RPM International Inc. (RPM) Earnings Call Transcript & Summary

Hi, and welcome back. Our next fireside chat is with RPM. And with us today, we're pleased to have Frank Sullivan, Chairman and CEO; as well as Rusty Gordon, CFO. Before we get started, just 2 housekeeping items. One, I would need to remind you that there are important research disclosures available on the Morgan Stanley research website at www.morganstanley.com/researchdisclosures. Please read those disclosures. And if you have any questions about them, reach out to your Morgan Stanley sales professional. Secondly, we do have the capabilities to take your questions. So if you have some, please put them in the question box in the web browser, and I would encourage you to do that sooner rather than later, both so that we ensure that they get to us because there can be a delay and also because I'm finding that it's sometimes better for me to feather these questions into the ongoing conversation rather than save them until the end. So with that, Frank wanted to make a few opening comments. And so I'm going to turn it over to Frank to do that, and then we will have our Q&A discussion. So Frank, thank you for coming.

Yes. Vincent, thank you very much, and thank you for hosting this investor conference. I'd like to make just a few introductory comments, and then we'll get to your questions. In general, the hot topic these days, obviously, supply chains, and we can talk about that broadly speaking. When you look at our first quarter results, I will bifurcate it in 2 areas. The first is our 3 more industrial segments, Construction Products Group, Specialty Products Group and Performance Coatings Group. Collectively, their sales were up about 15%, and their EBIT was up about 15%, indicating that we are able to pass on cost increases in equivalent price increases but not, at this point, sufficient to cover or enhance our margins. In our Consumer segment, we are facing very challenging comps versus the prior year, where sales were up organically in units, 34%, with a doubling of our EBIT and an unsustainable historic high EBIT margin. In particular, and the supply chain challenges are impacting our Consumer segment most severely for 2 reasons: number one, we are a disproportionately large user of the major paint competitors of alkyd resins; and a supplier to the industry in Columbus, Ohio, had a plant explosion at the end of April, and that took 30% of the alkyd resin capacity out of the U.S. market, and it was a somewhat higher percent of our supply. And so I'm happy to talk about what we're doing to mitigate that. The other area is across our consumer business, small project paints, wood stains and finishes, patch repair products, caulks and sealants and adhesives. We sell small container packaging. So we have a sizable amount of packaging, aluminum, steel and plastic packaging. So that has negatively impacted our consumer business as well. Across all of our businesses, I think one area of the gross margin deterioration that people have been missing is conversion costs. So while there's a lot of attention paid to cost-price mix, essentially raw material costs, our ability to pass on pricing and then very appropriate discussions around raw material and component availability, in many of our instances, half of the driver of the lower margins is conversion costs. That's driven by the raw material availability disruptions. And so this is what that looks like. On a Rust-Oleum production line, we might have the staffing in raw materials to run for 3 days. And then we have to shut that line down, waiting for packaging components or raw material components. We continue to employ and pay the entire staff in that particular facility given this labor environment, and so you are seeing factory overhead absorption, labor costs that are significantly outsized versus our normal operating procedures because of the disruption and shutdown periodically in a particular production line. That is true, to a greater or lesser extent, across multiple RPM manufacturing facilities in the United States and around the globe. So we see a significant couple of hundred basis improvement in margins immediately just related to normal flow of production through our manufacturing facilities once the supply chain availability issue is resolved. The last comment I'll make is what's particularly unique and you can see it in our revenue results about this period of time, any other time in my career at RPM where margins were deteriorating, and we saw, particularly in the consumer space, significant declines in earnings year-over-year. We would be enacting cost increases or taking other actions to address those situations. In this case, this is specifically and not unique to RPM, a universal supply chain challenge that we are working to get in front of. And so because of that, we are on offense everywhere. Capital spending this year will be $220 million. That's up from $150 million. We are expanding in our consumer space, in our Tremco Roofing and Construction Products Group and Nudura. And we are investing in our P&L to continue market share gains, which you're seeing in most of our nonconsumer segments. And so that's also very unique that we would be in a raw material and margin challenging environment yet playing very aggressive offense across all of our businesses. The goal of which is to have a confluence of market share gains, continued organic growth that marries up with a correction of our supply chains. And at that time, we think that we will be leveraging that superior growth very aggressively to our bottom line. Hopefully, that will show up at the end of the spring or early summer. That's our best guess as the period of time when supply chain challenges and bottlenecks will be fully corrected. But I would say, at this point, anybody that has a guess of when all that's going to come together is a little bit of a fool's errand. So Vincent, that's really the comments I wanted to make to start our discussion this afternoon.

Okay. Thank you, Frank, and I'm sure we'll dig into that in a little bit more detail in a bit.

The one thing I really wanted to get your take on because it's only happened since you last reported is, finally, we have an infrastructure bill, and I'd really like to hear your take on the final version of it and how that's going to benefit RPM.

Sure. That's a great question, and the answer is it will benefit RPM, particularly in our more industrial segment businesses. I mentioned that in our Performance Coatings Group and Construction Products Group and Specialty Products Group, revenues were up about 15%. While this is true, to a greater or lesser extent, in individual business unit, you can roughly think of that as half price and half unit volume. Particularly for Construction Products and for Performance Coatings, the amount of money that is in the system bodes well for the next couple of years, and that was true before the infrastructure bill was passed. There was $800 billion of CARES Act money left unallocated and unspent as of December 31. On top of that, there was a $1.9 trillion COVID Relief Act, a lot of which will go to onetime projects. So a good example is in Cleveland, Ohio, where our headquarters is. In the CARES Act, the city of Cleveland got $50 million. In the February 2021 COVID Relief Act, the city of Cleveland is getting $540 million. The state of Ohio is getting $2.5 billion across cities, counties in the state. Much of that is being used for onetime projects: school construction and renovation, hospitals, community centers. And we are particularly well positioned in our Construction Products Group to serve hospitals and school systems. They are core to our growth. In the Performance Coatings Group, not only will this drive infrastructure spending in highways and bridges, which is a major market for us, ports, airports, but also you're seeing just like RPM's doing increases in industrial capital spending. A good example is our Stonhard flooring business is the largest producer of static dissipating floors. We have the largest market share in the tech sector and chip manufacturing. For instance, we do every Intel plant in the world. And with the onshoring of a lot of chip manufacturing and technology manufacturing, we're very excited about what that means, and we're starting to see that as we speak. All of that is before the $1.2 trillion infrastructure bill. I don't think the real effect of that will take hold until the end of calendar '22 and into '23, all of which suggest that these dollars will really drive significant opportunities for our industrial segment businesses in the next couple of years.

Is there anything you need to do -- if you're saying you have some lead time line on. Is there anything that your individual businesses need to do to sort of be able to maximize their opportunity set?

So the answer to that is yes, and we're doing it. A big part of this bigger capital spend is creating expansion in our roof coatings, in particular, in our Nudura ICF Insulated Concrete Form business. That was a $35 million or $40 million business we acquired 3 or 4 years ago. This year, we'll do $60 million or $70 million in that. We are out of capacity. We expect new capacity to come on in the late spring or early summer. That's going to be a huge beneficiary of a lot of this spending, and so we are positioning ourselves from a capacity perspective to be able to ramp up and meet what we see as a rising demand that will probably continue for the next couple of years.

Okay. That's very exciting. Maybe one thing we talked -- you talked already a little bit about the supply chain and so forth. Are you seeing any issues on the labor front in terms of labor shortages at customers, suppliers or even how you're managing your own workforce?

Sure. So the answer is yes. Our labor costs are up. We've increased wages -- hourly wages in a number of places. We have an 8,000-person U.S. workforce, and about 3,100 of those are hourly wage associates. In our manufacturing distribution center and tech service jobs, we have anywhere from 300 to 400 open positions in the United States. I don't have the same specific data outside of the U.S., but it's equivalent. And so that is a challenge for us, and we are looking to fill those jobs as aggressively as we can. On the COVID front, we have not issued a strict vaccine mandate. We have insisted that anybody in -- participating in in-person meetings, all of our Board meetings, sales meetings that only fully vaccinated people can participate in those in-person meetings. But our plant people tell us that the quickest way to turn 300 or 400 open positions and 800 or 1,000 open positions is to issue a hard and fast vaccine mandate. So we have not done that yet, and we're -- while I'm on that, monitoring how the Biden vaccine mandate plays out in the next couple of months.

And that 300- to 400-person or job opening figure, how would that compare to the same time pre-COVID?

It would be less than 100. I mean we would have a handful of openings in most of our major plants, but this is 4 or 5x the normal level of job openings as we have transitioned.

Okay. And is that -- at what point does this become a bottleneck in terms of your own capability to serve customers?

So, so far, not a big problem because of the unscheduled shutdowns that I referenced. Literally, we can run a plant and some were a production line for, let's say, a 3- or 4-day period or a full week, and then we bump into some raw material component or packaging component that's short. We have to shut it down for a day or 2 and wait for those inbound components to show up and then restart it. The flip side is where we have an advantage, and we're still looking for more people, so some of these open positions is really back to playing offense. In our roofing, Tremco Roofing business and our Stonhard flooring business, in both cases, we have a unique supply-and-apply approach to the market. And so the labor that is either employed and/or controlled has given us an opportunity to take market share versus competitors and/or smaller contractors that are suffering through the same labor shortage challenge.

No, that makes sense. Maybe switching gears a little bit, and we just think about the demand environment, maybe if we go through the various segments, maybe starting with Consumer. One of the things that we're struggling with is that there's been all this debate over sort of how DIY is going to trend. And a couple of quarters ago, it seemed like we were getting a look into it. And now with all the supply shortages and stock-outs and empty shelves, you can't tell what's just not availability versus what's not demand. So what read do you guys have on it internally, as you can share with us?

Sure. So COVID was a big boost, and in some cases, an unsustainable boost to DIY in general. And certainly, you can see that with us. Last year, in the first quarter, our -- this is extraordinary, our Consumer segment grew 34%, and there was no price in that. It was 34% unit volume. And so when we look at the first quarter of this year, we are comparing it to the 2 years ago quarter. So in '20, we were up 34%. This year versus that extraordinary comp, we are down 16%, but we are 12% ahead part price and part units of the first quarter in fiscal '19. You will see a comparable down versus last year when we were up more than 20% in the second quarter in Consumer but up versus '19. And then I think as we get into the second half of this year, under the assumption that we're seeing resin flow free up, we should be able to comp modest year-over-year revenue gains in our Consumer group, in part, because of price increases and also because, quite candidly, where we are for the remainder of this fiscal year, we can sell everything we can make. So for the first time in my career, and this is true across much of RPM, our ability to grow is supply constrained, not demand constrained. And if resins free up, you'll see a booming second hit. That's a big if. But if resins free up, it components free up, forget about even cost, if we get back to a normal flow and our ability to produce, you'll see a really strong second half of the year on the top line.

That comment is primarily for Consumer or would that carry over to Construction and Performance and Specialty as well?

It carries over pretty much everywhere. In the first quarter, our best estimate of lost revenues because of supply constraints was $200 million: $100 million in Consumer and $100 million in the rest of RPM. A big chunk of that rest of RPM is in the Construction Products Group. We anticipate another $200 million of lost revenue in the second quarter, but we're in the side period of time, and this will be something we would have addressed anyways, it feels like in the last week or 2 that we're seeing raw material flow improve. We're seeing prices stabilize. I think we need to see that for a few more weeks to feel like it's a trend. We felt this way in early June and got pretty surprised pretty quick. But I will tell you, at its peak, we had 50 or 60 force majeures that covered thousands of individual product lines. And as we sit here today, our force majeures, in effect, are somewhere around 20 and affecting hundreds of product lines, not thousands. So we're seeing a decided improvement in force majeures and product availability. But I think we would -- we need to see a few more weeks of that be sustained to not have another head fake like we had in June and fall back into some supply chain challenges a couple of weeks from now.

And how would you characterize the volume that you didn't get to manufacture and sell in the prior period? How much of that is deferred versus denied or lost or however you want to frame it?

So particularly on the Construction Products and Performance Coatings Group, and it's back to the amount of money out there, the COVID Relief Fund and the dollars for the City of Cleveland or counties in Ohio or the state, there's a 3-year window in which the purpose of those dollars can be allocated and the projects be done. So if there are supply constraints on expanding hospitals, on replacing HVAC systems, which is a business that we're in now with the Pure Air acquisition, renovating and refurbishing HVAC systems with our Tremco Roofing Group, on industrial capital spending, those dollars, we believe, will be there when we can have the materials to supply them. And so I think that's very true. The consumer supply situation, hopefully, will be corrected this spring. And then what's clear to us and our big box customers is COVID expanded significantly better than we or they could have done on our own through normal advertising and promotion the base of confident DIYers. So there's just a larger base of people, whether it's gardening, whether it's small project paint, whether it's woodcraft work that we're exposed to and are excited about and want to continue maintenance repair or small project redecorating that we serve, and COVID did that. We believe it's real.

Okay. And maybe just -- you've done some recent acquisitions, and you're always evaluating a pipeline. How do you -- when you look at a target, how do you assess their P&L now because you've got all these issues where they probably have raw material shortages. So their costs are -- and their costs are up, and their volume is not what you think it's going to be. So how do you look at the P&L now and evaluate the business and decide what to pay for it or if you want to pay for it?

So that's a great question. And so every acquisition we've ever done has been driven by an IRR and growth, so we're not interested in buying a business that we can integrate and save money on if there isn't a compelling growth story with it. And so I'll give you an example without getting too specific. Our Tremco Roofing WTI business, it's weatherproofing technologies, it's the asset management, contracting and maintenance arm of Tremco Roofing. 4 or 5 years ago, it was $100 million. This year, we'll run through $300 million, and that's growing like a weed. They've been able not only to do some of the roof contracting management and maintenance work for big customers, but we've now worked with our Fibergrate business. It makes FRP grading to have a full line of rooftop safety systems for walkways and stairways and platforms on rooftops. Our customers have been asking us because we're on the roof, can we do the HVAC refurbishment or rehab for them, and we didn't have a good answer for that. We acquired a month ago Pure Air, and Pure Air was a $15 million or $20 million HVAC rehab and refurbishment business. Good margins, decent growth potential, but results that were inhibited versus where they were a year ago by these issues. So without getting into specifics, the multiple of earnings that we paid for that business is higher than you would expect from RPM or higher than you would see in our industry as a result of the temporary circumstances. But long term, this will be a home run. We should be able to double or triple the revenues of that business in the next 2 years, and the sky is the limit beyond that. It's a multi-hundred million dollar business. And in partnership with our Tremco Roofing business and their school system customers, their hospital customers, their big corporate accounts, this opens up the door for us to tackle something that our customers had been asking for, for a couple of years that we could not supply. One other example is we closed Bison a couple of months ago. Bison is a Colorado-based manufacturer of pedestals, also for rooftop platforms. So if you think of a hotel that would have an outdoor patio or terrace, very often, there's a patent of system. Bison would allow for the setting of those types of platforms, whether it's with wood or some synthetic or tiles without penetrating the roof. It was acquired by our Fibergrate business, common systems, huge opportunities in roofing, perhaps some opportunities in DIY, and so very excited about that as well. And I think the pipeline of our typical acquisitions are pretty good. The last thing I'll say on acquisitions is when you look at our now 4 segments' MAP to Growth, our Construction Products Group at $2.2 billion and our Consumer Group at $2 billion are sufficiently integrated and on a common ERP, such that we can start looking at larger acquisitions and really bring value to them by being able to integrate something more sizable. Whereas in our Performance Coatings Group and Specialty Products Group, the fact is there's still really a collection of independent businesses. So in those segments, we would either do small product lines we can integrate or freestanding businesses that are kind of the typical RPM heritage acquisition of a family business that would operate on a freestanding basis, and we would value it that way and run it that way.

Maybe the last thing to touch on in our remaining time. MAP, the original MAP 1.0 was obviously a transformational program for both the company and for your stock, and I know we're in the early days of planning MAP 2.0. So maybe you want to give us sort of some size, scope and scale of what you think MAP 2.0 could be and over what period of time.

Sure. Great question. In this early spring of last year, it was our hope to be able to come out with some details of MAP 2.0 right about now. And given the supply chain challenges, we are deferring that until we are more confident that the supply chain issues won't make any detail we provide kind of meaningless with the big swings here. So I would anticipate and hope that sometime either in April or July when we release our third quarter earnings or our fourth quarter earnings and fiscal year '22 results, we'll be in a position to provide more detail about that MAP to Growth 2.0. I will tell you that in November of 2018, one of our absolute goals was an EBIT margin of 16%, and we were making good progress towards that. This year, for obvious supply chain reasons, we will take some step backwards. That 16% goal is very much in the mind of everybody at RPM, and we look forward to an opportunity to provide some details around that in the spring or summer of '22.

Okay. Fantastic. Well, we're coming up on time. So I'm going to thank you, Frank, as always, for your time and your insights and look forward to seeing you again soon.

Yes. Vincent, thank you, and appreciate Morgan Stanley hosting this conference and inviting RPM to speak. We've had great meetings throughout the day, and we look forward to a few more. Thanks, and appreciate your support.

Absolutely.