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

Good morning, everyone. I'm Nathan Jones, and I'm the covering analyst at Stifel for Valmont. We're very glad to have Steve Kaniewski and Avner Applbaum with us here from the company today. Before we get started, a couple of housekeeping items. I'm going back to the bull case, bear case format this year, having abandoned it last year because everybody was singularly focused on COVID. I'll present 3 bear cases and then 3 bull cases. Steve and Avner will have the opportunity to respond to each of those, and then time permitting, we'll dig in with questions. [Operator Instructions] I welcome questions from investors. They're generally smarter than the ones I ask anyway. With that, let's begin with the bear cases. First one, the current inflationary environment could have multiple negative impacts. With this level of inflation not often seen, this could make it more difficult to realize pricing, and if passed through, could eventually adversely impact demand.

Okay. Thank you and I'll take this one. So it's true, right? The inflation in the raw material is really unprecedented. And we've seen metals like steel, aluminum, copper. We've seen very large increases, but we've been able to pass on the pricing. We've seen that in rapid inflationary environment, like the one we are in today, particularly with steel. We will get pinched for a quarter or 2, most notably in Utility due to the pricing mechanism, but we do recover it. And overall, we will actually make more profit. We actually don't mind higher steel costs because of our ability to manage pricing. And despite the dislocation, we actually -- it's actually better for the business. And now as it relates to the impact of the demand, we're actually a very small part of the overall project cost across the businesses, call it, maybe 10% to 15% as part of a large Utility project. Lighting and traffic, we're actually even a smaller percentage. So it's definitely not going to be a tipping point, and we have that mechanism to actually increase prices. We are kind of the #1, #2 in the markets we are. So we do have ability, and we do manage pricing. We've seen this year, we've been able to raise pricing 4 to 5x in some of our businesses. And we're the leaders in those areas, and our competitors will typically follow. Additionally, I would say that the -- after even we raised pricing, except for Utility where that mechanism is set, we will -- we do have the ability to hold on to the pricing overtime. So even as the the inflation has less of an impact, we're able to actually increase our margins. So -- and additionally, maybe one last point. The market drivers have not changed across all our businesses. They're very strong. Farmers will grow crop no matter what the -- what -- no matter what pretty much and the increase in grain and commodity prices actually help the irrigation market. So overall, that's how I kind of address this area.

Yes. I think maybe a couple of questions on this front. I would think even with the increase in steel prices and how that relates to the increase in pivot prices, the increase in grain prices and crop prices, in general. I would think the ROI calculation for the pharma today versus 12 months ago is actually stronger. I would think the value proposition based on where crop prices are today more than offsets the level of inflation that you're seeing in the irrigation business. Agree or disagree?

Absolutely, agree, Nathan. It's a very strong payback. And again, you throw one weather event into it within your region, and you're now down to a year kind of payback or less than a year payback. So even for accounting for inflation, the crop prices have definitely moved and net farm income is projected to be higher than that change. Inflationary pressure of our machines, at least.

And then if I think about the Utility market, generally, the costs there for the Utility go into the rate base. So they pass that directly on to their customers, and that's contractually paid for, right? So if their costs go up, it doesn't actually change their returns. It just makes power more expensive for the customers.

That's correct. And with the renewable mandates and the move of generation sources as well as the grid reliability, they've been able to get the rate cases sold to the public, I'd say, easier than in the past. Because you take of Texas to California, Florida, having issues with their power grid. People don't tolerate. Outage is the same way that they used in the past. And so those combination of renewables and the grid reliability really are helping push through those rate cases.

And then I guess, finally, on ESS there. What is the mechanism for those customers to pass that on to their customers? And is that an area where maybe inflation could have a bit more impact on demand?

It's -- again, if you look at our product set in there, lights and traffic barriers and things like that are very small piece as compared to aggregates, concrete, engineering, labor, et cetera. It is a fixed bid. Once you do it, if it's DOT, right? The actual Department of Transportation work. And so it has to be a part of their bid process upfront. And what I think you've seen the industry do in times like these is that bid prices are good for a week, maybe 2 weeks tops as opposed to, hey, here's something out there, it's 3 months effective. And so even the big EPCs have really changed that bid validity period to account for the higher costs. And again, that just goes back to the taxpayer in a sense, in terms of where the tax money and how much can be spent for it. The fact is, there are popular projects. If we're going to decarbonize or, in some cases, need it for bottleneck areas and ultimately, they tend to take place. It may adjust the timing slightly, but not in any significant way.

And then Avner, your comment there is that you'll not only be able to pass-through steel, dollar for dollar, you'll actually be able to make margin on these price increases. I was going to say, do you think that you could pass it through with current margins on it? Or is it going to be somewhat less than the current margin? So maybe be slightly dilutive.

Well, with the exception of Utility where kind of the mechanism is set for the most part, I'd say, in the other businesses, we will be able to hold on to some of these prices going forward. We might need to give some discounts in some of the businesses, but we're not going to reduce our pricing. So it will create margin accretion going forward.

Okay. I'll jump on to the next one here. Growth in infrastructure levered businesses is dependent on government spending, particularly U.S. government spending for you guys. The gridlock in Washington creates significant risk, the base spending increases will not materialize.

Yes. And I'll answer this one. First off, as a proportion of the overall ESS business, true government spend is maybe 1/4 of the total demand pie. If you take telecom, commercial lighting and things that happen outside of, let's say, Washington, D.C., international, as an example. So if you look at it, we've always accounted for the fact that there is a run rate that is attached to the FAST Act. There is a run rate that it happens at the state level. Old budgets have been largely shored up through the recovery bill that went through as well as tax revenues really not falling off as much as was predicted. So that's what we have built into our guidance, and we don't build anything in, as it relates to Washington, D.C. until it's actually done. And so even if it were to happen, say, this summer, we wouldn't see the effect of it anyway until towards the end of 2022. We will go last part of the road to get done. The last part of the bridge, this is the lighting, the traffic barriers, et cetera. So we always have time to react. And so we don't need to preplan a lot upfront in order to meet something that comes through this way. But I think at the end of the day is, we don't count on it because we shouldn't. It's been talked about before, it fails. Is there at least betting odds that this will have at least something come through of some significance? Yes. But we'll wait and see. Europe, there is real government spend right now that is taking place. Australia has been, over the last couple of years through their PPP projects, working through a lot of new things in Sydney and Victoria. So those things are materialized. But as far as the U.S. demand, we'll wait and see.

Yes. It's infrastructure week again, right, when it comes to planning for that. Okay, I'll jump up to the third one of these now. Valmont's businesses are largely low-tech metal bending businesses, where there is limited product differentiation, which will keep the industries fragmented and competitive and make it difficult to generate above-market growth and expand margins.

Okay. I'll take this one. So as you saw in our Investor Day, which we have a lot of emphasis on this. We're really moving towards an industrial tech company. We're accelerating the growth, we're focusing on innovation, higher growth products and services. We're increasing our portfolio breadth, and we're actually also expanding our addressable market through technology acceleration. We're investing global and high growth businesses. And maybe one good example, the recent acquisition of Prospera. It kind of hits all those items I just referenced. It adds irrigation technology. It increases our addressable market. It generates recurring revenue at higher margins. So overall, these type of areas is really a differentiation for us as a company. And overall, when you look at our strategy, which we, again, discussed during the Investor Day, it includes operational excellence. So we're implementing Industry 4.0. Our pricing leadership in the industries that we participate, focusing on deselecting of product, expanding the markets, accelerating innovation, all those items that I mentioned, which are all supported by our finance, operational and digital transformation, all of these things I just mentioned together actually will drive growth and will expand markets, which really brings us more to the kind of the industrial tech type company.

Maybe a couple of questions on Prospera, saying -- as you mentioned that. Is there applicability of Prospera's technology into your businesses outside of irrigation or into -- potentially into areas that you're not in that could open up different kinds of markets for you to go into just to expand where Valmont participates?

Yes. I'll take this one, Nathan. One of the things that we want to do is stay laser-focused on the agriculture area. So Prospera itself and the team around that will stay dedicated to ag. There is 96% more acres in our total available market that we're going after. But what it is doing for us is, it's provided a very nice model, and we can have some cross sharing of things as we build our infrastructure, gateways and business model there on the infrastructure side. One of the things, it relates to the last question. When people say low-tech metal vending, what every company can or could do, which I think we've done exceptionally well is, we have a channel to the market. And in the capital goods market, that channel is what's proved out to be the differentiator for us moving into tech. There is a lot of start-ups with a lot of great ideas, but not the ability to get to the market. And so what we really want to do is say, what we've learned with Prospera over the last 2.5 years as far as the go to market, the revenue model, pricing, what people need for support, that's what will be transferable as we think about the capital markets and the infrastructure, whether it's utilities or telecommunication companies or traffic and lighting type structures. So that's the part there. I think also what it does for us is really as an organization, learning how to run technology business at a Board level, being able to fund initiatives, looking at the way, you would, a tech kind of way. But the knowledge base that we have with Prospera, we definitely want that laser-focused on growth in ag.

So it's definitely -- I guess I step into a different area for you guys. What do you see as the risks around the Prospera acquisition for it not generating the returns that you're anticipating in your business case and business world?

The risk is if we treated it like it's a pure pivot irrigation play, and that was all we were going to do with it. This is really meant to be open field to be under -- whether it's a dry land, whether it's under a different irrigation source. But technology adoption has been very strong or even as we were declining on the machine side, where we were seeing 20%-plus growth there, that is now really inflected and moved up. The risks are if we don't resource it properly, if we don't think outside the box in terms of who the customer base is. And if we try to -- I'll say, it is over-Valmontize it in a way of treating it like it's just a pure industry or in addition to the industrial play. It's really meant to be a tech business, and it'll be run separately, reporting to me, within the rest of the company. And that's where -- but the channel piece is really the leverage that we have seen all along, right? That beach front property we referred to over time. And as we get to talk to growers, and they get to sell through our dealer networks. And the dealer is going to help install and service it, but they won't necessarily be the ones selling. And I think that's -- that would be the other impediment is that we left it solely at the dealer level. Well, if you're selling $100,000 pivot or a $3,000 a year recurring revenue, you're not going to put the same effort. And really, for us to develop that digital channel directly to the customer would be another risk area, but one that we're laser-focused on.

It's going to be interesting to see the evolution of it. I'll jump over to the bull cases now. After a multiyear downturn in irrigation, which I'm sure at some point, felt like it was never going to end, the rising crop prices over the last year have significantly increased farmer sentiment and their willingness to invest in irrigation. We are likely at the start of a multiyear up cycle in domestic irrigation markets.

We 100% agree. When we look back at the cycles, they're typically 7 years up, 7 years down. We don't know why it works that way, but it just tends to be the way. There is a lot of enduring drivers that are building, whether it's the global stocks to use ratios of some of the commodities, whether it's the ESG concerns that are really building into the food supply and the need to conserve and report on resources used to grow food. It's the fact that soy is now also used as biodiesel in Europe. It's providing almost an ethanol-like underpinning to the market in addition to the exports to China to rebuild their stocks of swine and birds. So there really is -- and I think the government spending over the last previous 2 years, while not necessarily earned income, it was used to really shore up balances. And so now seeing that there is a real net farm income generated on normal supply demand kind of curves, with solid balance sheets is what is driving ultimately some of the recovery and the inflation in beef and chicken and other things around the world, again, just a further part of doing that. So if we continue with economic expansion and particularly globally, then that stocks to use ratio, we always said is, it could change on a dime, and it frankly has. And as long as there is good demand drivers, we get another weather event, this is all without really a true weather event of drought. And so there is usually in that cycle one of those. And so that would just be additive to the whole effect because then water is the limit there between income and no income.

What's your view on the sustainability of some of the major crop prices at the moment? I mean, we haven't seen these levels since the last time we were at peak irrigation revenue about 8 years ago. Just what are your thoughts on it are? What your intelligence network is telling you about the sustainability of this, what the crop looks like so far for this year, those kinds of things that impact those kinds of prices?

Yes. I think you've seen some stabilization. Obviously, it was climbing and climbing. And now until you get to the harvest season, it'll probably stay range bound, I think, barring some bigger economic issue out there. And -- but when we look at the prospects of like into next year, people are still very bullish. And again, those drivers are multiyear in China. Biodiesel would be multiyear for soy. Ethanol will be where it is, but the corn is growing for use in Brazil as an example, also for ethanol. And so we do all that with the recovering economy, which, again, that's probably the key factor. Everyone that we talk to, whether it's at the dealer level, the grower level, the large growers, feels like they have to invest because this will be a cycle for a little while. In terms of the crop, it is drying up already pretty quickly in the Midwest. There is going to be a record drought in the West. That doesn't impact our business nearly as much as you get to some corn belt. So we'll see. North Dakota and South Dakota, there may be people that have not -- don't even plant. It's been that dry. If they don't have irrigation, they're probably -- they really have decided maybe it's better off not to plant. So I think there's some early signs that there's some stress in the -- what the yields will be.

Got it. I think we've probably largely covered the next bull case already in our discussion. So I'm going to just ask a couple of questions about International Irrigation. It's been part of my view that COVID is actually an accelerant for deploying pivots internationally, with food security being the big driver. I mean, you look at it 12 months ago, borders were closed down, stuff wasn't moving. And I think governments were really starting to look at the food security for their own people. You guys signed the biggest project in the industry's history. I'm sure that didn't just come around because of COVID, and there were a lots of discussions around that. You've made a big investment in Kazakhstan. Can you talk about the drivers for international investment over the next 5, 10, 20 years? And how you view food security as a driver of deployment of pivot?

Yes. I mean, if you start with the long term drivers. Population growth is going to occur internationally. And that was always why we said that ultimately, the international piece of the business will be larger than the domestic piece over time. Brazil is really building to becoming like another U.S. market. And so Brazil does that mostly retail, not through large projects because phenome really has been conducive to that. When you look at the rest of the world, Africa is laid in with opportunity. And they're different in West Africa than they are against the Nile and then sub-Saharan. But you can put together a number of projects that are in that $5 million to $15 million range that build through a private investment, sometimes government investment. And it really is to the idea of COVID woke people up, hey, if we can't get food, we could be out of power, right? Because our people will think as our power in Sudan, riot started there simply over bread prices. I mean, literally, it came down to things like that. So food securities is a major issue. Russia is pushing to do where they don't have to import anything. And that's driven really robust markets there. Eastern Europe has had real significant projects over the last year in places like Bulgaria, Hungary, Czech Republic. Places that weren't seeing on that quite development. Again, food security being a major driver. Central Asia is just a great place to help feed Southeast Asia to export into China, Russia, wherever it needs to go. And so us and along with other competitors, have noted that the size of the funnel now is much more significant than it's ever been. And that's hands down what's been helpful to the market. The biggest problem also with projects is that the timing of them can be worse than Utility projects because you get currency and making sure you can get paid and some of the logistics. So the life cycle tends to be long through those projects, but we're uniquely positioned from our factory positioning and where we can deliver, right? Our split shipment module that allows us to AI to put together the right package to come up and be competitive, but not necessarily the low price. And we've invested heavily in Dubai and recently in Brazil to make sure we have the right capacities and modern equipment there. So -- and our sales team has been largely focused on how and when those opportunities pop up to make sure we're part of the game. So we feel like the international market really independent even of net farm income projections. And now that crop prices are up, it makes it even easier for people to justify them. And so take Egypt. In hindsight, they started this before the rise in prices, now it looks like it will be a high payoff or a quick payback for the people of Egypt, simply because the crop prices are supportive of that.

That timing was about perfect, wasn't it?

Yes, it was.

Okay. I'm going to skip the #2 bull case because I think we largely addressed that already, and I'm going to go to the third one. And we can get off irrigation a little bit. Infrastructure spending as part of fiscal stimulus programs is on the rise globally, not just in the U.S. And Valmont is well positioned to capitalize on high priority areas of spending on roads, bridges, electrical grids and renewable energy. So taking this just even outside of fiscal stimulus and how that might add to it, there is some pretty good long-term secular drivers here in large parts of your business. So maybe if you could just talk about how you see the opportunities, and then how fiscal stimulus might add to that?

Yes. Maybe I'll start here. And clearly, it's not all part of the infrastructure bill, which is not final yet in the U.S., but we do expect some significant infrastructure built and spending, both in the U.S. and global as the start-up to help economies recover from the pandemic and to drive growth. So we will -- we do believe there will be a lot of spend in this area. If you look at the U.S. infrastructure in general, we need to modernize the roads, the bridges, highways, all those areas will have a positive and direct impact on Lighting & Transportation business. If you look at the infrastructure bill or even regardless, right, the electrical grid needs investment and grid hardening reliability, renewable energy and all those will definitely be key drivers for the Utility business. The infrastructure bill talks about high-speed broadband investment, which supports telecom. But again, regardless, we need to -- there will be investment in telecom to provide it to rural areas, to provide availability to every resident of every country, and that will drive additional 5G growth. And all those combined, right, also support our Coatings business, which support all of these business. So -- right infrastructure bill, the timing is not clear. It's uncertain. But overall, it's just a focus on upgrading the aging infrastructure, donation, roads, highways to reduce traffic, reduce the carbon emissions. Everything I kind of mentioned, right, those are very strong long-term drivers for our infrastructure businesses.

Yes. I would just say, Nathan, our infrastructure businesses are enjoying tailwinds that are -- I won't say unprecedented, but very supportive of our go forward.

Yes. I mean, it seems that all of the areas that people are talking about investing, whether it's through a discrete infrastructure bill or not, such as improving roads and bridges, such as delivering broadband to rural areas, such as decarbonizing the economy are really all areas that play into one part or multiple parts of your business.

Absolutely. And now it's -- we've had very strong free cash. So the growth parts of the business, we're really poised to resource to capitalize on them going forward and really have built the teams over the last couple of years. Got our operational house in order, and so yes, we agree very much with bull case #3, it could really help and reduce the business as we go forward.

Is it fair to say that an infrastructure bill would -- you would certainly benefit from it, but it's not make or break for you guys. I mean you're likely to see growth in these businesses. When did the current administration or any administration in Washington actually gets a bill pass to fund this kind of stuff, but you would expect that to be gravy on top of what should already be pretty strong markets?

Absolutely. And the move in utilities to decarbonize, it's happening regardless, right? Now it may move faster, if there was more stimulus, but it's happening anyway. Telecom is becoming the new digital highway you have to have as infrastructure, and that will be there. Roads and bridges and highways in developing countries, you need it to develop. And in aging countries, you need to renew it. And -- but again, whether you have a special bill to do it or not, we don't take the infrastructure spend at this point into our calculation. The bill, it's there. Great. We'll add it to it, and we have time to react, but it's not included in our calculus.

All right. Great. Well, we're up on time now. So Steve, Avner, I thank you very much for participating today. Also thanks to everybody who's listening in on the line. Everybody has a great rest of your day.

All right. Thank you, again.