Transcontinental Inc. (TCLA) Earnings Call Transcript & Summary

[Foreign Language] Welcome to the TC Transcontinental Second Quarter of Fiscal 2022 Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded today, June 8, 2022. I'd like to turn the conference over to Yan Lapointe, Director, Investor Relations. [Foreign Language] Mr. Lapointe, please go ahead.

Thank you, Jillian, and good afternoon, everyone. Welcome to TC Transcontinental Second Quarter 2022 Results Conference Call. Before we begin, please note that the press release, the MD&A, along with complete financial statements and related notes as well as the slides supporting our prepared remarks, are all available on our website at tc.tc under the Investor Relations section. A replay of this conference call will also be available on our website after the call. We have with us today our President and Chief Executive Officer, Peter Brues; and our Chief Financial Officer, Donald LeCavalier. Before I turn the call over to management, I would like to specify that this conference call is intended for the financial community. Media are in listen-only mode and should contact Nathalie St-Jean, Senior Adviser, Corporate Communications, for more information or interview requests. Please be reminded that some of the financial measures discussed over the course of this conference call are non-IFRS. You can refer to the MD&A for a complete definition and reconciliation of such measures to IFRS. In addition, this conference call might also contain forward-looking statements. These statements are based on the current expectations of management and information available as of today, and they involve numerous risks and uncertainties, known and unknown. The risks, uncertainties and other factors that could influence actual results are described in the fiscal 2021 annual MD&A and in the latest annual information form. With that, I would now like to turn the call over to our President and CEO, Peter Brues.

Thanks, Yan. Good afternoon and thanks for joining our call. First, from a safety perspective, we were pleased to see our 12-month rolling injury rate decrease by 7%. The team continues to assess manufacturing risks, train coworkers and regularly communicate our commitment to an injury-free workplace. In terms of financial results, we were encouraged by the quarter. Following a disappointing Q1, where Omicron had a significant impact on our ability -- on our operations ability to supply and manufacture efficiently and where a lag in the pass-through of inflationary increases had a negative impact on Packaging's financial performance, the team took actions to improve. Packaging's Q2 performance was solid, benefiting from the team's work to ensure a secure supply of raw materials and open communication with customers during Q1. Sales increased with particularly strong growth in meat and cheese. Profit increased due to the volume growth, though this was partially offset by the lag in inflationary cost pass-throughs. To be clear, earnings increased each month, and the full benefit of inflationary cost pass-throughs will be seen in Q3. The R&D and commercial teams continue to progress and commercialize recycle-ready, post-consumer recycled and compostable solutions. We continue to commercialize PCR shrink films across our beverage customer base and recently closed the deal to supply fem care packaging with PCR content to a major FMCG company. We can be proud of the solid growth achieved by our print business. That said, it was disappointing not to see it convert to the bottom line. As the in-store marketing business moved to absorb a 22% organic increase in sales, profit was affected by 3 elements. First, the team was behind in passing through raw material and freight increases. Second, the business experienced manufacturing inefficiencies related to onboarding new customers. And lastly, we grew indirect costs needed to absorb smoothly volume increases anticipated in H2. Having visited the ISM plant in May, I was pleased to see the team's actions to ensure costs have been passed through and to ensure volume growth in H2 is accretive. Confirming our ability to grow newspaper and that flyers remain a vital part of advertising retail sales, we were pleased to finalize the deal to print 2 major Western Canadian newspapers and to profitably extend a significant agreement with a major retail customer. Our media business was in line with our expectations. The more time I spend with the team, the more impressed I am by the quality of our management and the quality of learning tools we provide to teachers and students. This is a business we should grow, and the acquisition of Scolab further supports our customer offering by expanding our digital portfolio. In conclusion, I appreciate the work the team has done to address the issues we faced at the beginning of the year as well as the actions we have taken to continue to improve. It gives me confidence that we are well positioned for the second half of the year. And now I'll hand it over to Donald.

Thank you, Peter. Moving to consolidated numbers on Slide 5 of the earnings call presentation. For the second quarter of 2022, we reported revenues of $623.3 million, an increase of $92 million or 15% versus the last period last year. This revenue growth was driven by higher volume in our 2 main sectors and by price increases, following the pass-through of higher raw material and inflationary costs to our customers and by acquisitions: H.S. Crocker in Packaging, BGI Retail in Printing and Scolab in Media. On the profitability front, consolidated adjusted EBITDA was at $103.6 million for the quarter compared with $109.4 million for the same period last year. This decline of $5.8 million was mainly due to the Canadian wage subsidy of $7.5 million received in Q2 last year, partially offset by higher volume in our 2 main sectors and by the acquisitions I referred to earlier. Corporate costs declined from a lower share-based compensation expense due to the share price. Despite lower interest rates on our debt, financial expenses increased slightly, mainly from a currency loss. The tax rate was at 23.1%, leading to adjusted net earnings of $0.48 per share for the quarter. Now moving to Slide 6 for the sector review. In packaging, we recorded organic revenue growth of $55 million. This growth was mainly due to the pass-through of higher raw material prices and other inflationary costs in addition to volume growth of about 5%. In the face of continued supply chain challenges, we remain focused on ensuring continuity of supply and on supporting our customers' growth. Generating this level of volume growth reflects the solid demand for our products. Finally, the acquisition of H.S. Crocker early in this fiscal year contributed $19 million of revenues in Q2. In terms of profitability, adjusted EBITDA in packaging grew by $3.2 million or 6.5% as the pricing actions we have taken allowed us to mitigate higher costs. The increase also includes higher volume and the contribution of $1.5 million from the H.S. Crocker acquisition. When compared with Q1 2022, adjusted EBITDA grew by $13.5 million, highlighting the effects of higher volume and the benefit of the action we implemented. On slide 7, you can see that printing had a fifth consecutive quarter of organic growth with $15 million of revenue growth versus Q2 last year. The growth came mainly from our in-store marketing and book printing businesses where we saw double-digit growth, and to a lesser extent, from the pass-through of higher raw material prices and other inflationary costs. In addition, last year's acquisition of BGI Retail contributed $9 million of revenue for the quarter. Printing adjusted EBITDA for the quarter was $54.7 million, which was below the $67.3 million in Q2 2021. The decline was mainly due to the $7 million in wage subsidy we received last year and from the lag in recovering inflationary cost increases. The decline is also related to the additional cost in our in-store marketing activities related to onboarding new business and building capacity to further grow. The sector's adjusted EBITDA margin for the quarter was at 18.7%. Turning to cash flow. We generated $106 million in cash flow from operating activities before changes in our noncash items and income taxes paid, in line with last year at $106.1 million. We continue to maintain higher inventory as we prioritize the security of supply to support our customers' growth. Consequently, we had a working capital usage in the quarter of $16.5 million versus a usage of $9.2 million for the same quarter last year. Cash taxes were at $15.1 million compared to $13.6 million in the prior year. Our investments in CapEx at $34.8 million were in line with our -- with expectations. These investments are key to capturing growth opportunities. At the end of the quarter, our net debt ratio was at 2.35x, similar to the previous quarter at 2.34x, as we used the cash flow from operating activities to finance our capital investments and the acquisition of Scolab in our media sector. We continue to expect the ratio to decrease back to around 2x in the coming quarters, given our improving profitability and free cash flow generation. Despite our CapEx and other investments, we continue to maintain a strong financial position with $407 million of available liquidity at the end of the quarter. Finally, we distributed $19.6 million in dividends. As for the outlook, we are starting to benefit from the positive impact of pricing and other actions taken in the last months to improve profitability, and we are encouraged by the results. We look forward to improved second half of the second year and remain committed to deliver on our fiscal year 2022 outlook. In packaging, we expect to generate organic growth in fiscal 2022. We also expect profitability to improve in the second half of the year. In print, solid growth is coming from our ISM, book printing and pre-media activities. And we expect higher revenues and higher adjusted EBITDA in fiscal 2022 when excluding the 53rd week of 2021 and the impact of the wage subsidy. We expect corporate costs at EBITDA level to be around $40 million for the year. Regarding the use of cash for the year, we will continue to invest significantly in our future through our CapEx program and pursue potential acquisitions. As mentioned last quarter, CapEx in fiscal year 2022 is likely to be similar to 2021, contingent on the timing of key investments. We expect our tax rate will continue to be in the mid-20s, and we expect cash taxes to be close to $80 million for the year, reflecting the higher than usual cash tax in Q1 2022. On that note, we will now proceed with the question period.

[Foreign Language] [Operator Instructions] Our first question comes from Hamir Patel from CIBC Capital Markets.

Peter, on the printing side, just given some of the large cost increases you're having to pass along to your customers, are you starting to see any signs that those customers might be looking to reduce page count or circulation?

Thanks for the question, Hamir. So first, from a print perspective, our paper prices are locked in for significant periods of time. So it's not something where we're seeing a huge inflation from that perspective. So when we're talking about inflationary price increases and importance of passing through freight, it's more in the ISM and book side of the business where it's not contracted to the same level. So in terms of changing page count or changing number of the amount of circulation, it's not something that's being impacted by any change in pricing.

Peter, that's helpful. I guess I'm curious, though, on the newsprint side. How long does that contractual protection last? Because we've seen in the spot market a very significant move higher in pricing for graphic papers.

Good question. So that period, we'll be renegotiating that in the new year. So we're positioned to continue the year well. And in terms of general inflationary increases, they tend -- they adjust contractually, but it depends on the timing of customer contracts.

Great. That's helpful. And just last question I had was, again, about some of the pass-throughs across the business. Are there any caps on inflation in some of those arrangements? And if so, how meaningful are those? And what's the sort of timing as to when you can maybe adjust those at renewal?

Yes, there can be caps on the rates. And currently, as we renegotiate contracts, we're relooking at those caps and reviewing them to make sure that they reflect the current environment.

And I will add, the caps are mostly on the printing side of the business, but if you think of the contract, that we did talk in the past about the pass-through clauses that we have in contract on the packaging side, most of them don't have caps, so therefore, any increase, the only impact we will receive will be related to the months before we can pass this increase to the client.

Our next question comes from Mark Neville from Scotiabank.

In terms of the pricing adjustments in packaging, I'm just curious, trying to get a sense as to where you're at if you're sort of fully caught up and you sort of see the full benefit in fiscal Q3, or if this takes a couple more months and sort of it's a Q4 event. Just trying to get a sense of where that's at.

So there are a lot of raw materials, but we're focused -- let's first talk from a polyethylene perspective, and polyethylene went up significantly last year, stayed flat for a bit, declined slightly and now has gone up slightly, and in the last 2 months is kind of maintaining flat. So from a polyethylene perspective, you can look at it as it's been absorbed by the business and fully passed through, and as we move on into Q3 we're good. What we saw in Q1 that was important is that in noncontractual side of our business in a specific segment, we haven't passed through significant increases we had seen in polyester. The team was behind in doing that. So there was action taken at the end of the quarter to move that on. We saw a part of that benefit in the current quarter, but we'll see the full benefit of reacting to that in Q3. I'd also add from an inflation, now we've been talking about raw materials from a packaging perspective. In contrast to print where there can be a CPI index in most contracts, in packaging you don't usually see increases for outside raw material inflationary increases. And what we have been doing is move into the market and doing outside of contract inflationary cost increases, and the results of which we saw partial benefit in Q2, and we'll see full benefit of that in Q3.

And these -- the cost increases, we're talking about raw material so I assume you mean freight, labor, energy. Would that be -- I mean, I'm just curious sort of -- I assume it's a fairly easy environment to push that through, but just sort of curious as to the customer reaction.

I think that -- I think, first, what I'd say is that for all of us, both customers and ourselves we haven't seen inflation like this in 40 years. So I think as a result, we initially were slower than we would have liked to react to it. I think customers are also experiencing the same inflationary environment. And as you and I experienced when we go to the grocery store, you can see that our end customers are pushing through inflationary increases to the consumer.

Yes. Yes. Got it. Maybe just in terms of -- you mentioned in the prepared remarks, Peter, some new contracts in print. I'm just curious, will they all be incremental? And if there's some rough numbers you could maybe help us with in terms of sales, dollars or anything that you can help us with there.

Sure. So first, the reason I talked -- there are two. So one is that when I started working with the team, I really felt that we should be the last people standing from a newspaper and flyer perspective in Canada. We have an exceptionally strong base. And for me, we aren't -- the strategy was to be the last people standing, and we're not the last people standing. And so the challenge to the team has been we still have the opportunity to grow newspaper instead of talking about something that's shrinking. And so the reason I highlighted getting a couple of newspapers. First, they're important newspapers and we secured base business in addition to growing. It's -- the materiality of it, frankly, is not substantial. That said, it's an indicator to the team of what we're capable of doing. So yes, it's accretive, but it's measured in under $5 million in EBITDA. That said, it indicates our capability of continuing to grow and it reminds the team of the importance of growing. From a retail perspective, we're talking about an account that's more than $100 million a year in sales, and we were able to profitably grow with the account.

Our next question comes from Adam Shine from National Bank Financial.

Obviously, Q1 had a lot of pent-up demand. It seems like you worked through a lot of the backlog, I guess, is a better expression into the Q2. Peter, can you speak to some of the evolving demand going into the second half, the sort of line of sight? And perhaps the presumption that maybe not necessarily 5% volume growth in the H2, but certainly something nicely robust in the low single digits? And then I'll follow up with something.

So yes, there was a backlog in certain segments coming out of Q1, and we continue to see a backlog. That said, I think to say that we'll continue at 5%, I wouldn't want to put you on that journey. I think saying that we'd be at 2% to 3% makes more sense going forward. But really pleased with the work the team has done. The interactions they had with our struggles in Q1, the directness, the direct communication with our customers I thought was excellent. And the result is we're being compensated by continuing to see increased volume. So still a lot of work ahead of us. I don't want to pretend that it's an easy environment in terms of having access to raw materials and in terms of absorbing the growth we currently see. And we expect to continue to grow the rest of the year. And I think the team's positioned itself well to grow.

How much of a dynamic is shrinkflation in terms of the business and your need to perhaps adjust to changes in sizes of packaging that are being demanded by certain customers, certainly not all?

We -- this isn't something of significance that would be impacting our business. So right now, the focus is primarily on moving to sustainable solutions. But in terms of down-gauging a package, I mean, we're always working to down-gauge a package. But in terms of actually shrinking the scale and seeing that as being a negative impact on our business is not something that we're seeing today.

Okay. And just lastly, in terms of Publisac, obviously, we had some news flow during the period, but maybe you can just talk to sort of the volumes continuing, the distribution continuing. And perhaps any thoughts on next steps potentially, maybe a little premature nonetheless, but any quick comments around Publisac?

Sure. So Publisac being our distribution of flyers in Québec. And there was a city called Mirabel outside of Montreal where they suggested they put in legislation requiring customers to -- or consumers to opt in to -- in order to receive flyers. We have challenged that in court. The court favored against us. We'll be appealing that in the days -- in the next few days we'll appeal that decision. That said, what I'm extremely proud of is that the team -- the decision was made on a Wednesday, and the team was able to supply our customers' buyers to consumers without any delay the following week. So there was no change in our service, and it was completely smooth, and I think it's something the team should be exceptionally proud of. If I look at it going forward and legislation that's been put in place in Montreal, the team had been challenged to grow our flyer business given that the flyer is exceptionally important as a marketing tool to our customers and in an inflationary environment is exceptionally important to consumers. And so the team has been challenged -- when we look across Canada outside of Quebec, we've seen a decline in flyers as we've seen the newspaper distribution decline. And so the challenge for us has been, well, we don't want to become a massive distribution company across Canada. We do want to make sure our customers have the ability to get flyers to consumers wherever they may be because it's key to them. So the team has been working for over, I'd say, 12 months now on how we can increase distribution outside of Quebec. And the work that they've done position us really well that as we refer alternatives -- so we need alternatives to quickly stack, we're well positioned to continue providing the service to our customers. So really pleased about what happened in Mirabel. We're really pleased at the progress the team's doing, and we're committed to ensuring that our customers will continue to be in a position to have flyers to consumers and consumers will have access to this important...

Our next question comes from Sid Dilawari from Cormark Securities.

In your prepared remarks, you talked about the packaging segment experienced about 5% volume growth from new business. Just digging a little bit deeper into this, how is the pass-through mechanism on this new business? And like you also talked about some of the pass-through of this inflationary costs being passed on to the customer at the end of the quarter. So can we expect to see the packaging segment sort of return to normalized EBITDA margin level in the 14% to 15% range in the back half of the year?

Maybe just to make sure, when you mentioned -- it's Donald speaking, the volume of 5% in the pass-through, when we said volume about 5%, this is excluding pass-through. So it's pure organic growth. So the pass-through is not part of the 5%. So this is real organic growth. And okay, yes, and regarding margin, before I let Peter add -- finish for your question, if you look at the impact of all the increases we had to put on the pricing regarding inflation, raw material increases, margin, it will be tougher to evaluate the margin in the future quarter because it does play with obviously all the increases we're adding to our client. And therefore, the margin is not the best way that we track growth. It will be pure EBITDA. And my comments, when we say we should be better than last year, was regarding the EBITDA in dollars. This is what we're looking forward for the rest of the year. I'll let Peter complete the answer.

So when you asked about the 5% -- I mean, if I understand the question, the 5% growth is organic growth, and the 5% growth is at pricing that reflects raw material prices in the current inflationary environment. In terms of the impact of inflationary pass-throughs and some of material increases that took place for one segment where we were slow to move on polyester, that was done at the beginning of the quarter. The full impact of which would only be [Audio Gap] So that's specific to a polyester issue, and it's [Audio Gap]

Okay. Okay. That's helpful. And then maybe one for Donald. We saw inventories rising during the quarter. Is there something to unpack here in terms of stocking up? Or is it just inflationary to avoid input shortages? And how does this play into your COGS in the following quarters?

Well, yes. It is, first, inflationary when you compare to last year because with the huge [Audio Gap] and it's also that for some products -- specific product, we want to protect ourselves. We have a lot of growth on the sales side, and we want to make sure that some of our raw materials or other products are available. Therefore, we build a little more in the inventory. This is something, obviously, we track with the team. We make sure that to be as much possible efficient. We're confident it's some improvement over the rest of the year. But also that will depend on where the pricing on the raw material will go, and this is something that we cannot have any view as we speak right now.

[Foreign Language] [Operator Instructions] And we do have a question from Drew McReynolds from RBC Capital Markets.

On the retail flyer side, just with existing major retailers, we haven't really talked about, just coming out of COVID here and reopening, just what some of the trends and -- you're seeing in that core business. So if you can provide an update there, that would be great. And then secondly, maybe for you, Donald. I noticed in the other revenue category, it was certainly well below what I was forecasting. And I know it's not a big number, but it does speak to intersegment items impacting that. Is that something you can just quickly address here? Or otherwise, we can take it off-line.

I'll start by answering the question in terms of circular volume. In terms of circular volume, what I'd say to you is it's holding steady. So we haven't seen a significant change on the overall circular sales. And when we interact with our customers [Audio Gap] of how they view marketing [Audio Gap] interactions with our customers [Audio Gap] a tenfold benefit when you [Audio Gap] as opposed to a digital one [Audio Gap] is important to them.

As far as your question, it's mainly transaction between our printing group and our media group. As you're aware, we print most of our books that we publish on the education side. So it's more transaction for that group during that period. We're still building inventory for the media group.

Okay. Okay. Got it. And maybe one last one. Peter, you called out meat and cheese within packaging as certainly a particularly strong category more broadly across the different subcategories that you do packaging in. Is there any other kind of trends to flag on that, either kind of pockets of softness still or other pockets of strength? Or is it meat and cheese particularly strong and then nothing really notable across the rest of the categories?

So it was pointed out because it was the most significant. So I would say that meat and cheese [Audio Gap] beverage remains strong, especially with the work we're doing from a [Audio Gap] content, seeing strength there. I'd say the only part of the business where we're experiencing some [ weakness ] is from a Latin American perspective. You'll appreciate given the [Audio Gap] that there is -- 8% of the world's consumption of bananas is in Russia, and 25% of -- and Ecuador does -- is the exporter -- primary exporter to Russia. 25% of their production exports goes to Russia, and that caused banana prices to be impacted and there to be pressure on Lat Am. So that's the banana packaging side of the business, so there's some pressure there. It's not massive, but it's something to be aware of. So if I'm looking at from a pure growth perspective, that part of the business is relatively flat where we would have [Audio Gap]

[Foreign Language] Mr. Lapointe, there are no further questions at this time.

So thank you, everyone, for joining us today on the call, and we look forward to speaking to you soon.

[Foreign Language] Ladies and gentlemen, this concludes the conference call for today. Thank you for participating. You may now disconnect your lines.