Transcontinental Inc. (TCLA) Earnings Call Transcript & Summary

[Foreign Language] Welcome to the TC Transcontinental Third Quarter of Fiscal 2023 Results Conference Call. During the presentation, all participants will be in listen-only mode. [Operator Instructions] As a reminder, this conference is being recorded today, September 7, 2023. I would like to turn the conference over to Yan Lapointe, Director, Investor Relations and Treasury. [Foreign Language] Mr. Lapointe, please go ahead.

Thank you, Joel, and good morning, everyone. Welcome to Transcontinental's Third Quarter Fiscal 2023 Earnings Call. Before we begin, please note that the press release, the MD&A, along with financial statements and related notes as well as the slides supporting management's remarks are all available on our website at www.tc.tc under the Investor Relations section. A replay of this conference call will also be available on our website shortly after the call. Please note that this conference call is intended for the financial community. Media are in listen-only mode and should contact [Audio Gap] investor relations for more information. We have with us today our President and Chief Executive Officer, Thomas Morin; and our Executive Vice President and Chief Financial Officer, Donald LeCavalier. As referenced on Slide 2, 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 these 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 2022 annual MD&A and in the annual information form. With that, I would like to turn the call over to our President and CEO, Thomas Morin.

And thank you, Yan, and good morning to everyone, and thank you for joining the call. Three months has passed since our last call, which was actually my first day as CEO, and I'm pleased to be with you again today. At that time, our Executive Chair, Isabelle Marcoux, and I shared with you our 4 priorities. Number one was to grow organically and profitably; second is to deliver strong return on assets; third is to reduce our debt; and fourth is to commercialize sustainable products. Aligning the organization on these 4 priorities has been the focus of my first 90 days, and I'm happy to report that the team has responded very well. We took quick actions to adjust to market conditions, which were more challenging in Q4 than in Q3 than anticipated. These actions enabled us to improve our conversion rate, mitigating the impact of lower volume on our profitability. We also made good progress on working capital by continuing to reduce our inventories and this is a key component for us to drive our debt down. Part of my agenda was also to review our senior management structure and create a leaner, more focused and more agile team aligned to deliver on that 4 priorities. And this was done quickly and a new executive team was announced mid-August and is now fully hands on. Also went on the road to better understand our printing business, visiting our plants, meeting our teams and our customers. I must say that I'm impressed by the engagement of our leaders and coworkers, the quality of our assets and the strength of the relationship with our customers. This has enabled me to see more clearly the potential of our printing business, and this includes our more traditional activity. All in all, I'm satisfied with the work accomplished and confident that these actions taken this quarter and this year will also benefit us in the long term. Now going back to our results and starting with safety. Our year-to-date incident rate has decreased by 23% compared to last year. This is obviously a major achievement by the team. Although significant work remains to achieve an injury-free workplace, this is obviously a big step in the right relation. Turning now to our sectors and starting with packaging. Like our peers, we were impacting by market dynamics that continue to -- we continued de-stocking as well as the softening demand due to the economic context. But despite these lower volumes and thanks to our actions, profits were in line with last year. In terms of commercializing sustainability, while generating profitable growth and better return on assets, let me give you an update on our recycling strategy and come back, of course, on the investment we've announced on August 22. First, we took a step back to review our recycling operations and took the strategic decision to move recycling directly into our film production facility. By bringing recycling closer to end markets, we are reducing costs, and we are better positioned to commercialize products with PCR content. With this evolution, we will be closing our Montreal recycling facility at the end of this month. Second, we've announced a major investment in the new BOP film line to be installed in Asparenberg, South Carolina facility. This new offering is a game changer for our industry and for TC Transcontinental. The superior capability of this team will give us a competitive edge and as a consequence, will enable us to gain share as the market evolves towards more stability. We are pleased with the early interest shown by many of our key customers. Now in the printing sector, the measures we took have resulted in significant recurring savings. On the downside, fly volumes continued to decrease and books have had a challenging quarter. We will continue to adjust cost to volume and take all the measures necessary to protect profitability. On the positive side, we are pleased with the rollout of our reinvented flyer raddar in Montreal in May as well as in Vancouver last month and we are now distributing over 1 million copies of raddar every month. Also, in the wake of having in-sourced newspaper volume from Metroland earlier this year, we are taking on new volume from another newspaper publisher this year maybe. This year we made this announcement to [indiscernible] earlier this reduction. In summary, with our key focus on our 4 priorities and acting with speed and agility, I am confident that we are on the right path. And on that, I will pass it over to you, Donald.

Thank you, Thomas, and good morning, everyone. Moving to consolidated numbers on Slide 5 of the earnings call presentation [Audio Gap] 5.5% decrease in revenues versus the same period last year. This was mainly driven by lower volume in both our packaging and printing sectors. Regarding profitability, consolidated adjusted EBITDA for the quarter was $107.9 million, down 4.5% compared to Q3 last year as the improvement in our packaging sector was not sufficient to offset the decline in our printing sector. We have accelerated the implementation of cost reduction and efficiency measures across the organization, and we are encouraged by what we see. As Thomas mentioned, we streamlined our management structure to better support our operation and become more agile in a fast-changing environment. These changes in addition to the initiatives implemented at the beginning of the calendar year have improved our cost structure and overall profitability. Taking together, these measures add up to $40 million which over $20 million coming from the printing sector. Financial expense increased to $16.1 million, mainly from the impact of higher interest rates on our variable debt. Adjusted income tax of $10 million was $3.2 million lower than last year and represented an effective tax rate of 18.5%. This resulted in adjusted net earnings of $0.51 per share for the quarter. Now moving to Slide 6 for a sector review. In packaging, we generated revenue of $403.3 million compared with $426.2 million last year, down 5.4%. The decline is mainly due to volume being down about 10% from continued customer destocking and recent market softness impacting both segments. However, we benefited from a stronger year-over-year U.S. dollar. In terms of profitability, despite a challenging quarter for volume, adjusted EBITDA in packaging was up 3% to $53.8 million as favorable exchange rate, pricing action to recover inflations, cost savings and efficiency improvements were able to offset volume impact. Moving to Printing on Slide 7. Revenues decreased by 5.6% to $273.7 million. We continue the pass-through of inflationary price increases in the quarter, but we were impacted by lower volume, mainly in our book and flyer printing activities. Printing's adjusted EBITDA was $45.2 million for the quarter compared to $52.3 million last year due to the lower volume in the quarter. That being said, we are accelerating the implementation of cost reduction measures to better position our cost base for the future. We have already realized over $20 million in annualized profit improvement initiative for the sector and the teams continue to identify and implement new actions. The deployment of radar also contributed positively in the quarter. Corporate expenses were in line with last year at around $10 million. Now turning to cash flow. We generated $109.1 million from operating activities, an increase of $60 million versus last year, mainly driven by improved working capital as we continue to make progress on [ releasing ] inventories. We went from a working capital usage of $46.9 million last year to a positive $26 million this year. This is the second quarter of positive working capital in a row, and we continue to be confident in our ability to deliver strong cash flows in the fourth quarter. Our CapEx at $44.1 million are higher than last year, but has started to decline sequentially. We continue to expect CapEx of about $160 million for the fiscal 2023, net of potential disposal before returning to a lower run rate in fiscal 2024. While impacting our debt in short term, our investments such as the new $60 million BOP line recently announced will provide a lasting competitive advantage and should be a key driver of our long-term growth. Despite our investments in CapEx, our net debt ratio continues to improve, standing at 2.50x at the end of the quarter -- the third quarter compared to 2.63x at the end of January. The improvement over the last 6 months is mainly due to higher cash flow generation from positive working capital. Debt reduction is our priority, and we are committed to a strong free cash flow generation. Our net debt should come down to close to 2x in the coming quarters. In closing, through the first 9 months of the year, despite lower volume, we have delivered similar adjusted EBITDA than last year. By driving substantial cost savings and efficiency across the organization. In terms of outlook and packaging, while we expect pressures on volume to persist in the near term, we continue to expect to improve profitability in fiscal 2023. In [ TRIM ] we continue to expect lower adjusted EBITDA for fiscal year 2023 from the impact on inflation on volume and cost structures partially offset by the impact of the ongoing cost reduction initiative. We also expect strong performance from in-store marketing activities and a positive impact from RADAR in the fourth quarter. We expect corporate costs at the EBITDA level to be around $40 million for the year. Moreover, cash tax to be around $60 million for the year. On that note, we will now proceed with the question period.

[Foreign Language] Ladies and gentlemen, we will now conduct a question-and-answer session. [Operator Instructions] Your first question comes from Hamir Patel with CIBC Capital Markets.

Thomas, on the packaging side, I believe Donald mentioned that volumes were down 10% in the quarter. How did volumes fare in August? And when would you expect volume comps to turn positive again?

Yes. Thank you for the question, Hamir. A couple of comments on that. We anticipated destocking when we had our call in Q3 back 3 months ago, basically. We actually anticipated some customers to reduce [indiscernible]. They have told us and sent us on some mornings. This came a bit stronger than expected. So obviously, we circled back with them and try to -- it's actually pretty focused to be clear. And they all confirm they would have a positive outlook for the year, all confirmed that they would grow this year, and we would grow with them. Now this impact in Q3, combined with the seasonality. In some cases, the summer is not a high season for some of the packaging segments we play in. This was larger than anticipated. This caused us to reduce costs faster. Now your question is more forward-looking. The -- we see an uptick in the month of August starting to recover, that was expected. The question is how long is this going to last? And is this going to be at the level we were expecting or experiencing last year, but we see an uptick in the first month of the fourth quarter going in the right direction. We'll see if it is confirmed for the remainder of the year.

Okay. Great. And sorry, just to clarify, that's an uptick year-over-year or sort of sequentially coming off the fiscal Q3?

It is not yet back to last year in dollar terms. I need to double down on the volume piece, but it's certainly better than Q3 for sure. No doubt.

Okay. Fair enough. And then just turning to the cost side. Have you seen much benefit yet from the falling spot prices for resin? And what kind of tailwind could that be for you in 2024?

Yes, good question. The 2 things to say on that. First, we've been reducing significantly our raw materials inventories in the course of Q3. And I would say it started in Q2 as well. So we would expect to see flowing through some production coming from raw materials. Don't expect much though the -- if you follow the resin price, yes, the spot market has been evolving faster. But the overall resin market hasn't gone down that much yet, a little bit still. So yes, we would expect to see to see some benefit from that. Difficult to estimate how much, but certainly going in the right direction, especially now we've reduced our inventories in raw materials.

[Foreign Language] Your next question comes from Adam Shine with National Bank Financial.

Can we go back to the first question, maybe just to unpack it a little bit related to the packaging volumes. So you have 2 elements. One, an acceleration sequentially in the destocking? And then you also alluded to softness in volume related to just economic backdrop. So Thomas, can we just go back to some of your answers earlier in terms of specifically around destocking. Do you think destocking as a pressure point runs it's course by the end of your fiscal 2023? Or can it potentially continue into F '24? And then on the volume side, as it relates to the economic dynamic, are you similarly seeing an uptick or at least sequential improvement related to that factor as well? And then I'll circle back with another question.

Yes. Thank you, Adam. So let's be very specific. When we had some supply issues, all the industry, everybody has grown their inventory. So we grew our raw materials inventories, our customers grew their packaging inventories. Everybody did that in the course of the last, say, 2 years. The -- we ended up both our customers and ourselves with way too much inventories as the supply chain resumed to a better service levels. And when we had these discussions with them, we were talking about a month too much. If you can, in a number of days, it would have been about 30 days, too many in terms of inventories. This has led to this reduction in the summer, and the numbers -- the reduction has been pretty quick. So to your question, the -- I believe the adjustment has been done with the customers we're working with. I wouldn't make this a general statement across the industry. But as far as TC Transcontinental is concerned, I would say most of our customers have reduced pretty much their level of inventories to the right level, which is about a month, say of inventories. Now -- so that's what I believe will drive a better -- a more, I would say, normal demand in the forthcoming months. The thing which we -- which is difficult to estimate is the impact of inflation, our customers have passed on to the market. So like we did, all our customers have passed a significant amount of inflation this year to the market. And this, at some point, may have an impact on demand too early to say, Adam, but that's something we obviously actively discussed with them so far and as what I said, all of them report steady demand and don't expect to see a reduction in volume. But at this point in time, that's still to be demonstrated.

Okay. No, I appreciate the added color. If we go back to one of Donald's additional comments, in terms of outlook, he did allude to the fact that [ ISM ] should grow, which is something you've been alluding to in recent quarters, but you sort of come off the idea that book is going to grow. And obviously, you saw pressure in book in Q3. Can you just speak to what exactly transpired early in H2 and whether indeed that book pressure continues into Q4?

Yes. I mean, we'll cover that [indiscernible] with Donald. The -- so on ISM one quick word, the order intake and book is strong. The pipeline is strong. So it's really promising. So I confirm what obviously, Donald said. On the book side, it's been a bit of a roller coaster. We were very busy until a few months back, and then we saw the demand reduced. Obviously, this is something we're investigating. We're adjusting our cost as we speak, obviously, to take care of that. Now the team has been very quick in identifying some potential growth opportunities in book. So that's where the focus is on now, Adam. We have a good asset base, as I said, good team. We know from a quality standpoint, where we should be playing. So it's all about going and hunt again, which is where the team is focusing on as we speak. Now how long is it going to take? I'm not too sure yet. But for sure, there are some opportunities.

[Foreign Language] Your next question comes from Drew McReynolds with RBC.

Yes. Thanks very much. Adam kind of ticked off a few of mine. Just 2 then. On the radar, Thomas Morin or Donald just can you give us a little bit more granularity on what you've seen since that launch in May and how it's contributing to results relative to what Publisac used to? And then secondly, back to packaging, maybe for you, Thomas. Obviously, a lot of investment going into sustainability, kind of recyclability efforts. Do you expect a flow-through to crystallizing that investment to kick in fiscal 2024 and how confident are you in terms of kind of gaining market share within the segments that you compete in?

Yes, Drew, I'll take the one on raddar. At first, the most important thing for us on raddar was the importance of securing our print product. We had a quick turnaround in Montreal facing the situation, and we're really proud of how quick we were able to react to that. And now as you can see, we're starting to do some real product also in Vancouver. So that's very important for us. So far, the clients appreciate the solution. We had great feedback after first quarter of doing business with raddar and Montreal. So this is very interesting. In terms of number, obviously, we won't disclose any numbers regarding the impact on the bottom line. But what I can tell you is that distribution in Montreal for us was operating loss before raddar and now behind us. So that's a good news.

Yes. And I think it's been very impressive, the speed at which the team developed the product, having them to connection with our customers and stakeholders the way it's been -- the Vancouver example was done within a month. Yes, that's pretty impressive. All right. Second question was on the investment in sustainability and how fast can we expect to see this flowing through our growth agenda. Obviously, this is a key milestone, not only for TC Transcontinental, but also, I believe, for the [ flexible ] packaging industry. The BOP film provides a great deal of benefits. And I suggest we have a specific event on that because there is a long list of things we can share how great this product is from a performance perspective, all the way down to the total cost of ownership for customers. The process and the agenda so that we clear -- the line will be operational in spring next year. So it's a big machine. We expect to pull the first roles of film sometimes in March, April and start the commercialization right after that. Now we obviously are already working at qualifying this thing with customers with a great deal of success as we speak. So the question becomes how fast is this going to be delivering growth. It's obviously part of our plan. We wouldn't do that otherwise. Difficult to tell you exactly the date should we have an impact in '24. I think the first thing will be to secure and replace the current nonrecyclable films, we buy today by this film, so this will bring benefits, but not necessarily a visible benefits in the first year. I think it's prudent to say that. And now on the long term, obviously, this is delivering a significant amount of additional volume, which is already something we have identified and already working on with customers. So we're already working on share gains, if you will. And it's done in line with the customers.

[Foreign Language] Your next question comes from David McFadgen with Cormark Securities.

A couple of questions. So when we look at the packaging business, it seems as though the organic decline in Q3 was primarily a destocking event that's over now? Is that correct? It wasn't really that much macroeconomic driven. It's more of a onetime destocking event. Is that correct?

When I look at the $41 million, to be extremely specific, I would say, clearly identified 2/3 of that is destocking. That's very clear. This is something we could share with customers, and we could definitely double check on. The rest, it's smaller accounts, smaller customers. Difficult to say whether this is activity related -- the one thing we know though is that there is no share of wallet loss or very little, no customer loss. So I would say amongst the $40 million to be clearly specific, call it, $30 million is for sure destocking. And then [ $10 million ] is yet to be fully understood.

Okay. And when you characterize your packaging business as being pretty recession-resilient?

Yes. I mean, so -- and I would say I would be very specific on that. The about, I would say, more than 90% of what we do is packaging food, if you will. So this, for sure, is resilient. There is still some activities we do in the industrial market, which is not a recession resilient, and that's a minor share of what we do. The rest is food and pharmaceuticals and medical related. So this has proven to be resilient.

But where we need to be prudent, David, is that I agree that it's recession proven, but with inflation going on right now, especially at the grocery, we're doing packaging for food. So we'll -- the numbers of items that people will buy will remain the same in the next months if inflation keep pushing in that direction. That's something that we're following closely -- and obviously, we have discussion, as Thomas mentioned earlier with our clients. But this is something to consider. So there's a recession, but there's the impact of inflation. And as you know, it's regarding the price of the grocery, it's very important right now the impact. So this is something to consider also.

Okay. So when you look at your free cash flow, obviously, you're starting to free up some of that working capital that you invested over the last couple of years. I think you invested I think, it's like close to $200 million maybe. Do you think you could get a lot of that -- do you think you could get a lot of that back?

Well, obviously, if you look at the price, it was an example of the reason, it's not at the level it was before we invested that $200 million, so that will remain a negative impact. But for sure, as our clients are doing, and this is what we've been doing in the last 2 quarters, we don't need as much in the entries, as we needed during the supply chain issue. So that we're gaining back. And we're still going to push. And I think we can do -- we did a good job so far, but we're not satisfied. We're going to push for Q4 and everyone is aware in the organization that 2024, we want to push in that direction because, as you know, our priorities is pay down debt, and that's an easy way to pay down debt.

Yes. Exactly. So just on the book volume, just kind of wondering what is driving -- or what drove the results in Q3 on the book side just a little surprised of the weakness there?

I think Thomas gave some color earlier, but what I can add on that is that book a little bit like we talked a lot about the destocking on the packaging side, but this is something that -- that happened also on the book side before like last year and even at the beginning of this year, but mostly last year when you compare to last year, supply chain was an issue on book, issue was a closed market. Publisher were ordering a lot in advance, and then now they're doing the same. They're just pushing down their inventory. Maybe less books are re-write now because we're post COVID [Audio Gap] impact of that in this quarter. Overall book year-to-date is still in advance versus last year. So that's good. So we still believe that book is a growing business for us, but it was a tough quarter. And operating, we had to do some adjustments also.

[Foreign Language] Your next question comes from Stephen MacLeod with BMO Capital.

Just a couple of follow-ups for me. Just on the packaging side. I just had 2 questions. Are you largely through the destocking impact? And then secondly, on packaging, are you still seeing the ability or having the ability or needing to put through price increases?

Right. So on the destocking, I think we covered some ground already is the -- and I will repeat that I think we've seen the bulk of it. Now again, to be confirmed because there was a combination of seasonality and destocking in Q3. So we need to see both reversed in Q4. So far, we see some of it, maybe not full of it yet. So to be continued as a discussion, at least on the destocking, I think we've turned some corner. We need to confirm that. As far as the ability to pass on price increases, I mean, we've done most of what we had to do in line with our customers and contracts. The inflation of our input costs is not decreasing, but not increasing anymore. That's what I can see today. There are a few pockets here and there, but nothing really that would cause us to pass on increases to customers at this stage. I don't see, I don't see things -- at least in the near term, I don't see things that would cause us to have this discussion.

Okay. That's great. And I did dial on late, so I apologize if you already covered that on the destocking.

No, it's always good repeating.

And then sort of sticking on packaging and putting all those moving parts together, how do you see volumes -- how do you see volumes and maybe organic growth evolving in Q4? And would you expect to see a similar level of margin pressure?

So on Q4, I'd like to rewind the tape -- so Q4 versus Q3 should see a better sales volume just because of seasonality and less of destocking, as we said. The question really we have is Q4 versus last year because if you remember, last year was a period of time, where customers were stocking heavily. So the reason we're destocking now is that because we stocked back in the day, and that's what happened last year. So if we compare organic growth, we need to take this aside and understand how much of the growth last year Q4 was related to customer stocking and so that we can compare apples-to-apples to make it very clear. Now moving forward, as you've seen, we are investing in TC Transcontinental a lot of capacity for specific markets, we talked about sustainability. There are other market segments we're invested in. This is done in line with customer contracts and agreements. So we've always been favoring customer-backed investment, and this leads to organic growth. So to your question, this is our [indiscernible], and this is what we've done. And therefore, we expect to see growth coming in, in those specific market segments.

And maybe, Steve, to add when you mentioned margin pressure, I think we're -- yes, we do have margin pressure. But when we compare to last year, I would say that margins are going in a better direction than last year. And actually, when you compare our Q3 versus our Q1 where we had the same top line, the margin was way better and all the cost efficiency that we've put in place at the beginning of Q1 on the packaging side and some price increase to cover inflation are resulting in that right now. So yes, margin pressure, but at least it's going in the right direction compared to fiscal 2022.

[Foreign Language] [Operator Instructions] There are no further questions at this time.

Thank you, everyone, for joining on the call today, and we look forward to speaking to you soon. Thanks.

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