Valmont Industries, Inc. (VMI) Earnings Call Transcript & Summary

Good morning, everybody. This is Nathan Jones at Stifel, and we are at the Valmont fireside chat presentation here. Pleased to welcome Steve Kaniewski, CEO; Avner Applbaum, CFO; and former CFO, Mark Jaksich, on the line as well. [Operator Instructions]

Jumping right in here. Valmont was an early reporter with still a week to go in April and in the middle of the total lockdown, which I'm sure made it a lot more difficult to give investors much color on how COVID-19 was going to impact the businesses. With the rest of April and now May in the books, I wanted to ask about the final trends you saw in April and then how May has progressed from there. Starting with Utility. In your business update, you had expected Utility to see minimal impact from COVID-19. Is that how the quarter has progressed out so far? And are all of your facilities open and operating normally?

Yes. This is Steve. In Utility, all of our plants remained open throughout the COVID shutdown areas. And May and the early part of June have progressed as we would have expected, which is that the business remains strong. The production is strong, and our customers continue to take products and to do projects in that space. In Irrigation and in ESS, all of our facilities there are back up and running as well as Coatings. We had -- really, ESS and Coatings were the most impacted globally during the COVID crisis, where we had upwards of, let's say, 20 plants that were shut down in April. But as we had said, in May, most of those would come back up and did. We do have one small warehouse and operation in Argentina that's not yet opened, but everything else in our system is open at this point. And people are taking the products. People are paying for their invoices. We've not seen any kind of mass liquidity issues or other kinds of warning signs out there. So as we're progressing through the second quarter, things have been pretty good.

Excellent. So Irrigation was expected to see some moderate impact. I think it was your orange color. I think that was primarily centered around some of the lower corn prices that we're seeing as ethanol demand decline. And I think you had some government-mandated closures in Argentina and South Africa. Can you update us on how demand has progressed there? I think you said all of the irrigation facilities are open except Argentina, if I misheard that. Any COVID-related disruptions that you might have experienced that could have further impacted demand?

Yes. The food supply chain and ethanol disruptions are still in place in North America. And so I would say we're coming in along the guidance range in North America that we expected when we gave guidance at the call. The international operations were less impacted overall because food security and food supply issues were -- vary in places. An example, Brazil, even though Brazil has been a mess from a coronavirus perspective, we're still seeing strong shipments and strong orders in that region. We had a record first quarter in local currency. And they have really truly benefited from the trade war issues between the U.S. and China and so they still see that. Australia was minimally impacted, Australia and New Zealand. And in fact, they've really been able to operate pretty much at the same levels going -- coming out of the crisis as they were going in. And then Eastern Europe still remains pretty strong. So Irrigation, again, internationally, less impacted. North America, we still see the impact. We also now have over 100,000 connected devices with the AgSense products. That has moved forward at a nice, steady clip because, again, the value proposition has been strong even with all the issues in the marketplace. So overall, kind of as expected in the Irrigation segment.

Okay. You also had the ESS business in that moderate impact bucket. And I think primarily the impact there was coming from -- less from the demand side but more from mandated closures of some facilities that you've seen in France and Asia. Can you talk about how you -- those things have proceeded in terms of those facilities being able to open and run? It sounded like, from some of your comments here, that possibly those things have got opened faster than you might have expected. Any impact on whether you're still in the orange bucket -- or I guess the yellow bucket for that one in terms of how you see that business progressing?

Yes. Within the quarter, we will see April as being the very difficult month. We weren't sure how particularly, let's say, France as a market would respond and resequence their backlog. It appears that they came up relatively quick, not from a date perspective but from a ramp-up of business activity. They came back quicker than we probably would have expected. That was good for us. In Asia, it was about where we expected the ramp-up to occur, India being a little bit of a laggard in terms of getting migrant workers back into some of the other fabrication and projects that are out there, particularly in the utility and telecom space in India. And then generally, all other plants kind of coming back up online within our expectations. The order rates particularly, let's say, in North America, from a lighting traffic perspective are pretty, I would say, inconsistent. We get a couple of good weeks. We get a couple of weeks that are not there. But not everyone has been back at work in all the jurisdictions that we are out there with. So some of it could be a clearing of the desk, so to speak. I was out for 2 months and now I got to get these orders out. And then if you don't see orders, it's not necessarily indicative of a lack of market demand. It could just be that they have to have public hearings and other things in order to do the tenders. So that would be our expectation as we look out into the third and fourth quarter as well from a lighting traffic perspective. Within the telecom space, there's very -- the carriers have been very public about their capital expenditures in the space. And that will continue, albeit, like it always is in telecom, up and down week by week and month by month.

Okay. The last piece is Coatings, which you had in the most impacted bucket, which is not surprising given the economic sensitivity of that business. And a lot of your customers will likely shut down for some period of time. The reopening of economy seems to be going better than certainly how I would have expected 6 weeks ago. Have you seen any improvement in the Coatings business just as we're going sequentially along here, as customers get back to work? Would you expect June to continue to get better than April and May?

Yes. Our Coatings business, probably with the way you portrayed the general economy, is exactly what we're seeing. It's coming back stronger than we would have anticipated. We did have a number of plant closures. So the quarter would see April extremely impacted; May, less impacted; and we expect June to kind of come through with a better overall demand profile. From where we guided in the second quarter, we gave a range of 20% to 25% down. We're probably closer to the 20% versus the 25%. So just as an indication, a little bit better than our worst-case scenario.

Okay. So it sounds like modest amounts of upside here across the portfolio relative to where you expected things to be 6 weeks ago.

Yes. And we would expect from an overall company performance perspective to be in line with our expectations and probably a little bit to the positive side than to the negative.

Okay. That's helpful. So I did want to ask about some of the execution issues that we've seen over the last couple of quarters, primarily 3Q and 4Q last year, before a much better performing quarter in the first quarter of this year. You had a couple of hiccups in the Access Systems business with a specific prison project hitting you in 3Q and then low demand in 4Q. And those 2 cost you about a buck worth of earnings last year. Can you talk about what went wrong in that business and on those projects and demand there and the steps that you've taken to correct those things?

Sure. So the market demand, we now expect to stay kind of where it is based on the markets that we serve in Australia and Southeast Asia. So we've been able to largely mitigate those impacts that we had in '19 by exiting what we call the supply-and-install business. And it was the install part of that side of the equation that really hit us hard. So we're able to do that. And we have taken a significant reduction of SG&A and foregone some revenue in this space in order to get the right kinds of gross margins and size the business more correctly. We will have further restructuring in the second quarter that we will detail at our earnings call and when we release earnings, but we largely expect those issues to be completely behind us at this point. So we went in and really took some pretty aggressive actions to ensure that we have a business that can return capital.

Okay. Well, I guess we'll wait to hear what the restructuring plans are for that on the 2Q earnings call. I won't push you anymore on that. You also had some operational issues last year in the Utility business. Can you talk about the underlying causes of those problems and what actions you've taken to optimize the throughput of the facilities, get the productivity up, get the capacity in the right places? And do you feel you have the right people in the right seat to manage the planning and execution of projects in those factories?

Yes. So I'll start with what the issues were. The issues were largely due to unanticipated market demand from 2 things. Really, it was the grid hardening efforts on the West Coast as well as the large project in the Southeast that we were awarded last year. Both coming through to where our capacity was, we were under -- we had too little of capacity to meet the market demand and thus why some of the lead times had extended to the extent they were. Whenever we ramp up facilities and ramp up our capacity, it usually is a labor constraint both in terms of the hiring and then the productivity of that labor as it comes onboard. And so we had to make some conscious choices from a customer service perspective to work very inefficiently, particularly in the third quarter. And then that continued a little bit more into the fourth quarter. That has now been largely behind us in the first quarter as we brought that capacity online and people ramped up their productivity probably a little bit quicker than we had anticipated. We originally anticipated around the second quarter to hit a full run rate. So we got ahead of it a little early, and now that capacity is online. It's productive. And lead times have now moderated back to, let's say, that 26-week time frame, which is where both customers and us would expect from a market perspective. Backlog remains strong there, so that gives us a lot of good visibility. And we have a great team that can do the S&OP process to match the supply and demand profiles of that business. We think we have the right type of capacity/price paradigm in place that will allow us to continue to maintain good, strong pricing in the area as well as meet market demand and not bring more capacity into the market itself. So things are largely behind us from a Utility/ESS because we use the plants for both capacity, productivity issues.

Okay. Do you guys feel that you have the right ERP systems in place, the right IT in place to ensure that you get the appropriate information in a timely fashion to make good decisions? Or are there upgrades that you make to the IT systems there to provide you with better information to assist in the decision-making process?

Yes. We're always looking for better information to get a lead in earlier, to be more productive in getting things through the whole engineering approval process, et cetera. So one of the things that we do -- the systems themselves that we have are fine. What we are really looking at from a value stream perspective is trying to optimize the value streams between engineering to order, configure to order and really specification or stock orders. And so that is where we will spend much more of our time and effort related to systems. We have a new CIO onboard, who's been here for about 8 months. And then Avner -- that reports up to Avner. And they will have an opportunity to really do an assessment of that based on these value streams so that we can get a little bit more visibility within the organization. But more often than not, it's on our market intelligence. As we mentioned last year, our issues were primarily around unanticipated demand. And so how do we get better indicators from a demand profile that come through so that we can then get the right things in place internally? So that's where we will be spending a lot of our time and effort and system effort around getting information a little bit earlier.

Okay. The Utility business has seen very strong backlog growth with a number of large projects coming in. Large projects will typically see higher margins. Should we expect mix to be a tailwind to margins over the next few quarters?

I would say that larger projects are not always indicatively higher margin for us. You have to earn more margin, and that's probably the ramp-up period. However, it does provide a significant bump in the market demand, which then allows us to do better with pricing and gross margins as we move forward. The mix that's out there right now is still primarily small pole versus large pole. So even if we have large projects, what we look for to have a better mix indication is the size of the structures. So the larger the structures, then the better it is overall in our mix because our factory throughput is better as well related to that. So these projects that have recently come through have been larger structures. And so those will help us, from a margin profile, to help blend us up over time with the rest of the mix being relatively small. And what we had said earlier was we did not expect the historic mix over the last, let's say, year to really change significantly as we look out over the next maybe 2 years. So it will be primarily lower voltage classes. The large price that we do have is a very -- it's a high KV and large structure. So it's very helpful for us overall.

So a little bit better mix but nothing hugely meaningful is what you're -- kind of what you're alluding to there?

Yes. It won't get back to a '13 time frame where the mix was extraordinarily positive.

Yes, yes. So lead times did extend out. They've moderated a bit as you guys have brought capacity into the industry but still remain elevated. And when lead times get long, pricing tends to improve. Are you seeing the ability to generate positive pricing in this environment?

Yes. I would say that us as well as others, there is definitely the opportunity, albeit with Utility, it takes a little longer based on pricing agreements. We have a number of alliance customers to get fixed pricing over a time period other than the steel inflation/deflation. But we have seen our gross margins improve sequentially from quarter-to-quarter as we've been able to really take advantage of a good paradigm between capacity and pricing. In the '13 time frame and as we came into '14, there was really a lot of capacity that was -- came into the market, and then the market demand went away. We've been much tighter in this cycle to manage that process closer to not add too much capacity to the market. And I would say that the rest of the industry kind of has followed in kind there.

We have seen steel pricing coming down. I know some of that is passed through on the MSA agreements that you have with Utility. There's the spot market, though, where you could maintain that. Are you seeing the ability to retain that lowest deal that you are pricing in a lower steel price environment? Or are you having to pass that on to customers?

In Utility, it's pretty close to the actual steel price, but we have seen still margins overall improve. So we've been able to hold a lot more of it. In some of the other businesses, we've been able to hold it entirely. So we've been very diligent. All of our teams are hyper diligent when it comes to not giving back steel pricing in areas like irrigation and some others because it's pointless in a market that is already down in, let's say, the irrigation space. And in ESS and Utility, we have good market demand profiles. Steel prices have moderated. They were dropping. There were some price increases that went out there. A lot of capacity that was taken offline. So there's been no need to give back anything that came down even though it was pretty substantial. So that has helped us as we look at our margin profile and our pricing profile.

Okay. Can you talk -- in USS again specifically, can you talk about the pipeline of opportunities in that business? Is it reasonable for us to expect that you can continue to grow that backlog over the next 12 to 24 months?

The backlog itself, if we get a couple more of these large project awards, then I would say yes. Otherwise, the backlog, where it is, is on a pretty elevated market. And we should be able to maintain the backlog at least with the different hardening projects, renewable projects, line extension projects, substations, et cetera, that are out there. So in order for it to really grow the backlog, we'd have to have, well, 2 things: One is another large project award. It will probably come up this summer for rebid. And then the International business does provide us some opportunities to grow the backlog there. In the first quarter, we had some pretty good success obtaining some orders in Europe around both lattice as well as round structures. And so those 2, plus the solar business, also should allow for some growth in the backlog. But from the, I would say, the traditional transmission, distribution and substation, it will take a large project tender to -- but it shouldn't go down. It should just be able to maintain based on some of the seasonality of projects as they go through.

And just to be clear, I think this -- the project that you're talking about coming up for summer is an extension of projects that you've already won. So you are the incumbent, so to speak, on that kind of project, correct?

That's correct. There was 2 of the 5 tenders that were already out there. So this would be the third.

Okay. So you've been adding some capacity to that business. I think you talked about this a little bit already. Can you talk about where you are in the process of adding that capacity and whether that capacity is now up to performing at a normalized level of productivity?

Yes. It's progressed flawlessly, actually. That -- we were able to get most of it online in the first quarter. And then our productivity has advanced as we've gone through both the first and the second quarter. It was around a 5% total volume expansion for the North American piece of the business. And we're in a very good position to manage that. Whether it was COVID or non-COVID, we were able to stay open. And so that allowed us to really continue the productivity gains.

Okay. I've got a couple of questions on the line. So I'm just going to hit those. First one is could you provide an update on solar structures? It seems to have not gotten off to a very smooth start since you purchased that business. So just any update you can give us there?

Yes. What we had said when we purchased, it was Convert Italia and the solar business, was that it was a heavily project-based business, that it was really not a run-rate business. So we came out and we had a very good first quarter of last year. And we said don't expect that to continue because it was just an anomaly in terms of the whole project delivering within the quarter. Since that point, we have now gotten our products certified here in the U.S. and we have been able to secure some orders here in the U.S., which we said would help moderate the peaks and valleys of the business. One of the other things that happened is we had a large project -- 2 large projects in South America. And some of the political unrest there caused the projects to move and anticipated for us into the third and fourth quarter of this year. So the underlying variables around the solar market are very strong. The supply chain synergies, we're working on. And getting the product certified in the U.S. was a big piece of our strategy, and that is now complete. So at this point, we will see, particularly in the third and fourth quarter, improving solar performance within the Utility segment as we go forward. But we had said to expect first and second quarter to be impacted by these project moves. So it's a matter of really just getting the supply chain synergies in place and getting, frankly, smaller projects that are more continuous so that you're getting more of a run-rate business versus $40 million in one quarter, $8 million in the next, et cetera, like we've seen.

Okay. I have 5 minutes to go. I guess I'm going to have to move along here. I think probably the domestic irrigation business is where I'd like to go next. We've seen corn prices drop down here in response to COVID-19 with lower gasoline consumption driving lower ethanol demand, hence, lower corn demand as the backdrop to that. You've also got people concerned about China's ability and willingness to honor the Phase 1 trade deal as the U.S. administration seems to be inflaming tensions there as well. And finally, it looks at the moment like we could have a strong corn crop this year with high plantings and good weather so far that could also put pressure on corn prices. I'd be curious to hear your views on the corn market and how all those impacts play into where you're thinking -- how the implications of that play out for demand for the Irrigation business. And I guess it's more probably a 2021 question given that we're kind of towards the end of the selling season this year anyway.

Okay. Well, first off, corn/soy has been less a part of our percentage of sales as we've kind of, over the last couple of years -- if we go back to '13 and the hypercycle, it's probably about 65% of our total sales. It's closer to now 50% of our total sales. And so -- within North America. Corn prices likely, to your point, will not move much because unless we get some type of an event, all of the factors that you bring up are what is in our analysis, too. Ethanol will come back somewhat now that people are driving again and oil has gone up, but it won't be anything spectacular in terms of recovery. There are good crop projections that are out there. How the stimulus of the $16 billion will actually feed into the market also remains to be seen. So largely, we expect the market to kind of stay where it is and maybe just improve slightly because it was depressed pretty artificially for the shutdown period. But there's nothing that suggests in '21 any type of resurgence, at least at this point, as we look out. So we would expect our Irrigation business to be relatively flat to where we've been this year.

Okay. Moving over to the International business. Can you talk about any impact you've seen on international projects from COVID-19, whether that's ability to deliver during the lockdown or customers slowing the pipeline of orders or anything else unusual there?

The primary issue that came out of the shutdown was that there was a flight to the U.S. dollar. And as the dollar strengthened, some of the projects were put on hold as they had to build currency again in especially developing countries. But largely, projects have moved forward in the international markets. The food security issue is even a bigger issue in those markets. So it's actually kind of provided a little bit of a tailwind from a market demand perspective, particularly in places like Eastern Europe, Africa and the Middle East. So those have held up relatively well. Australia and New Zealand, really, because the droughts and the fires and the floods had more to do with market forces there, COVID had little impact from an Australia and New Zealand perspective. That market held up very well through that time period. South Africa and South America, Argentina saw some more moderate impacts. And as I mentioned in my comments earlier, Brazil has been able to withstand at least the forces to date, with COVID and the governments, et cetera.

Drought, fire and flood in Australia, that sounds about right to me, all in the same year. I do think it's worth discussing a little bit. I do see one definite positive that could come out of this whole pandemic for you guys that could serve as a meaningful catalyst to sell more pivots over the next several years, and that's food security. A pivot gives farmers really significant yield increases versus other methods of irrigation or no irrigation at all. And I think this pandemic has brought food security into much greater focus around the world. Can you talk about how you're thinking about the potential to see more interest in pivot irrigation as countries reevaluate their own food security?

Yes. I think it's a continuing trend. And COVID, really, along with the drop in oil prices in a lot of these countries, have brought that foremost to the mind of policymakers and growers in those areas. So we think that, that is a tailwind. And we are trying to capitalize on that move to, "I want to grow things closer to home. I want to be able to have control over it." And combined with ESG and the factors around how much inputs I've used into growing that product, the 2 of those combined should help to offset some of the weakness in true net farm income and commodity prices. Is it enough to overcome it? It remains to be seen. But at least right now, that has provided at least a little bit of a floor for some of the other factors like ethanol and others that have gone away. So we do agree with your assertion there and think that, that's something that can be capitalized on.

Okay. Just hit the balance sheet here real quick in the last few minutes. Balance sheet is in great shape, about 0.5 turn in net debt. After a number of acquisitions in '18 and '19, you had talked about pausing on that front to integrate those businesses and get them running at a high level. Can you talk about those acquisitions in aggregate and whether they're performing above, below or in line with your expectations when you bought them?

Yes. I think on the aggregate piece, they're slightly behind, and that really is more due to COVID and some of the issues that we face there. From an integration perspective, they've been integrated well, but we still have a little bit of work to go there. We did pause in order to get them integrated, and we're still doing some of that activity. But on balance, the markets -- as an example, the Larson Camouflage is meeting the telecom market demand. It's been growing very well. Solar, we touched on earlier. Very good mid-term, long-term drivers and short-term issues with projects. Some of the other road sign, smart city-type initiatives, it probably has taken us slightly longer as we've had to integrate those. But overall, nothing that is a substantial issue or a problem for us, and on the balance, we believe will be very accretive for us as we move forward. Again, some short-term market issues related to COVID in some of the regions that we service. But overall, they've been -- they fit with what we want to do from a total market perspective and hit in the cycle at a point where we're looking at the up cycles versus the down cycles. In irrigation, they've been primarily related around technology, including our latest one which was Solbras, which was a solar business that is primarily ag-based in order to help things like pumps and pivots run. That was in Brazil, and we just completed that about 1.5 weeks ago. And so those have largely added to our already quite sizable lead in the technology space around irrigation. As I mentioned earlier, we're well over 100,000 connections now. And so our momentum is good. Our Valley Insights product has really blossomed quite well. The Prospera joint venture that we're working with there has really allowed us to get on to the acreages that we expected and that people paid for. So again, from an overall acquisition perspective, we feel good about where we're going.

Okay. I just wanted to ask one final one on the dividend. Your payout ratio here is a bit -- a fair bit lower actually than a lot of maturer industrial peers. Are you happy with where the dividend is? Or would you consider raising the target payout ratio?

Yes. So this is Avner. I'll take this one. Right. So right, the dividends, right, they're determined at the Board level. And we plan on continuing to pay a reasonable dividend, and we discuss this regularly with the Board. So again, this is an unchanged part of our overall capital allocation plan.

And I would say and just add to that, that as we really get businesses to get to their cost of capital, they will generate more cash, market multiples being what they are due to low interest rates. Acquisitions, we have to be very disciplined on. And if we have excess cash and we see an ability to continue to generate that cash in the future, we'll constantly look at that ratio. We're high to some and low to others. It just depends on who the peer group is and who you're picking. But we recently did raise the dividend, and we hope that the shareholders do appreciate that.

Okay. Well, I know we're a few minutes overtime here. So I want to thank you guys very much for your time here. Look forward to catching up with you later on in the day.

All right. Sounds good. Thanks, Nathan.

Thanks, guys.

Thanks, Nathan.

Thanks.