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

Good afternoon. Welcome to the CJS Securities 23rd Annual New Ideas Conference. I'm Chris Moore from CJS. Very pleased to have with us management from Valmont Industries today. Presenting from management is Stephen Kaniewski, CEO; Avner Applbaum, CFO, and Renee Campbell, Senior Vice President. Just a quick reminder of the presentation format. I'll hand it off to management momentarily for 15- to 20-minute high-level overview. After that, it will be more of a fireside chat format. [Operator Instructions] With that, Steve, Avner, why don't you get us going?

Thank you, Chris. So for everyone, thank you for joining us. As you can see here on the slide, and this will get updated shortly. We've just finished the 2022, but we finished with around a $7 billion market cap. We are in 100 different countries, 85 manufacturing locations. We're broken down into 2 segments, infrastructure and agriculture. Agriculture was the start of the company with the center pivot irrigation. It has moved beyond that now to include technology and services and infrastructure, really compiling a couple of areas, hot-dip galvanizing, utility support structures, traffic and lighting structures and telecom structures. Next slide, please. So talking first and foremost about our biggest segment, the infrastructure segment. Really, you can see the product lines there that I just mentioned, including renewables. The big advantage for us in these marketplaces is that almost all of these structures are uniquely engineered. They are not spec product, and they're not even really configured product. They are very specific to the application at hand. If you think of a utility line running down the side of a highway, you would say that all those poles are the same size. They may end up at the same height, but they sure as heck are not the same size. They have different thicknesses, different wind loads, different actual loads that are placed upon them, different foundation types, et cetera. And that's why we -- it allows us to create a unique structure, which then has its own pricing mechanism and cannot be kind of spec product. We have a series of offerings across all these different product lines that you see here. But needless to say that multiyear drivers that are lined up for us are very strong. If you think of utility growth, utility is growing at 6% to 8%, and that is actually now up from probably 2% to 3% a few years back. Why? Well, as we can see the move to renewables is strong. The need to create grid hardening, to endure storms, to really move to this new electrification is ever present. And the fact is, for the first time in about 2 decades, we actually have load growth. And so as many of you have seen through the winter season here, there was already a bunch of warnings for the PJM area, from the ERCOT areas. And that's because most of these systems are at or almost at capacity. Lighting and traffic is another big area for us and that will also see long-term growth as the infrastructure bill that passed through Congress about 1.5 years ago. It becomes more into play. What it allows for states to spend on large projects over multiple years. So previous to that bill, there was -- obviously, there was still highway spending, but it occurred on a yearly basis. So states were loath to enter into the large projects, which are more in our sweet spot. So that will continue over the next 10 years in a very strong manner. The need to refurbish infrastructure is strong and whether that's bridge, highway, roadways, traffic safety, creating efficiency as we get to autonomous vehicles, all of that will play a part in driving that business. In the Coatings business, all of these materials that are steel-based have to be dipped and to preserve the life of that structure. It's rare that you see any structure that is no longer hot-dip galvanized. Even if it's painted, it will be first base coated in galvanizing material and then move forward for painting. So that's also an area we see nice growth, although it tends to grow at a GDP plus kind of manner as opposed to some of the stronger growth drivers in the product lines above. In telecommunications, again, this is a business we've been in for a long time, but it was always typically pretty small, and it's now becoming a bigger and bigger piece of the portfolio. It's being driven by the move to 5G and the digitization of just about everything. Rural broadband connectivity is an example that's driving this business as well. And it's international. Everyone around the world is moving and is evidenced by our ConcealFab acquisition last year and the partnership that brings us with Ericsson. This is an area of focus for us because of the high CAGR growth and the strong gross margins that are associated with that business. And renewable energy, again, another growing area for us. It's something we weren't even in prior to 2018. And that is really around solar trackers and trackers being used in both utility scale and distribution scale or distributed energy scale applications, not just in the U.S. but in places like Brazil, Italy, North Africa and Eastern Europe. Next slide. In the agriculture segment, again, I said this is kind of what started the company over 76 years ago. It was the center pivot irrigation machine. That is primarily what we've produced there. And as you can see, International is getting closer and closer to North American irrigation in terms of overall percentage of sales and agricultural technology sales, which were nonexistent 5 years ago or now really picking up and are very highly margin accretive. And we have a lot of strong goals in those areas. The market has been driven by the normal constraints on freshwater and how it's applied for agriculture. It was the natural outcome of improving diets and population growth. And recently, bigger issues around food security as evidenced by the war in Russia and Ukraine. Some of what caused the Arab spring was related to food. You'll see that there's also the need for ESG initiatives, how much water is being applied, how much the utility is used in the process and really creating sustainable farming more than, I'd say, smart is what is the strong drivers in the market. Obviously, crop prices have been strong and in the farmers' favor that leads to better net farm income ultimately. And it looks like 2022 will be a record net farm income year. And even '23 still has strong projections, albeit maybe not as high as 2022. Next slide. So talking about our sustainable long-term growth, there's a number of factors that we believe set us apart as we look over the next 5 to 10 years. We're in first and foremost, markets that are favorable and really don't follow the cycles of the general economy. So infrastructure, whether it is utility, telecom, lighting and traffic have very independent drivers from the rest of the economy. All of those are funded. All of those have seen significant investment that has to pay back. If you think of even 5G, the spectrum has to be paid for. So you really can't park it and wait. They have debt payments that they have to make on that spectrum as well. So we're seeing that rollout take more and more place, and really the densification is now the next step that we see there. I already mentioned utility, having to meet an ever more electrified grid, backed by renewable generation, and we serve both of those there. And then in the traffic and lighting space, the infrastructure build not just here, but in places like Australia and Western Europe. Infrastructure spend is always politically good spend, whether it's the left or the right side of the aisles. And it's something that the populations see right away in terms of traffic congestion, deteriorating roads, et cetera. So strong markets there. And in ag, ag is a forever cyclical market, but the cycles right now are strong. And our new businesses in Ag Solar and technology really should help offset some of the down cycle when it inevitably occurs in the future. We're innovating like crazy. I talked a little bit about some of the technology products we have in both ag and infrastructure. We're in strong new markets in telecom. We're bringing things like autonomous drone certifications to infrastructure. So 1 of only 5 companies that has that designation here by the FAA. And we will continue to invest heavily into new product innovation as well as manufacturing innovation. We're the first to undertake completely autonomous welding, so the decisions are made by the welding machine of how to weld. That is not typical in current robotics, but it's something we're doing with our path cell, the first of its kind. Obviously, ESG is to drive sustainable outcomes. We believe ESG just embodies everything that we do on a regular basis over the entire 76-year history of the company. We look at this as a way to be more productive that the things we're entering into make sense for us. It's how we deliver value. It's how we manage our resources. It's to the benefit of the shareholders and to our employees and our communities that we live and work in every day. So everything that we've undertaken there is just really to bring clarity of message around what we do. We don't have to apologize for any of our products, or any of the processes with which we produce the products. Ultimately, it's about feeding people more efficiently and giving them a better quality of life and protecting them. So in both of those areas, we feel very strongly that we're well aligned. And like I said, it is part of our DNA. Okay? And if we look at how we expand upon the markets that we serve today, you can see that right there around $3.5 billion share in 2021, we've seen good strong growth for 2022. Those markets continue to grow. We will bring additional products and services. I won't read the list that in its entirety here as well as strong geographic expansion. We recently announced that we divested of our wind business in Denmark. One of the reasons that we do that with our capital is if we cannot see a path to become a global business and influence prices as a result, then that is not a business we really should be in for the long term. So we're always looking at the global potential of the product, whether it's telecom, utility, agriculture, traffic and lighting, all of those businesses are global in reach and give us ever-expanding TAMs that we can go after, okay? And then from kind of what are the megatrends that we're touching on. So you can see that everything fits into digitization, sustainability or energy transition or how we use resources that are out there. Obviously, food security is unique to agriculture and is a strong driver within the ag markets. But along infrastructure, everything is going to become more and more data oriented as dollars and the need to renew infrastructure continue, there won't be enough money truly going to go around for the amount of infrastructure that has to be replaced. Many of you will see every year that the Society of Engineers says that there's tens of thousands of bridges just in the U.S. alone that have to be restored. What you will see is the inspection of those bridges, highways and structures really leading to strong businesses around digitization, conserving the resources and the energy transitions. Avner?

Thank you, Steve. Looking at our back on performance since 2017, Valmont demonstrated its resilience and ability to execute through the cycles. Even in the down cycles, we've been able to maximize profitability and grow our margins through our strategic pricing and operational excellence, while we still continue to invest for growth with a disciplined and balanced capital allocation. Moving to our capital allocation. Our capital allocation policy is one our core assets. Our objective is to create balance between investing in the business for growth, preserving our strong balance sheet, leverage and liquidity position to ensure financial flexibility and returning capital to our shareholders across the economic cycle. Over the last 5 years, we deployed more than $1.5 billion of capital with approximately 2/3 reinvested in the business and 1/3 returned to our shareholders. Our highest priority is to reinvest in the business to drive organic growth, followed by acquisitions with our belief that this will drive the highest returns to our shareholders. CapEx spending will support strategic initiatives such as digital customer experience, Industry 4.0, advanced manufacturing and ESG-related initiatives. And we are prioritizing the projects that have the high return on invested capital. We have a solid pipeline of acquisitions with a goal to increase our portfolio breadth and expand our addressable markets through technology acceleration and investment in global and high-growth businesses. We'll continue to return cash to our shareholders through share repurchases and dividends. On the share repurchase side, we'll maintain an opportunistic approach based on our cash flow generation and the intrinsic value of our stock. On the dividend side, in February 2022, we announced a 10% increase -- dividend increase, which followed a 11% increase in 2021 and a 20% increase in 2020 with a payout ratio target of 22%. Our goal is to increase the dividend over time as a function of earnings growth. In summary, we're maintaining a disciplined and balanced capital allocation driven by ROIC and creating stakeholder value. Turning to the balance sheet and liquidity. We ended the third quarter with roughly $166 million of cash. We have no significant long debt maturities until 2044. Our debt to adjusted EBITDA leverage ratio of 1.5x remains within our desired range of 1.5 to 2.5x. Moving to our strong cash flow generation. Our long-term goal is cash flow conversion of 1x net earnings, which will fluctuate year-over-year due to project timing and inflation. In 2019 and 2020, we had very strong cash flows, as you can see, while in 2021 and the first half of 2022, our cash flow was challenged due to rapid raw material inflation, which create short-term cash flow impacts. Over this period, we elevated inventory to help mitigate supply chain disruption, and we strategically secured raw material to support strong sales growth. Accounts receivable was also higher due to the strong sales growth. In the second half of 2022, our cash flow performance has significantly improved. And as our historical results have shown, we will continue to see improvement in working capital in 2023 as inflation subsides. Our strong balance sheet and ample available liquidity will continue to support our long-term strategic goals. We are highly focused on maintaining this liquidity to support operations and maintain our investment-grade credit rating. Our long-term financial targets. Our goal is to grow revenue at least 7% organically and 12% including acquisition. Value-enhancing acquisitions, investment in R&D are driving revenue and EPS growth, margin expansion and improved ROIC. Our entire team is working to achieve our EPS growth target between 13% and 15% with operating margins of more than 12%. As I just mentioned, our strategic working capital initiatives enhance our strong cash flow generation, which gives us confidence we can generate free cash flow greater than 1x net earnings and drive ROIC in excess of 11%. We are focused and confident we can achieve these targets. So in closing, why invest in Valmont? First, in great businesses that are aligned with long-term secular growth drivers, and we're executing a clear strategy across the portfolio to accelerate growth. We're infusing technology and innovation within this portfolio both in our unique products and solutions as well as our internal operations to help address our customers' biggest challenges. Our 3- to 5-year financial targets reflect our focus on sustainable, profitable growth as we are targeting operating profit margins above 12% and return on invested capital above 11%. Our Valmont business model drives our advancement of operational excellence through Industry 4.0 principles, pricing discipline, utilizing Lean and Agile and technology to continue delivering results and increasing shareholder value. Finally, we continue to deploy a balanced capital allocation framework that supports both reinvesting in the business and returning capital to shareholders. With that, I'll turn it back over to you.

Terrific. That was helpful as always. So let me just start kind of more macroeconomics. During our December update calls with clients, there was lots of talk about the visibility or lack thereof in 2023 and really kind of 2 questions there. In the near term, I'll have to talk about inventory and supply chain issues, clouding end market demand. And then for the second half of '23, kind of that overarching question about recession. And if so, how bad would it be? So start with the first. You guys have done better than most on the supply chain side. Any thoughts in terms of challenges moving forward from a supply chain perspective, from a labor perspective?

I would say, Chris, that labor, we actually feel some of the pressures abating, particularly in some of the more labor-intensive parts of the business like coatings, where last year, we were having to get temporary services, a lot of overtime to keep up. A lot of that situation got improved through the fourth quarter. We're not out of the woods and the historic issues around skilled labor like welders is still present. But overall, the labor situation, I guess, went from red hot to maybe not as hot as it was before. So that's good for us. And it will show a lot in our efficiency because we were spending a lot of time taking the best and the brightest of the floor is to train a lot of these new people. So that perspective there. The supply chain itself I think we went from last year with Omicron at the same time, it's a lot of turmoil, a lot of volatility. Much of that has settled down. Are there still pockets of it? For sure. We feel like we play whack-a-mole every day. But at the same time, it's not 5 things coming up every day like it was before. So generally, I think that has settled down. Inflation remains ever present while some of the headline inflation around some of the raw materials are down, the cost to run your business today with insurance and health care and every fee for anything that's out there has gone and stayed up there, plus a lot of those raises that we gave last year and other companies did too, you start to now see the year-over-year effects of those kind of being strong there. So that also is why we have to stay ever vigilant on pricing. But the supply chain -- supply, demand and supply dynamics are strong for us. So there's no reason there to move on price to the negative side of things. In fact, other than our utility business, where we're contractually obligated to give back some of the steel pricing. Everywhere else, we're continuing to raise price. And it's holding and it's sticking because, again, as a part of a project cost, we're still very minimal in the overall project costs for our products and services.

Got it. Very helpful. From a kind of second half potential recession standpoint, your prepared comments talked about some of the businesses not necessarily in sync with the rest of the economy. Just any thoughts in terms of what a mild recession might mean to Valmont.

A mild recession, again, more probably favorable from a labor perspective than otherwise would be there and some abatement of some inflationary items. And market-wise, coatings is probably most susceptible to something because it does tend to follow a lot of different macro markets. And so if those were to tail off, there could be some impact there. But the strength in utility, lighting and traffic, agriculture and being that 35% of our volume is internal should at least negate much of that impact. So that's probably the single biggest area we would worry about. Outside of that, we have good visibility to all the end markets. We have good backlogs in many of the businesses. So we're not as concerned as maybe other industrials are or other consumer-based companies would be in that sense.

Got it. Very helpful. So you guys provided kind of preliminary 2023 outlook at Q3. I touched on it here, 6% to 9% revenue growth, 11% to 15% increase in adjusted EPS. Maybe can you just talk a little bit further about the key assumptions behind that price and volume and just kind of any other things that came to mind when that particularly the 6% to 9% revenue growth was put out there.

Sure. So on the revenue side, the volume is going to be mid-single digits. Volume side with pricing around 1%, which there are actually 2 parts of that pricing. We do have our pricing in the utility business. We have some of our pricing mechanism based on an index with our alliance. So that -- just because the steel has gone down, that pricing will go down, while it doesn't necessarily impact our margins, the pricing will be lower. What more than offsets that is the pricing and all the other parts of the businesses where we continue to take pricing leadership, raise our pricing, provide the value to our customers. We do -- on top of that, we also have -- or when we gave the guidance, it was a 1% negative impact of FX, which we will update when we give our guidance. So in summary, mid-single-digit volume growth, pricing about 1% and then a negative 1% of FX.

Got it. Helpful. In your longer-term goals, you've talked about 12% operating margins at the corporate level. Maybe just talk to that a little bit further in terms of what would have to happen to get there? And are there kind of a few key assumptions behind that?

Sure. So over the last several years, as everyone knows, there was a lot of disruption through COVID, supply chain, labor, hyperinflation, steel movement. So as we go into 2023, while we might not run optimally and there are still constraints on some of the labor side, we'll see better alignment between our revenue and cost. We will see -- even on the labor side, when you had a higher turnover in COVID, spending more time on training employees. So we will get some good improvement on the labor side, better alignment on the pricing and cost. We have been raising pricing, improved productivity in the shop. Continued growth in our businesses that we have higher and accretive margins, such as telecom, and additional technology sales. So a lot of these initiatives are already in place, and we will see continued margin improvement as we go into 2023. So we have a pretty good line of sight to the 12% operating margin growth. And I'll just also point out that as we see opportunities to continue to invest in R&D, and in other areas that could continue to support our long-term growth initiatives. We'll continue to invest but we feel really good about the next steps and line of sight to achieving our 12% operating margin goal.