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

So welcome back. Next, we have RPM. And with us, we have Rusty Gordon, CFO; and new IR representative, Matt Schlarb. And before we get started, let me just read these important disclosures and invite you to see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. And if you have any questions, please reach out to Morgan Stanley sales representative. So welcome, guys. Thank you for joining us. Great to be back here. I know, Rusty, you've been a mainstay at this conference. So it's great to have you back in person.

And yes, I just -- I think maybe a place to get started. We're kind of in the second day of this conference. So there's a lot of dialogue ruminating amongst all the different companies. And the big themes have been around demand, macro economy, Europe, China COVID, raw material costs, pricing, price/cost relationship and so forth. So maybe we'll go through some of that stuff. And maybe just to start on the demand side of the equation because you guys have been seeing very good demand still unlike a lot of the rest of the industry where they start to see things tail off. So maybe we could start on consumer. You had very strong performance in the fiscal first quarter of 2023, and you did indeed guide the second quarter of 2023, the second fiscal quarter, ahead of where Street expectations were. So can you talk a little bit about the underlying consumer demand, sort of what you've seen and what you're seeing in the reference of destocking versus restocking. And you guys had sort of an idiosyncratic supply event last year. So maybe you could just sort of frame where we are, where we've been and sort of how you think the outlook looks.

Good. Yes. We've seen changing demand to summarize it over the last few years. Of course, we had the COVID bump in the summer of 2020 when sales were up organically over 30%. Then in 2021, we have the supply chain challenges with 30% of North American alkyd resin supply going offline due to a plant explosion for one of our suppliers. That was challenging because as you know, our Rust-Oleum aerosol paints and brush goods use alkyd resins, and that was a challenge for us. And we've -- due to some self-help measures, we've restored a lot of that by purchasing a plant facility in Corsicana, Texas and then starting to produce for our own internal purposes alkyd resins. And our fill rates have increased, and that's helped us fill in a lot of those blank spaces you saw on shelves last year. In terms of demand, we've been through a few things. First of all, everybody was sheltering in place in 2020, and there was a lot of do-it-yourself activity. And that continued into 2021. Unfortunately, we had the supply challenge. But then I would say the summer of 2022 was probably marked, Vincent, by what I call revenge travel, lots of people traveling who didn't travel during COVID. And as you know, when people travel, they're not doing do-it-yourself projects. In spite of that, we saw POS that was some weeks maybe flat or up a little, some weeks down 10%; on average, down a little bit. And that's actually been very good because we have finally caught up with the selling price increases in consumer just this past summer. So we're not seeing a big unit volume decline in spite of a significant catch-up to restore margins.

Yes. So you had -- you sort of had a nice sell-in to deal with the fact that you had very low inventory levels. But then it sounds like the retail takeaway, the POS that you're seeing is maybe down low single digits, right? Which is...

Against very difficult comps, right? In the prior year period.

Right.

And maybe just talk about sort of the mix of repair and maintenance versus new projects and then also sort of how you fit in sort of, obviously, you have significant DIY exposure, but you also have professional contractor exposure as well and what maybe you're seeing differently across those cohorts?

Yes, sure. So within consumer, we're about 85% repair and restoration and 15% related to new construction. Overall, for the entire company, it's closer to 2/3, is about -- is repair and restoration. Looking at -- we don't look at it so much on DIY and PRO, but we do have some data points on that. And PRO seems to be doing a little bit better than you see on the DIY side. But like Rusty said, from a POS perspective, we're down mid-single digits on average in consumer.

And Rusty, how are you thinking about margins? I mean, obviously, we've gone through this incredible raw material period over the last 2 years. And you've taken a lot of price, you've caught up. But the math on that means margins are lower, right, on a percentage basis, maybe on a unit basis or a dollar basis you've caught up, but the margins are lower. So how should we be thinking about the pace of margin improvement over the balance of the fiscal year?

Sure. Yes. In terms of our guidance for the fiscal year, of course, we've only guided for the current quarter, the second quarter. We also introduced last month a new margin achievement plan to improve our EBIT margins overall for RPM up to 16%. And if you're talking about consumer, consumer is a very large part of our MAP 2025. So yes, we do see potential upside. Our first quarter in consumer, while it looked good year-over-year, was not a record, not close to a record for EBIT margins. We're just recovering. So there are more opportunities to get better, especially through the self-help measures of MAP 2025.

Okay. Sticking with demand, but shifting to Construction Products and Performance Coatings, here, you've got larger exposure to Europe, right? Consumer is very modest exposure to Europe. How has demand been evolving in both CP and PC? And are any of the sort of diverging demand trends that you're seeing?

Sure. Go ahead.

Sure. So Construction Products overall demand still -- in North America has remained strong. But in Europe, we are seeing weakness there from some of the pressures they're seeing on a macro basis in terms of cost inflation, energy prices. And so we are seeing weakness there. Again, overall, Europe is only about 13% of overall sales. In our Performance Coatings Group, we also have European exposure. We're a little more insulated there because we have oil and gas exposure. And so that's remained a little bit more resilient compared to some things that are more dependent on general macroeconomic conditions.

Okay. And then in CP, this is one of your growth platforms. How are you thinking about sort of the things within your control, product launches specific to you versus the potential for some slowdown in the broader environment. And I guess you can layer on top of that, but hey, wait a minute, don't we have an infrastructure bill, it's finally going to actually get some shovels in the ground and so forth. So how do we kind of reconcile those 3 dynamics?

Yes. Obviously, as interest rates go up, you worry that construction projects may be deferred or passed on. We still have great backlog, and you hit on the point, infrastructure, a lot of spending, not just from that, but from COVID relief bills even back in the Trump administration, a lot of those dollars have yet to be spent. A lot of that's going to schools, which is a core market for us, probably our biggest market for Tremco and our roofing division. So that should provide us some support. Even if the economy goes down, the infrastructure federal spending should help us. We also, of course, just had a horrific storm in Florida, Hurricane Ian. There will be a lot of cleanup and roof restoration as a result of that storm. So we still see good backlogs and good demand trends and feel pretty good about it. Obviously, the long-term trend is towards high-performance buildings, which insulate better, can withstand effects of climate change, whether it's hurricanes, tornadoes. Now, we have the best high-performing building systems at RPM in our Tremco Group or Nudura wall system. So long term, we feel very good about investing in that division's growth.

What's the lag on timing from when we have one of these natural disasters in terms of how long does it take before you start to see the order flow through?

Yes, we see it even before the storm because we have a subsidiary in specialty products called, Legend Brands. And they manufacture equipment for dehumidifying, air movers, air purification as well as disinfectants. So they -- even before the storm starts moving inventory in position. And they, from a big storm, will get sales not just right after the storm when people are trying to dry out and save their dry wall from having to be ripped out, you only have a small window. But due to the fact that a lot of these buildings sit waiting for construction workers to show up for months, they are still dehumidifying. And we still see sales even a few months after. And then in the case of our roofing business after hurricanes, yes, we typically do see months worth of increased sales as we restore roofs.

And I'm assuming some of that comes back into consumer as well?

Yes, that's right. In our consumer group, we do have some specialty cleaning products. One is called Concrobium used for controlling mold and disinfecting. And their sales definitely spike up with these storms.

In the specialty segment, this has been kind of a different type of story where you've made some changes from a managerial perspective as well as, I think, a little bit strategically. So can you talk a little bit about the transformation that's already taken place, some of the key initiatives you've been pursuing and the fruit to be borne?

Sure. Yes, Matt, why don't you...

Sure. So like, for example, we had a product NatureSeal that was on patent. That patent expired a few years ago. And so that obviously was a hit of sales. But we put in the new management team, and they've really been focused on introducing new products and having -- and then also taking those products to new marketplaces, which has helped that business expand. We've also benefited, as you've seen some of the COVID-related restrictions on food. Some of -- as those have gone away, that has also been a tailwind to growth in that part of the business, which has helped propel growth.

Okay. Great. And getting back to the price raw materials situation. Do you have a dollar amount of raws that you've had to absorb since 2021? And I think you said in the last quarter, you've caught up from a price perspective, but what is that gross dollar amount that we can now start to think about maybe coming back from a deflationary perspective?

Sure. Yes, I'll give you a few data points. Last year in fiscal '22 as we said on Investor Day, there is about $500 million of inflation we absorbed that year. And our selling price increases grew steadily. We started fiscal '22 at about 4.5%, finished the year at about 14%. So on average, we're in the ballpark of 10% or so for the year. And the latest quarter, we were up 15% in selling price. Now on gross margins, last year, they were down every quarter, so we didn't catch up. Finally, in our consumer segment, as you would expect, they have the biggest lag of all of our segments and recovering selling price. And they got it this summer so that they're back, improving margins again. We still have work to do, as you can see in our Construction Products Group. They lost margin in the first quarter, and they are ramping up selling price increases across the board this fall to try to recover.

When you say consumer had the biggest lag, was that because of the alkyd resin issue? Or you're saying just generically, consumer lags the other segments?

They do typically in all cycles in terms of the time to get a price increase through the big box channel -- it's traditionally taken longer. And that happened to us last year, but we were able to get that accomplished this summer.

So in the other segments, you can go to your customers more frequently than you get in big box?

Yes, outside of the consumer segment, there's not one customer that's even 1% of our sales. So it does happen more readily.

And then so when we get to the other side of this eventually if we're not there already, how do you think about trying to hold price and sort of restore the margin structure at the same time, obviously, you got to recognize you took pricing the way up [ and the magnification ] give back on the way down. So how do those conversations go?

Yes, sure. Do you want to take that, Matt?

Sure. So in terms of keeping pricing, historically, we've done a pretty good job at it. And there's a few reasons for that. Like one, we do have strong brands, and those brands resonate with consumers like you see it in our consumer segment, we've increased prices significantly over the past -- or since this summer. And you've seen POS sales down mid-single digits, which is evidence that our brands do have some power to them, and that helps us maintain pricing. We also work with our customers in terms of category management and making sure that those products can -- help drive demand for those products. And we also come to market with new innovations which are valuable to our customers, and that helps us maintain pricing as well.

So there's a lot we bring to the table besides the price. There's a lot of other things that help us so that -- the strength of our brands at the end of the day is what helps us. The fact that if consumers don't find our brand, they'll jump in the car and go to some place else where they do carry our products. So that's helped us as well.

But you don't have to worry about price gaps with sort of competitor products or anything like that?

Yes. I mean we have competitors, and we have to monitor that closely. Getting outside of our consumer segment, a big part of our MAP 2025 will be using more data on our pricing versus competition to help us compete and win better and with better margins.

Okay. And you mentioned the Corsicana plant earlier because of the alkyd resin customer outage, you sort of went in that direction. Do you have a generic goal to become a bit more vertically integrated in certain products? Is there more stuff you can do within that plan other than just alkyds? Or what's the thought process?

Yes. That plant we acquired in the fall of 2021. And the initial goal was to in-source alkyd resins due to the supplier outage. That plant was also purchased for all of RPM to build supply chain resiliency. And it's a very flexible workforce. They've had a number of different corporate parents over the last decade. And as a result, they've been able to transition very well. And for example, the alkyd resins took about 2 months for them to be up and running on those. So we have the equipment, the reactors, the workforce. And we have 120 acres of open land that we can expand on. So we are delighted with that acquisition.

Okay. Let's dig in on the MAP 2025 program. And maybe just starting on the top line goal to get to that $8.5 billion revenue target. Our math sort of suggests that's a core growth CAGR of about 5%. I think you said half of the growth is going to come from strategic investments. So maybe you could just sort of help us understand the confidence that you have in that target, how much of it is within your control versus how much you're assuming is just sort of market growth, price or what else?

Sure. Matt, do you want...

Sure. So our -- if you -- to get to FY '22 sales, the $8.5 billion, which is end of the year run rate, the CAGR on that is just a little north of 6%. And that includes everything. That includes core growth. It includes M&A. It includes the strategic growth initiatives. That has been our average CAGR over the past 10 years. And then when you layer on some of the investments we're making in terms of CapEx for new products, SG&A investments to expand product lines like Carboline, for example, and then you add on the pricing that we're getting right now, we think that's a very achievable figure by our target base.

Are you assuming that any price gets given back sort of later in that period if we have deflation? Or is that -- if it did, that would just sort of be offset by the deflation in the EBITDA?

Correct. But historically, we haven't given back pricing. And for the reasons we talked about earlier. With the strength of our brands and the product innovation that we have, we are pretty confident that we'll keep most of that pricing.

Okay. Even though, I mean, you've never taken as much pricing before, right? I mean if you have ever taken mid-teens pricing?

Not since the '70s. I wasn't working there then. [indiscernible] we'll ask him.

Okay. And then so the cost savings, which I think is about $465 million, and that's obviously a core component of the bridge to the 16% EBITDA margins. You did reference earlier, consumer is going to see a lot of that early on. So maybe just talk to us about what it is that you're doing there, what you found and just sort of -- how that's going to sort of flow into the numbers over this fiscal year and next.

Sure. So a lot of the benefits that consumer is receiving upfront are from our MS-168, which is our manufacturing efficiency program. And so this is something that we started in MAP to Growth in 2018. So we have a lot of experience with that. And we have actually been -- we've never stopped with these initiatives, but some of them are masked by the supply chain issues that we've had over the past several years. So as our supply chains normalize, we expect to get more benefits upfront from MS-168. And then as MAP 2025 progresses, those would get smaller and smaller. On the other -- our 2 other work streams are procurement. And so procurement's $215 million in total. And so a lot of -- about half of procurement will come from what we call the commodity cycle, which is basically the ability to maintain pricing as you get a normalization of raw material costs. And then the other things are working with strategic suppliers, things like that, to help generate more procurement benefits. And then our final work stream is the commercial excellence or CS-168, and that is a new program. And we really weren't able to implement those initiatives in the past because we didn't have the data visibility. So these are really data-driven decision-making that we're making in terms of pricing, sales force effectiveness, mix. And so as -- so we've done a tremendous amount of ERP consolidation. We had over 70 ERPs before the all MAP began. And now we're consolidating those into 4, one for each segment. And so with -- now that we have done a lot of the work in that space, we're able to really ramp up the CS-168 program. So that will -- the benefit that, that contributes to MAP will grow each year throughout the program.

Okay. And how are you feeling about just sort of the timing and your ability to sort of control the implementation of all this?

[indiscernible]?

Sure. So if you look at our total $465 million, about 75% of that is within our control. The piece that's not is the commodity cycle. So if something were to delay it, like let's say, we have a really severe economic recession, and that impacts our volume and it delays some of the savings from MS-168 or CS-168, what you're probably going to see is you're going to see a greater decrease in raw material prices. And we're probably going to have more power with our procurement because there's not going to be this much demand for these raw materials. So that would help offset any delay that we would see in MS-168 or CS-168.

Okay. And maybe let's talk about capital allocation. I think one of the other goals is on free-cash flow conversion within MAP. So what are we thinking about there?

Yes, sure. Well, we would expect cash flow to get much better than it was last year during the supply chain mess. We were trying to get raw materials wherever we could, and our inventories built up. And as a result, cash flow was not good. That should improve as we normalize our inventory levels. We do not face the challenges today that we did last year in terms of getting raw materials. So the mentality has changed. And we've started to buy what we need, not buying the same thing from 2 different suppliers because we're going to have a 50% chance with each of actually getting it. So that -- we do have programs in place for structural change to improve our sales and operational planning. We started that with the original MAP program, then we had Winter Storm Uri and everything was on pause. So we would expect much better working capital performance to help cash flow as well as better margins and really getting back to that $800 million a year cash flow from operations rate we were at right before Winter Storm Uri.

And then in terms of what you're going to do with that cash flow, I mean, I traditionally think of you guys raising the dividend. And I think of you guys are going out and doing M&A. So maybe let's start with the M&A piece. And I guess a couple of different questions. One is just we went through a period of pretty heavy industry M&A kind of in late 2020, 2021. Multiples got really high. That seems to have calmed down, obviously, in uncertain environment. And then the second part of it, sort of in terms of what are you seeing out there in terms of targets? Is your lens different now that you're in the second part of MAP, having done the first one? And now when you look at targets, is it both just sort of strategically in the products they have and the portfolio they bring in, but you also are really starting to proactively think about how you can integrate and how you can really improve their underlying performance and what the 2 plus 2 equals 5 could be?

Yes, absolutely. Yes. As a result of MAP, we've really gotten our house in order so we can get more synergy out of acquisitions. So that's helpful to us. As you mentioned as well, valuations have been out of whack. RPM is very disciplined, and we pay a reasonable multiple, but not the sky high multiples you've read about in recent years. I think those expectations are in the process of getting more realistic. For now, we've been doing small deals. I think this year, we've done quite a few small deals in the single millions of dollars range. We'll continue to do those product line acquisitions, have been very good from a return standpoint. One business we bought last year called Pure Air, does HVAC restoration, about a $10 million business. We're up on roofs every day all across the country. We can multiply that by several times with our geographic presence, our great sales force. We restore roofs. We can restore the HVAC systems. So we're going to continue to find those good product line acquisitions. In terms of doing bigger deals, I think right now, we see more attractive use of capital on internal investments, especially high-performance buildings, building up capacity in our consumer segment, where we've been facing strong demand, we couldn't meet over the past couple of years. So internal investment will be big. And then we're going to continue the growing dividend. We just raised it for the 49th straight year. That's a great way to give return to our shareholders, is a steadily growing dividend because being in the maintenance business, we have very steady cash flow to pay those dividends. So that's worked well for RPM.

Any questions here in the audience? Oh, let's wait for the microphone.

What do you think about next year, do you think you can keep the price, so the higher margin. Among the different sectors, I kind of feel like for consumer and special products, maybe they understand, but do you think for the construction on the performance coating, you can also maintain the price [indiscernible] higher margin because you are facing competition there?

Sure. You want me to take on...

Yes, go on...

Yes, in terms of pricing, we typically don't give back pricing like we talked about. I think if we do face a commodity cycle crash, a lot of our business is bid business. We're bidding on construction projects. And if construction goes down, commodities come down, it does get more competitive. So I think that might be if we were to face that. Right now, we don't see it like we talked about. We're mostly North American. There's the infrastructure bill, there's the COVID bill. We also serve markets such as semiconductors, energy, food and beverage, all doing well, reshoring occurring in all those industries. So right now, we don't see that. But in a 2009-type economic collapse scenario, that could happen on a lot of our bid work. But right now, that's nothing we see on the radar.

Have you guys changed over the last, say, 3, 5, 10 years the way you do financial forecasting or the way you think about long-term growth or look at end markets? Has anything changed about your process?

Absolutely, yes. We took a lot of pride at RPM since the 1970s in our planning process. Every one of our businesses, whether it was $5 million in revenue or $500 million would have a day of planning. And then we had a growth and strategy conference in advance of planning for all our companies, whether $5 million or $500 million to present their opportunities for growth. So the planning process is about 4, 5 months. And our compensation was geared on performance to plan. Since the MAP program began, we started compensating more based upon performance versus peers, growth as opposed to negotiating a plan and then beating it. So that's changed the mindset quite a bit. People are thinking bigger in terms of growth ideas. I think the other thing we've done, maybe not directly addressing your question, but we've also changed the compensation for the top operating people to be more RPM-focused versus their individual units. So we've gotten better collaboration. People are thinking more holistically. And that's been, quite honestly, what our MAP program was about. It's about leveraging our resources. We started MAP with 130 plants, 60 were working on a single shift basis. We didn't need to do that. We were not leveraging our assets. So we closed 30 plants. We started leveraging our procurement resources better by centralizing it. And we started buying like a $6 billion company, not a collection of smaller business units. So really leveraging resources has been a great thing for RPM, and you're seeing it in the numbers.

What about just sort of just plain vanilla forecasting and thinking about macro events sort of in your outlook and stuff? I mean you changed the way you thought about that at all?

Yes. In terms of forecasting and macro events, I think in terms of our forecasting, one significant area, and it's not really addressing macro, but we are going to be, I'd say, incorporating more of our operations, sales people, forecasting and communicating better so that we can work on our inventory levels. I would say our plants have been operating under a heroic firefighting mindset for years where they tried to respond to changing demand. And I think we're going to see better teamwork with improved sales and operational planning so that we get better communication and can really drive inventory at a more manageable level because our inventory has been much higher than peers.

Anything else from the audience? Okay. Thank you, guys.

Yes. Thank you, Vincent.

Good to see you.