Masco Corporation (MAS) Earnings Call Transcript & Summary

Good morning, and welcome to the 2021 RBC Global Industrials Conference. My name is Mike Dahl. I cover homebuilding and building products here at RBC. We're happy to kick off the conference this morning with John Sznewajs, who's the CFO of Masco. John's going to give couple of minutes of overview commentary and then we'll jump into Q&A. I'd like to remind the audience, please participate through the Q&A chat function. I'll be happy to ask any questions that come through. Thanks, and over to you, John.

Okay. Hey, thanks, Mike, and good morning, everyone. Thanks for joining us today to learn a little bit about Masco. So as Mike suggested, what I thought I might do is start a little bit -- start the conference here by just giving a bit of background on Masco in case folks aren't familiar with who we are and what we do. So to kick off, Masco is a -- finished 2020 with about $7.2 billion in revenue. Our portfolio consisted of 2 very strong segments, and I'll start with our $4 billion plumbing segment. 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. 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 which include home centers, plumbing wholesalers, showroom and e-commerce partners. In addition to Delta and Hansgrohe, we have several other companies in the segment, including Watkins, the world's largest outdoor spa business, and BrassCraft, which manufacturers brass valves and is well known by plumbers around the United States. Turning to our $3 billion Decorative Architectural segment. Behr is the largest company in the segment, which makes paints, 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 also 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, there is Kichler with 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 this cycle. We leverage our scale, consumer insights, strong channel relationships in our Masco operating system to make our businesses better together. So what makes our portfolio so strong? We believe there are 3 critical components to our success. It all starts with having the best brands that are coveted 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, and Behr and KILZ in paints and primers. Next, we support our strong brands with investment in innovation, with 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 channel partners, stores, showrooms and websites to purchase our products. Innovation can take many forms, including new products such as Hansgrohe's Rainfinity shower and our recently introduced BEHR DYNASTY, Behr's best paint ever. And lastly, our products are found 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 our major product categories. It's the combination of these 3 elements that leads to Masco's most significant attribute, our ability to generate a tremendous amount of free cash flow. We used this cash to execute our disciplined and balanced capital allocation strategy. Finally, given the strength and resiliency of the portfolio in its low-ticket repair/remodel focus, coupled with our strong brands and 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 businesses. We believe the repair/remodel industry grows at roughly GDP plus 1% to 2%. We expect our businesses to outpace market growth. We look to supplement this organic growth with acquisitions that will add 1% to 3% to our organic growth. Due to 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 average annual EPS growth of approximately 10%. Add to that roughly 1% to 2% in dividend yield, that leads to shareholder returns of 11% to 12%. We believe this is a compelling and powerful model. So Mike, that concludes my remarks. Let's jump into the questions.

Great. Thanks, John. That was helpful. So I want to kick it off. We are starting to get some audience questions, but I think the burning topic or a couple of the burning topics this week just in light of some of your competitors in paint preannouncing really both in terms of on the sales side and on the inflation side, but let's start with inflation. You've obviously guided to pretty substantial inflation in the back half of this year across your business, but in particular, in coatings. It sounds like, at least from a couple of your peers coming out of the storms and some additional disruptions, that some inputs may have moved higher. What can you talk to in terms of what you're seeing and what you're expecting in the second half?

Yes, Mike. So let me talk first broadly about how we're seeing inflation across the portfolio, and then we'll dive into each of the segments. So what we've said and we're continuing to see, like you said, we're seeing input costs continue to rise. And what we're calling for right now is high single-digit inflation across the portfolio for the full year. Obviously, given the way this is all unfolding, there's going to be a higher run rate in the back half of the year. So I'd say probably low double digits in the back half of the year. That said, if you parse out, and you specifically focused on your comments on paint, I'd say on the paint side of our business, we'd see mid-teens inflation by the end of the year. So you're right, inflation was a little bit less impactful in the first part of the year. It's much more impactful in the back half of the year. And so that's how we're currently seeing things.

Got it. And can I get the...

And the other thing I would remind you, Mike, is what we did say is between our pricing actions and our cost containment actions, that we are and we continue to believe that we'll be price-cost neutral as we exit the year.

Got it. Okay. And so I guess, to be clear, that mid-teens in 4Q, I think that was your expectation coming out of the second quarter as well. So what you're saying is there's really no change to that at this point. Is that what you're saying? And then b, have you -- I think there were other actions being taken by some of your peers around some surcharges and additional pricing actions. Have you gone back to the market with additional either pricing or surcharges at this point?

So Mike, in terms of additional pricing, we really don't comment on pricing actions in this segment too much because of the concentration of our revenue with a single customer. That said, what I would remind you is if you look at our portfolio of coatings products versus the portfolio of our competitors, we are actually very different. We don't -- we are solely in architectural coatings. We don't serve the automotive industry, the industrial industry, some of the broader markets that some of the competitors have made some announcements earlier this week, sort of which I think probably have an impact on their revenue.

Yes. And so that was where I was going to segue into, and this also ties into an audience question as well. It does seem like channel exposures may be to, at least, in part, to blame for maybe one of your peers. Another of your peers, it sounds like there's also a disruption though on the consumer side in terms of their revenue guide and expectations. So this is also a question from the audience, but the organic guide in your decorative segment of flat to down 3%, that now seems a bit higher than potentially what your peers are expecting. So what's giving you the continued confidence in that?

It's just, right now, Mike, what we're seeing is demand is good. I think what people are maybe [ ensuring with a little bit ] is on the supply side. And so far, our supply demand looks good for us. And so it's interesting that people say we might be aggressive. I mean coming out of our Q2 call, we had a lot of comments that our guide for the back half of the year look conservative. And so depending on which month you're looking at, these things can change. But what we're seeing coming out of Q2 and what we said on our Q2 call is there's really not a lot of difference between what we're seeing then and what we're seeing now.

Got it. Yes. It is funny what a difference a couple of months can make, but that is -- it's a unique environment. And then it doesn't seem to be -- dynamic nature doesn't seem to be changing right now.

Yes. Mike, what I would remind you, there's a couple of things that we called out on our Q2 call that may help frame why we think our guide looks pretty good. One is we're launching BEHR DYNASTY, right? And so there's a load-in associated with that. And so that's good business. And then our Pro demand continues to be very strong. So those 2 elements, while we're seeing a little bit of softness on DIY compared to what we saw a year ago, which was extremely robust demand, those 2 things are helping to, I think, make our view on the market still pretty good.

Okay. And I want to come back to the supply chain discussion. But just since you mentioned BEHR DYNASTY, I think kind of 2 things around that to me would be interesting. First would be, is there any way to quantify what this load-in represents? But then second, just it does seem like a pretty meaningful launch in terms of brand and innovation. So can you just talk a little bit more about what you think this is going to bring to the market? And what are your -- maybe if you can articulate some longer-term expectations around this?

Yes. Mike, the BEHR DYNASTY launch really is focused on what I mentioned in my prepared remarks, innovation. And really what we're hearing from both consumers in the field as well as some pros is that they were looking for -- there's room for a higher price point paint within our channel partner, The Home Depot. And this is a premium price point in retail, north of $50 a gallon in most machines. But it is, like I said in my prepared remarks, it is our best paint ever. It's great, one-coat hide, scuff-resistant, it's LEED certified, it's GREENGUARD certified. So it's got all the characteristics that we hear from our consumers that they wanted in a can of paint, because what we're fighting for with them is their discretionary time. So they want to get in and off the job as quickly as we can. And this BEHR DYNASTY really addresses that . In terms of what this means for us longer term, it's not going to be -- because of its price point, it's not going to be a huge driver of the line because it's in the select part of the pricing segment. That said, is it going to be tens of millions of dollars of revenue? Absolutely. And so that's the way we continue to look at.

Okay. Great. That's helpful. Okay. So let's go back to the supply chain for a minute because I know that you have been -- so this is specific to dec art, but if you want to expand on initiatives in plumbing, you can as well. But I know there've been sourcing initiatives where you've tried to diversify your supplier base and use that as kind of a lever to help you mitigate some of the challenges that the industry is seeing. Can you just give us an update on progress around those? And to what degree is that really driving a potential difference between what you're saying and, again, what a couple of your peers have commented on more recently?

You're right, Mike. So like a lot of the folks in the industry, we have faced some supply disruptions, the most significant which were obviously because of the winter storm that went through Texas in February. And then we have some other supply chain disruptions with, unfortunately, a plant explosion that had one of our product lines. And as a result of that activities -- or those actions, we've taken actions to look at diversifying our supply base, both, like I said, in the decorative architectural area, but we've also looked at diversifying our supply base in other parts, in the plumbing segment as well. And we've made progress. We are finding alternative suppliers for some of our products. So does that ease some of the supply tightness for us? It does. But that said, I don't want to mislead you. I mean the demand is still extremely tight. And so we're navigating this as well as we can in this environment. So I wouldn't want to mislead you, it is still challenging. This is not like we found the silver bullet to solve all of our problems. We've got -- our supply chain teams are doing a fantastic job of managing both the challenges in their supply networks as well as the distribution and logistics challenges that people are facing.

Yes, sure. And I guess, as a starting point, do you think that prior to some of these efforts, when you look at your -- how your supply chain was positioned, do you think you were potentially a little more concentrated than your peer group, and this is bringing you more in line with peers? Or do you think this is something that you're kind of ahead of the curve on how you've been able to qualify new sources?

Yes. I can't really speak for the competitors. Obviously, they're in a different environment. I would say that it was something that our team has responded to very quickly because of the challenges that we faced. Does it put us in a distinctly better position? Again, hard to say in this environment. It seems like it's working well for us here in the short term. What the long term looks like, it would be hard to say.

Understood. Okay. We've got another question coming in, which is kind of a good segue back to the demand conversation. The question here is how is DIY looking in decorative in the second half? Clearly, incredible run and you did start to see some pressures in 2Q. So how are you thinking about the potential for normalization? And what are you seeing in DIY right now?

Yes. Mike, as we kind of foreshadowed, we had very strong DIY demand both in Q2 and Q3 last year when a lot of things were shut down and as the economy is opening up. We weren't surprised to see some of that DIY demand soften as people use their discretionary time for other more enjoyable things than painting their homes. And so we do see that normalizing a bit, but it's kind of normalizing to the degree that we laid out on our Q2 call. I mean really, there's no difference. So DIY is softening, but what we are seeing now is a ramp up in Pro demand on our products. And so that's the reason why we got into this Pro business is to make certain that we have that kind of countercyclical balance between DIY and Pro. and it's playing out -- the Pro, DIY balance playing out just like we expected.

Okay. Yes, that's good to hear. And I mean, do those comments extend across the plumbing as well? The plumbing growth seems to have stayed potentially stronger. I know the guide is still for some moderation in the back half of the year, but how would you characterize the demand in plumbing currently?

Well, the plumbing demand remains very good, like, both domestically as well as internationally. If you think about Hansgrohe sales, we've seen continued very good growth in Central Europe, which we define as kind of Germany, Austria, Switzerland, France as well as China market. China has been -- has come back very, very nicely, following some softness in the first part of 2020. Turning to the U.S.. We've seen continued very good demand from Delta across its product categories, whether it's their strong Delta brand or whether this is the Brizo brand, which is their upmarket brand here in the United States. And in the same vein, we continue to see very strong demand on our hot tub business, which we've referenced before in prior calls. The consumer demand for both faucets and showers as well as outdoor hot tub has been very, very good.

All right. And that's an area of the business that -- well, your spa business in general was impacted a little bit more middle of last year during the initial shutdowns just because you actually had to truly shut production. That demand seems to have roared back. And I think on the last call, you mentioned your lead times were out to, I think it was 30 weeks or something. So how should we think about the recovery in tubs, spas, and what that's contributing and what the backlog looks like in that?

Yes. So Mike, let's make sure we've framed this up right. So if you think about our $4 billion plumbing segment, our hot tub business is roughly 10% of the segment sales. So even if it's an extremely strong recovery, if you think about the guide that we gave for this year for plumbing segment growth, which is in the 22% to 24% range, it's going to have the impact of even the strong demand that we're seeing in hot tub is going to have a relatively modest impact on that overall sales growth that we're experiencing across the segment. The big portion of the sales driver in the plumbing segment is both Delta and Hansgrohe.

Okay. Got it. And then the -- I guess, just moving to -- or back to kind of the price/cost conversation. This has been -- it's been such a unique environment in terms of just broad-based strength in pricing on the back of unprecedented cost inflation is virtually every category you can track, right? And so it's led to probably initially some easier conversations than in the past around price with some channel partners. How do you think about how this plays out looking to next year? A, what's your expectation for inflationary pressures and how long they persist? And b, when these ultimately hopefully fade, how do you think about that pricing dynamic? And what ultimately happens to channel partners, ask for more back? Do you hold it for longer? How do you balance that?

Yes. Mike, you're right. It has been broad-based inflation. And just given the fact that it has been so broad based and actually so persistent and elevated, the conversations with price -- around price, they're not unique to us. The other competitors of ours are seeking pricing from the same customers that we're seeking price from. And so it's like we're unique in seeking that. As we look forward, we do believe that a lot of this is supply-driven inflation in that as supply comes back online that this will moderate. Will this extend? No. What it looks like in '22? Don't know exactly yet. We'll give probably more guidance on that in our Q4 call in February. But this looks like it's going to be at least persistent in the near term. What happens, generally speaking, I'll speak in 2 different parts of the business in terms of your question. If you look at our Decorative Architectural segment, specifically architectural coatings, in inflationary periods, we generally get pricing; and in deflationary periods, we generally roll back pricing. That's just the nature of the relationship with that customer. Compare and contrast that to our plumbing segment because a lot of our plumbing segment, we sell to smaller customers, smaller wholesaler, showrooms, things like -- customers like that. Oftentimes, we will hold on the price once it's in the marketplace. And so we generally don't see significant rollback in pricing in the plumbing segment as compared to what we might see in the Decorative Architectural segment.

Okay. That's helpful. We have another audience question, and I want to kind of augment it a little bit, but just stepping back to the plumbing demand side. Again, the question is around the implied deceleration in the second half in plumbing and given what seems to be some continued strength across the channel, whether or not there's some embedded conservatism in there. And I guess what I'd ask as well is you've made comments on the last call about sell-through being stronger than sell-in. And so when we think about channel inventories and the potential to replenish channel inventories, how are you thinking about that? And what are you kind of baking into that back half deceleration assumption?

Yes. So again, this whole -- similar to the conversation we had on paint a couple of minutes ago, we obviously had a very strong sales in Q2, Q3 last year. And so as the calendar rolls, you can ratchet up against some tough comps. And like you said, we did see some tightness in the channel inventories in the second quarter. And I suspect that, that channel tightness wall is continuing here in Q3. So is there some opportunity to reload the channel or fill the channel a little bit more as we go into the back half of the year? Yes, that opportunity exists. So there's a little bit of baked into that into our guide. That said, we gave our guidance for the back half of the year just over 30 days ago. And based on the trends we have seen so far, we're not coming off that guide. I wouldn't tell you that there's any conservatism or any aggressiveness. I think the way we called it is the way we're seeing it and continue to see it.

Fair enough. Let's segue into capital allocation. That's clearly, as you articulated earlier in your opening remarks, around what your story actually is. This is a big part of it, the consistency of capital return, but also the M&A angle. Let's start with M&A. We've seen, I think, a lot -- across a lot of things that we cover and track, it does seem to be like assets are kind of shaking loose and starting to trade, whether that's just 1.5 years into the pandemic, whether that's people looking forward and thinking about tax consequences, what have you, but what are you seeing in your pipeline across the 2 businesses? And do you think there is -- or do you think you are seeing catalysts for change where we could see an accelerated pace of M&A?

So we are seeing a lot of things that come to market, as you suggest, Mike. I don't know whether it's post pandemic or just the strength in the market that people are seeing this a good time to come to market, but we are seeing a lot of strength. We've got a great team that we've put in place to cultivate our pipeline of leads and desires for M&A targets. We're continuing to work that pipeline. What that leads to, it's always hard to predict because you can never obviously force a seller to sell. That said, we -- what we like right now, what we're seeing in the marketplace is better value at the lower end of the middle market. The bigger companies that are trading at pretty high -- from our perspective, pretty high multiples. And so as a result, if we think we can create more value, as evidenced by some of the smaller transactions that we've announced in the last 9 months because a lot of these can be folded into one of our existing companies, and we extract a fair amount of synergies from them. So we like that recipe, and we're going to continue -- that's going to be our principal focus going forward for M&A.

Okay. Got it. And is that true across both plumbing and coatings and your adjacencies? [ You have comment about ]...

Yes. I'd say they're both -- yes, that's either both very similar, Mike.

And in terms of the competition, how would you characterize the level of competition from other strategics versus maybe more PE or financial buyers?

We're seeing a balance of both, depending on what assets in the marketplace, right? It's -- some assets are more strategic focus. Some have a better balance or better mix of PE. And the mix we're seeing, we're seeing both as competitors for transaction.

Okay. And then on the other part of capital allocation, you've got the guide out there for $1 billion, which will be, I guess, technically that's repurchases and M&A. Is that right?

That's technically correct, yes.

But it sounds like at least, in the near term, that may be more geared towards the repurchase?

That's right, Mike. And just to remind everyone, through the end of the second quarter, we repurchased about 5% of our outstanding shares so far this year through our share repurchase program, and we're continuing to deploy capital to share repurchases during the third quarter.

And so if I look at just kind of the growth algorithm and think about what that translates to in terms of free cash flow over the next couple of years, it seems like you can pretty comfortably stay above that $800 million in -- plus, in free cash flow. I think we've got actually rising closer to $1 billion in free cash. Some of that goes to the dividend. But should we think about recent levels of buyback activity as being something that's fairly sustainable and programmatic? I know you've done ASRs in the past, but how would you characterize that?

Yes. Real quickly because I think we're running close on time. Yes, I think we'd be -- programmatic is the way I would describe it with a little bit more aggressive action if there's a dip similar to how we've executed the program in the past. We'll pull back a little bit as the shares run, be consistently in the market and then buy more aggressively on the dips.

Okay. All right. Well, John, thank you very much for joining us this morning. Audience, thank you for joining us and for your participation. And with that, we will end it.

Okay. Thanks, Mike.