Silgan Holdings Inc. (SLGN) Earnings Call Transcript & Summary

I'm Dan Rizzo, Jefferies Chemical Research. Thanks for coming today. Up next, now we have Silgan Holdings. With us today are Robert Lewis, he is EVP of Corporate Development and Administration; and Alex Hutter, who is VP of IR. This is going to be a fireside chat. We're just going to talk up here, but if you guys have questions, please just raise your hand, and we'll definitely work them into the conversation.

So I guess to start, something that's been of topic lately. Can we just talk with the near-term issues you're seeing with destocking. I guess, have the trends changed at all in the last, I don't know, a month or so since you reported?

So everybody hear me okay? Yes. So as we came through the second quarter, we did announce a call down that was largely driven by some destocking, predominantly in the food and beverage sector, and that was driven primarily by what we believe to be our customers' decision to get prepared for some activity -- promotional and discounting activity to drive volumes in 2024. So therefore, they didn't want to carry high-dollar cost inventory into the year. So as we've come now through the subsequent months, we have seen a few green shoots in the sense that we've had a few customers come back and say perhaps they went too far. So that should be a favorable sign. Nonetheless, the destocking is transitory and that we believe that 2024 will be back to a more normalized kind of volume, particularly as they get back to some discount and promotional activity.

So you may use the word transitory, which is interesting because I do think this has been a unique environment because of the buildup because of COVID and the problems we had last year with logistics. So if we think about that aside, if you look at just kind of a traditional recession -- I mean, what is a traditional recession. But if you look back, say, 2008, 2009, I mean how does Silgan do in such an environment where it's not necessarily destocking because of an overbuild, but just, I don't know, soft over -- soft macro environment?

Yes. So to be clear, the COVID-related destocking has already happened and is behind us. If you think about the business as it exists today and looking forward to should we go into a recession? Typically, these are product categories that have performed well in recessionary environments, and we would expect no difference in terms of the portfolio. Where we have changed this is a little more weighted to the dispensing and specialty closures since the last recession. And I think a lot of that also serves the food and beverage market and then more on the household side. It's more surface cleaners, consumer staples, which also are pretty stable through a recessionary period.

And are there levers you can pull if things do kind of flatten out where like restructuring or cost savings? I know you guys want to [indiscernible] one of those other things -- steps you would take to mitigate just some flattening out of demand?

Yes. We talked about that on the last call. And if you go back to kind of the pre-COVID time frame, we did have some restructuring activity that was on the table. We were focused on 6 plants across the network. We did close 2 of those plants. We pulled back and deferred that restructuring program to make sure that we had enough capacity as coming through a period that we expected to be a surge period. We've now come through that. We can pull that playbook back off the shelf and implement that, as well as looking more broadly across the portfolio given some additional insight that we've gained over the last couple of years. It's not unique to this time frame. It's something that Silgan has done repetitively over time. If you look at -- and I'll just use our Food Can portfolio as an example, for every 2 plants we have today, we've closed the plant over time. So cost out and operational performance improvement is not foreign to us. So we do have those levers should we end up in a recessionary period where we need to take cost out.

So I think one of the things you also called out on the last call was a labor issue that you were having. I was wondering if the expectations for that have changed. I think you said it would probably be kind of dealt with by the end of the year. Is that still the expectation?

Yes, we still expect to have that behind us through coming through the year-end. To be clear, it's a closure plant in a rural area that is a skilled workforce, but it's a particular insular region. And it's a plant that ran hard through the COVID years, 365 quite frankly, for coming up on 3 years. We ended up with a workforce that likes to be outside, likes their time off, and they decided that they were going to take that time off in unsanctioned ways and that put us in a situation where we were unable to meet some demand. We needed to move some volume around. We took some pretty harsh action. We relocated a particular line out of that plant. We moved several hundred million units of volume out of that plant into some other plants. Where we stand today is that we are making progress, and we fully expect to be through this issue coming through the year-end. And I would say if there's optimism there, it's the fact that we've already gotten to a point where the plant productivity has improved. So pretty optimistic that we have that behind us coming through the year-end.

And that makes complete sense. But we have seen, I guess, in the newspaper, if you look at a lot of things, that there's a lot of rhetoric now about labor being an issue. I know this was just one plant, but is there any concerns that this could kind of, I don't know, crop up elsewhere?

Well, there's no question that labor is a challenge across the board, right? Keeping folks -- wanting to do the type of work that we do in the manufacturing environment continues to be challenging. I would say it tends to be more challenging at the less skilled portion of it, where you've got packers, which primarily is oriented more toward our Custom Container business. This particular issue happened in a more skilled set of labor force, where it's a limited labor force. You can't draw from other jurisdictions. So I don't think we're unique in dealing with these kind of challenges. It's just the order of magnitude in this particular case was a bit outsized for us.

All right. And before I just go to next questions again, if anybody has any questions, please feel free to raise your hand. But okay. So one more question about the near term and then we're going to move to some maybe larger topics. But -- so you don't -- you have a majority of your presence in the U.S. with some in Europe as well. But I was wondering if your customers know you do a lot of exporting to China, where China is having a knock-on effect for demand maybe in some of your beauty segments or fragrances? Or are you seeing anything like that at all?

Yes. So predominantly, our revenue stream is in the U.S. It's about 75% or so of our revenue stream is in the U.S. and produced locally. The remaining -- probably the majority of the remaining 25% is predominantly in Europe. We do have some Latin American and some Asian sales. Generally, what we produce in Asia stays in Asia from a market standpoint. The one product category that perhaps gets exported back into the Asian market would be on the fragrance side. And it's predominantly for the category that we play in is the high-end fragrance, which is a market that has been really stable through, quite frankly, all economies because it's a consumer set that has the ability to afford those higher-end products. So broadly, we don't export back into Asia or China on a broad base.

Okay. And then I guess, just kind of more broadly speaking, if we think about Silgan, where will you be 5 years from now? Will you be a different company? Will you be transformative? Or is it more about like blocking and tackling and just kind of following the current game plan?

Yes. Good question. Look, I think 5 years from now, a shareholder should not be surprised by what businesses Silgan is in, right? The strategy has always been to run the businesses in an efficient manner, generate a lot of free cash flow, deploy that free cash flow back into the business for growth, whether it's for organic growth through CapEx in our existing businesses or whether it's through M&A, which we would endeavor to continue to be active in. But with a discipline that says where you can't find those opportunities to deploy capital and get an effective return for the shareholder, then we will either continue to delever for a period of time or as we drift toward the low end of the leverage metric, return capital to shareholders. And I think it's important to understand that any activity for capital investment, whether it's a restructuring activity, a capital activity or an M&A activity is all benchmarked against the same model. So we're looking at a cash-on-cash return, a discounted cash flow model that earns an adequate spread against our cost of capital, and that gets compared on any individual return against what's in it for a shareholder should we do a return to capital -- return of capital to the shareholders. That discipline regardless of where we sit in the cycle remains intact. And I think you should expect that, that will be so on a long-term basis. So do I think we will grow the company? I do. I think we'll do it in a disciplined way that won't shock anybody about the markets that we're serving, the technologies that we invest in and the customers that we do that for. So in many ways, the strategy is unchanged, and the market will dictate where some of that capital deployment goes over time.

So you're talking about capital deployment and you kind of went through it. But just given the current valuation of the stock, but as well as the current debt level and the current credit environment, does that change at least in the near term, some of the tactical moves you will make as far as your cash flow goes?

Yes. Look, I think in my prior comments, the return hurdles just got more challenging, right, in the sense that with the cost of debt rising and any incremental acquisition is benchmarked off its own capital funding. So it doesn't get the benefit of the current capital structure. So inherently, there's a challenge to get the kind of return that we have come to expect and want to drive to for our shareholders. Beyond that, I think the story is the same. So we'll end the year closer to the low end of our range. And we've said 2.5x to 3.5x is the right leverage range for us. We will probably end at 2.75x to the lower end. So we're happy to sit there for a period of time. I do believe that there are plenty of opportunities out there that fit our investment criteria from a strategic standpoint. The challenge will be making sure that they marry up against the investment hurdles. And like I said, our discipline will be at play there to make sure that we're doing the right thing for the shareholders.

It seems that actually R&D and innovation is an under regarded important aspect, particularly in, say, Closures and Dispensing. I was just wondering if you could just talk about the innovation R&D that's happening at Silgan and that's going to help drive sales growth over the next 3 to 5 to 10 years.

Yes. And you're right. That's particularly the case as we think about the Dispensing and Specialty Closure side of the business. It's -- the technology and the ability to meet either real or perceived challenges for our customer is really where the battle is won. And I think the group that does it for us, particularly in that business is best-in-class. We continue to win in that market. We will continue to invest capital there because it is an important part of what we do. It is our highest margin business with the highest growth rate from an organic standpoint. So our interest is to continue to allocate capital there, whether it be through that product development skill set or whether it be through physical assets to continue to drive growth in that business.

And a lot of what we've been focusing on in Specialty Closures innovation has been focused around ESG trends as well. So think about PCR-type dispensers, plastic springs to replace metal and those dispensers as well, as well as in other parts of our businesses outside our Dispensing and Specialty Closures is focusing on replacements for single-serve plastics.

Okay. So would you characterize it then going forward that sustainability is the single biggest driver for innovation or do you think it's more broad-based than that? Because I mean, sustainability has been kind of a buzzword for years now, but I was wondering how it's really fitting in?

I mean I think it's across all areas. ESG has been an area where we've been focusing, I think, in some product categories. But in other product categories, we have really good ESG attributes, and so the focus is elsewhere.

Okay. If you look back at some of the acquisitions you've done last year, I guess, particularly help you. They brought things to the table like innovation. I mean, have you assimilated maybe the new workforce and they've helped you kind of drive growth as well?

Yes. I think if you look back at the 2 larger acquisitions that we did in the Dispensing and Specialty Closures segment, which is the WestRock acquisition and the Albea acquisition. Both of them in different end markets, quite frankly, had a fairly sizable exposure to new product development. And I think we were able to meld those 2 cultures together, kind of take the best of the best across those 2 businesses in terms of the new product development and end up with a team that I think competes with anyone in the packaging industry. So I think that has formed the foundation for us to continue to expand across that new product development landscape and continue to make deeper and deeper inroads with existing customers and uncover opportunities with new customers.

And if we think about the margin profile over the next, say, 3 to 5 years, how should we expect things kind of to move going forward? I mean obviously, we're not asking for specific numbers, but just how we should think about the framework?

Yes. I think if you think about the Dispensing and Specialty Closures business, it is our highest margin business and our fastest-growing business. So if we're continued to be successful at growing that business in line or better than the market, then we should see the margin profile of that business overall continue to increase. And you're talking about higher level margins being north of 20%, and in some cases, as high as 30%. So it's a good place to be from a growth model perspective as well as the higher-margin side of the business. But I think there's opportunity across the rest of the business as well to continue to drive margin improvement, whether it be through lower growth, but still growth profile as well as operational improvement and cost containment.

So these purchases they've kind of helped I guess, increase your presence within Dispensing and Specialty Closures. They've increased your product profile. But I was wondering if you're also looking at potentially increasing your geographic footprint is something you considered as well. I mean you are U.S.-focused, which serves you well, but I was wondering if there's opportunities out there to kind of expand that.

Yes. I think the natural progression here, particularly with the focus on the Dispensing and Specialty Closures business is that it will inherently be more geographically diverse than our existing business. And I think that, over time, will continue to drive more international exposure. As an example, the Food Can business is a relatively mature, relatively consolidated business. So it's not likely that there's much more activity, particularly in the U.S., to be done for Silgan. Our focus right now is on the Dispensing and Specialty Closures side of the business, and that will bring more geographic presence to it. We understand that, that drives more risk in the profile, which means the return profile of any acquisition that we might do has to stand up to that risk-adjusted return.

All that said, Dan, I think our preference is still for mature markets, right? So I wouldn't want you to be surprised if you saw us do anything sizable in emerging markets. It's really a focus more around mature markets and mature end markets where we think we can make a difference.

Is there a risk in the emerging markets do you think for what you guys want to? Or is there any reason, I guess, for you to avoid that area?

Yes. Look, I think there's volatility that where we have opportunities to be in more mature markets and mature markets tend to embrace packaging on a much broader level. So I think it's natural for us to want to be in those kind of markets where the consumer is more stable, the workforce is more stable.

Okay. And then I guess another just kind of near-term question as we head into the spring -- I'm sorry, into the fall here. How we're thinking about the European Pack and the American Pack as we head towards the end of the season here?

Yes. Look, to put it in perspective, the pack is a relatively small piece of what we do. I think where we've called out some risk on both sides is on the tomato side. Tomato is, particularly in the U.S., got into the ground late. Weather conditions were not optimal. I think there was -- early on, there was some thought that they could be as much as 8 weeks late. Being late brings more exposure because you're exposed to rain or frost. That's picked up a little bit -- picked up, meaning it's accelerated. So derisked, maybe a little bit from where we were. I think if you think about that product line, what goes into the can is the more high-margin part of the product for our customers. So typically, where the flex goes, it goes into bulk paste. So tomatoes in the U.S. are roughly 5% of what we do. So kind of on the margin, there may be some risk, but I don't think it's significant. Tomatoes in Italy kind of the same type of exposure around the pack, a little less so for us because we don't go that far into Italy from a tomato perspective. Where we do have a little bit of risk is on the peach crop in Greece. Again, a relatively small part of the overall portfolio. So I would put overall pack change as more noise than anything as a real driver of volume. And certainly, what happens in any given pack year isn't indicative of where the overall market goes. Typically, you have a bad pack, acreage gets increased in the ensuing year. Likewise, if you have a really good pack, acreage gets decreased so that our customers manage their inventory over a longer period of time.

Okay. I think that's all the questions I have. I don't know if there's anything coming from the audience. But if not, I want to thank you guys for showing up today. We really appreciate it. Yes. Thanks, everyone, and thanks, everyone, for listening.