reevaluate that. But again, it's -- that's for them to decide. We will happily participate and support them in their promotions. But probably more to come on that, a little more in the next several weeks, several months.

That's great. Great. Well, that actually kind of takes us right towards the end of the time slot or about a minute or so. So I want to thank you, John and Masco, for participating today. It's great to see you. I look forward to seeing you next year in person, if not sooner. We are going to continue the program at top of the hour with TopBuild, which I know you're familiar with and followed, in turn, by Installed Building Products and Green Brick Partners. Again, John, thanks. Have a great rest of the day, and we'll see people on the webcasting back at top of the hour. Thank you.

Thanks, Mike.