CCL Industries Inc

TSX:CCL.B

Earnings Call Transcript 2022-Q4

[Operator]

Good morning, and welcome to CCL Industries' Fourth Quarter Investor Update. Please note that there will be a question-and-answer session after the call. The moderator for today is Mr. Geoff Martin, President and Chief Executive Officer; and joining him is Mr. Sean Washchuk, Senior Vice President and Chief Financial Officer.

Please go ahead, gentlemen.

[Sean Washchuk]

Thank you, Holly. Welcome, everyone, to our fourth quarter call. I'll draw everyone's attention to Slide number 2, our disclaimer regarding forward-looking information. I'll remind everyone that our business faces known and unknown risks and opportunity for further details on these key risks, please take a look at our 2022 and 2021 annual MD&A, particularly under the section Risks and Uncertainties. Our annual and quarterly reports can be found online on our company's website, cclind.com or on sedar.com.

Moving to Slide 3, financial summary for the fourth quarter and the year. For the fourth quarter of 2022, sales increased 6.6% and with 4.9% acquisition growth and 2.3% positive impact from currency translation, part offset by an organic decline of 0.6% resulting in sales of $1.59 billion compared to $1.49 billion in the fourth quarter of 2021.

Operating income was $211.2 million, for the 2022 fourth quarter compared to $208.8 million for the fourth quarter of 2021, a 2% decline, excluding the impact of foreign currency translation. Geoff will expand on our segmented operating results for the CCL, Avery, Checkpoint and Innovia segments momentarily.

Corporate expenses were down slightly for the fourth quarter with an insurance accrual reversal offsetting higher expense for long-term variable compensation compared to the prior year fourth quarter. Consolidated EBITDA for the 2022 fourth quarter excluding the impact of foreign currency translation, increased 2% compared to the same period in 2021. Net finance expense was $17.6 million for the fourth quarter of 2022 compared to $13.9 million in the 2021 fourth quarter due to an increase in total debt outstanding and an increase in interest rates on our variable rated debt.

The overall effective tax rate was 21.2% for the 2022 fourth quarter compared to an effective tax rate of 20.1% recorded in the fourth quarter of 2021. This reflects the utilization of previously unrecognized deferred tax assets at certain subsidiaries of the company in the prior year quarter that did not reoccur in the 2022 fourth quarter. The effective tax rate may change in future periods depending on the proportion of our taxable income earned in different tax jurisdictions with different rates.

Net earnings for the 2022 fourth quarter were $145.2 million, down 3%, excluding foreign currency translation compared to the 2021 fourth quarter. For the 2022 year, sales increased 12%. Operating income increased 5%, including a $3.5 million noncash acquisition accounting adjustment to fair value the inventory at Adelbras and net earnings increased 5% compared to 2021.

2022 included results for 12 acquisitions completed since January 1, 2021, and delivering acquisition-related sales growth for the period of 4.8%, organic sales growth of 7.3% and a foreign currency translation headwind of 0.8% to sales.

Moving to the next slide, earnings per share. Basic earnings per Class B share were $0.82 for the fourth quarter of 2022 compared to $0.80 and for the fourth quarter of 2021. Adjusted basic earnings per Class B share were $0.83 for the 2022 fourth quarter compared to adjusted basic earnings per Class B share of $0.81 for the fourth quarter of 2021.

The change in adjusted basic EPS to $0.83 is primarily attributable to an increase of $0.02 from our joint ventures contribution of $0.03 from currency translation, partially offset with $0.01 from higher tax rate and $0.02 from increased finance costs.

Moving to the next slide, free cash flow from operations. For the fourth quarter of 2022, free cash flow from operations was $271.6 million compared to $197.2 million for the 2021 fourth quarter. The increase in cash flow from operations of $74.4 million is primarily attributable to strong working capital management in the fourth quarter of this year compared to 2021.

For the 12 months ended December 31, 2022, free cash flow from operations increased $42 million compared to the 12 months ended December 31, 2021. This comparative improvement is primarily attributable to increased earnings, better comparative working capital management, offset by an increase in net capital expenditures.

Moving to Slide 6, returns to shareholders. For the 2022 year, the company repurchased almost 3.4 million shares at an average price of $58.95 and for total proceeds of $200 million. Including the 14.3% increase in the 2022 annual dividend announced in February of this year, dividends year-to-date have amounted to $170 million representing a solid 27% dividend payout ratio.

Moving to the next slide, our cash and debt summary. Net debt as at December 31, 2022, was $1.52 billion, an increase of $273.1 million compared to December 31, 2021. The increase is principally a result of new borrowings to finance the company's acquisitions during the year and the repurchase of shares under our normal course issuer bid.

Although the company's net debt increase, the balance sheet closed the quarter in a strong position. Our balance sheet leverage ratio was approximately 1.24x, increasing from 1.06x at the end of the prior year. Liquidity was robust with almost $840 million of cash on hand and $0.9 billion available on our revolving credit facility.

The company's overall average finance rate was 2.9% at December 31, 2022, compared to 2.4% at December 31, 2021. This reflects an increase in our interest rates on our variably drawn debt. The company's balance sheet continues to be positioned well to move into fiscal 2023.

Geoff, over to you.

[Geoffrey Martin, President and Chief Executive Officer]

Thank you, Sean. Good morning, everybody. I'm on Page 8 highlights of our capital spending for the year, $419 million net of disposals for the year, a little higher than we thought, but the inflation doing its dirty deeds on is there too. And it excludes right-of-use assets and depreciation for the -- the comparison you see on the bar charts there. We are planning $415 million spending in the year of 2023.

Moving to Slide 9, highlights for the CCL segment, 1.8% organic sales growth, very mixed picture. North America up mid-single digits. Europe and Latin America are up high single digit, and Asia Pacific, which is where the challenges have been and was down a little over 20%. With strong results in the Home & Personal Care, health care and specialty and food and beverage spaces in an unusually soft quarter at CCL Secure. And then at CCL Design, we were impacted by the slowdown in electronics demand with many OEMs. And then the COVID events in China accelerated that even further. But that was part of certain CCL designed by gains in automotive.

Moving on to Slide 10. An offsetting here on the CCL segment was really the results of our joint ventures, which are exceptionally strong. So that's why our earnings were a lot better than our EBITDA and our results through any consolidating earnings here, not the EBITDA numbers and another slide you see on the slide here on Slide 10.

Slide 11 results from Avery, strong gains in the direct-to-consumer channels, especially in North America, and we had another good quarter in Brazil at Adelbras tapes acquisition. The reason for the decline in the operating income margin is really the mix of business we have now due to the more recent acquisitions in the Avery space.

Checkpoint on Slide 12. The MAS merchandise availability business improved overall. And in all regions of the world, except Asia, which had very tough prior year comps on 1 rollout we had last year and challenging markets overall, especially in China. The apparel label business, which has had a very strong year so far, slowed in the fourth quarter, the apparel industry focused on managing excess inventory at all points in the channel. We expect that situation to continue in the first quarter coming up here as we speak.

Slide 13, Innovia. Volume decline on soft demand in the label industry in Europe and North America. So there's been some trade data published in -- particularly in Europe where label materials demand. It's not label demand, but the materials -- the labels are made from declined over 25% in the fourth quarter, which would have been due to the buildup of inventory due to the many supply chain problems, particularly in Europe in the earlier part of the year now correcting. So our sales to laminates in that part of the industry have been particularly difficult in the fourth quarter and continue to be so far in the first quarter.

Energy and freight inflation and the new EcoFloat line start-up in Poland impacted profits in Europe. And in the U.S., we continue to be impacted by the margin squeeze from having higher cost inventory as resin indices continue to decline, reducing selling prices to our customers. That has begun to reverse in the early days of 2023.

So Slide 14, just some comments on the outlook and then we'll open it up for questions. The Core CCL business units' orders pictures, that's health care and specialty, home and personal care, food and beverage is still solid. The CCL Design picture has not changed outlook similar to Q4. We do expect that to pick up as the supply chain situation corrects in China and the economy there opens up.

CCL Secure volume has improved dramatically in the first quarter compared to the fourth quarter, which is very slow. Avery direct-to-consumer strength remains and we've got the recent acquisitions and then the horticultural space, it's the peak season in Q1, which we missed when we bought one of those companies last year.

Now the Checkpoint, the apparel destocking, as I mentioned, earnings is expected to continue for a few months. The MAS outlook has been stable and we have a much easier comps than we had this time last year. Innovia volume will be subject to the label industry demand recovery when that occurs. But the good news is inflationary prices have stabilized, particularly on energy and freight and the inventory cost squeeze is reversing in North America. And we expect a modest foreign exchange tailwind at current rates as we go into the current quarter.

So with that, operator, we'd like to open the call up for questions.

[Operator]

[Operator Instructions] Your first question for today is coming from Walter Spracklin at RBC Capital.

[Walter Spracklin, RBC Capital Markets]

So really, when I look at the results, a little weaker than expected, but it appears that a number of the driving factors look to be temporary. So a few of my questions are really to assess whether that -- whether in your view, it is indeed temporary and just starting with CCL Secure, Geoff, you called it out as unusually weak, but having rebounded quite significantly. Any indication as to what caused it to be unusually weak? I know this is a very good business. Is it just kind of a few events that all happened all at once and how those are done and behind us? Or just your views on what caused that unusual weakness?

[Geoffrey Martin, President and Chief Executive Officer]

What happens from time to time, Walter, in this industry is banks don't want bank notes. There's not a lot we can do. There's only one customer per country. So if they delay orders from one quarter to the next, then we just have to put up with it and move on. And so we had an unusually weak Q4. And orders that we would have normally have in the fourth quarter of last year and coming in the first quarter this year, and that's really the driver for it.

[Walter Spracklin, RBC Capital Markets]

Okay. So chalk that up to timing. On Avery, Geoff, you mentioned the margins were down due to the mix from recent acquisitions. Is that because the acquisitions that you've made are running below your efficiency level, which you hope to bring up? Or is it just the nature of the way they operate and they are a lower margin albeit accretive type of business that we should now recalibrate our Avery margins going forward to reflect this -- the new paradigm of these acquisitions?

[Geoffrey Martin, President and Chief Executive Officer]

Well, we have to wait -- that the -- all the anniversaries quarter-by-quarter flow through. So -- but the Adelbras and the horticultural -- the two horticultural acquisitions, which combined sales for all of those three done together well over $200 million, $250 million, something like that. They are materially lower margins than the core Avery business is today. I mean we still make a good return on capital on those deals, and they're definitely accretive to the company.

But the margin -- it will change the margin picture of Avery going forward. And the seasonality will also be a factor, Walter. So the horticultural season, the strong period for that is the very latter part of the year and particularly the first quarter.

[Walter Spracklin, RBC Capital Markets]

Got it. Okay. That's great color. And last question here on China. Clearly, the lockdown having impacted your quarter in the fourth quarter. Indications as to how that's adjusting now here in the first quarter? Are we seeing that ramp back up? Could we see any pent-up effect or supply chain issues still kind of tempering what would have been an otherwise stronger rebound in China following that lockdown?

[Geoffrey Martin, President and Chief Executive Officer]

Yes. Well, I think you've all seen the results from the tax base. So the mobile phone guys, the computer guys, so there's nobody reporting, particularly good news in the tech space at the moment. So that's definitely a factor that affected our performance. But it was, for sure, compounded by the lockdown. So the supply factories to those OEMs were severely impaired in Q4. When this epidemic occurred in China, many factories were forced to close. So that was the factor.

So we do expect the second of those two trends to come back quite strongly at some point in the first half of this year. We had an early January Chinese New Year this year. So that -- and also took this factor through the end of January. But the order picture is beginning to pick up now as the supply chain mix begins to normalize.

[Operator]

Your next question for today is coming from Stephen MacLeod at BMO.

[Stephen MacLeod, BMO Capital Markets]

I just wanted to follow up on a couple of things. One was on the CCL Secure. Are you able to quantify what impact that had relative to your expectations in the quarter?

[Geoffrey Martin, President and Chief Executive Officer]

Well, the business lost a little bit of money in the quarter, which it doesn't normally do -- it's one of our more profitable businesses. This is probably the most color I could really give you.

[Stephen MacLeod, BMO Capital Markets]

Okay. Okay. And then just on the Avery...

[Geoffrey Martin, President and Chief Executive Officer]

Swing a little over $10 million quarter-to-quarter, Stephen, to give you a frame of reference.

[Stephen MacLeod, BMO Capital Markets]

That's $10 million in profit?

[Geoffrey Martin, President and Chief Executive Officer]

A little over $10 million.

[Stephen MacLeod, BMO Capital Markets]

Okay. Okay. Great. And are you able to quantify what the top -- what like organic growth might have been, excluding the CCL Secure impact?

[Geoffrey Martin, President and Chief Executive Officer]

It's not a big business, so it doesn't really -- it's still a huge $200 million in sales. So it's not a huge factor on the top line. CCL design is a much bigger factor on the top line because of the slowdown in electronics.

[Stephen MacLeod, BMO Capital Markets]

Okay. Okay. And then just on Avery, with respect to the mix shift that you're seeing. We used to think of that business as potentially having a margin profile reaching into the low 20s on eBay. Is that something that's still possible? Or do you think that is now like a high teens, 20% tops margin business?

[Geoffrey Martin, President and Chief Executive Officer]

Yes. We'll have to wait and see how these new acquisitions bed in and we understand their seasonal pattern. So there'll be certainly quarters where we'll have in excess of 20% operating margins and there'll be other quarters where we don't. And I think we'll have to understand the seasonal effect as we go forward quarter-to-quarter. But the Avery business performed very well in 2022 at all levels. The acquisitions contributed, the core business did well. I mean we had a great year there, and it's continuing to be strong in the first quarter of this year. So there's nothing we're concerned about on the Avery at all, actually.

[Stephen MacLeod, BMO Capital Markets]

Yes. Okay. Okay. That's great. And then maybe just higher level, as you think about the year ahead here, 2023, do you sort of expect the first half of the year to look a lot like Q4 and then well, maybe even stronger and then a bit of a rebound in the back half of the year. Is that sort of how you're thinking about things unfolding in 2023?

[Geoffrey Martin, President and Chief Executive Officer]

Well, certainly, we'd certainly say that about Innovia. So Innovia, we'll have a difficult top line Q1 like it had in Q4 because of that label industry, raw materials impact. So that's -- we sell to companies like Avery Dennison and UPM in that space, and they've all reported slow numbers in Q4 and forecast slow numbers in Q1. So they are our major customers in that space. So whatever happens to them is going to happen to us.

So they're predicting that will change in the -- from Easter onwards, and that's probably -- we think it will be some time around Easter or early summer when that situation changes. That would be the picture for Innovia.

I think Avery will start off the year strong. I think Checkpoint will be okay. We do have to remember the apparel industry is going through a compression in its inventory management situation, just addressing bloated inventories at all points in the supply chain and correcting that. So that's a pretty common theme in that space. So that will have a more negative effect.

And then the core CCL businesses look okay. So that's the picture as we see it as I try to put on the outlook slide comment.

[Operator]

Your next question is coming from Michael Glen at Raymond James.

[Michael Glen, Raymond James]

Geoff, I'm just trying to fully understand the commentary surrounding the soft demand for the label materials industry in Europe and North America and what appear to be relatively strong conditions for CCL segment in Europe and North America. Is that -- just if you could walk through that in a little more detail?

[Geoffrey Martin, President and Chief Executive Officer]

Yes. I think what happened, Michael, last year, so in the early part of 2022, one paper company went on strike in Europe, a very large supplier to the label materials industry of release liner, and that caused everybody in the label converter channel to over order and panic and they don't create false demand on the labor materials industry that was not really reflective of the end-use demand.

So many label converters including ourselves, stocked up of pressure-sensitive materials supply particularly in the first half of last year. And then once the strike ended in April of last year and then gradually as the rest of the year unfolded, things began to ease and then people stop -- the labor converted channels stopped ordering materials from those suppliers. So -- and as our films are used by them to make those materials, they start ordering on us, and that's basically what's happened.

And it will probably -- I think it will go pretty big phenomena in Q4. I think it will carry on in Q1, sometime in Q2 will probably ease off and then we'll move on back to normal.

[Michael Glen, Raymond James]

Okay. That's really helpful. And then just in terms of some customers like customer trends on volume across some of the large CPG companies have continued to see some challenges in Q4. Are you seeing any of that show up in your order book?

[Geoffrey Martin, President and Chief Executive Officer]

It didn't in Q4. So in Q4, we had very -- we had strong double-digit growth in the healthcare space, I mean very strong double-digit growth in the healthcare space. Home & Personal Care was up mid-single digits. Food & Beverage is up high single digits. So there's some price in there. So -- but I wouldn't have said our volume was lower than it was in the prior year in those three spaces.

So, so far, I'd describe it as a very solid picture. But we read the results for those companies the same as you do. And they're all noting sort of low to mid-single digit declines in unit volume. But so far, we haven't seen that translate into actual label demand.

And in some categories, like in our Aerosol can business, we're booked out almost through the summer. It's very strong.

[Michael Glen, Raymond James]

And if I go back to Q3, I think you highlighted beer in Q3 was a particular outlier for strength. Did that continue in Q4?

[Geoffrey Martin, President and Chief Executive Officer]

It did. That's not in the U.S. I mean we're not a big supplier in the U.S. Beer industry in the U.S. is very concentrated, as you know. But around the international beer business was strong in the second half of the year for sure. and it started off okay this year as well.

[Operator]

Your next question for today is coming from David McFadgen at Cormark Securities.

[David McFadgen, Cormark Securities]

A couple of questions -- so yes, just a couple of questions. So when I look at the organic growth across all the segments, obviously, it was a lot lower in the fourth quarter. So is it safe to conclude that the pass-through's are basically done now, and we're going to get more into a more normalized organic growth going forward?

[Geoffrey Martin, President and Chief Executive Officer]

Yes. I think that's a fair statement, David. And I think we also have to bear in mind we paused through very considerable price reductions in the Innovia space with huge declines in resin. So the resin went up a very escalated level in '21 and then deescalated at the same pace into all the way through 2022. So we've been passing price reductions really for pretty much all of last year. And that's now stabilized. So as we go into Q1, resin on the slight uptick again in the U.S. in the early part of Q1.

[David McFadgen, Cormark Securities]

So just continuing on that theme, how many more months or quarters will take for you to work off that high-cost inventory at Innovia?

[Geoffrey Martin, President and Chief Executive Officer]

I think probably one more quarter.

[David McFadgen, Cormark Securities]

Okay. And then just on Checkpoint, so you talked about the excess retail apparel inventory, and it's going to take a few months to work that down. I was wondering how many months you -- can comment on that. But do you think that, that business might also be starting to see the negative impacts of a recession?

[Geoffrey Martin, President and Chief Executive Officer]

I think it's more inventory than a recession, to be honest. I think it's just -- when probably driven by a slowdown in demand, but I wouldn't say a recession. I mean I think demand is definitely down compared to a year ago, but it's -- I wouldn't say it's shrinking. The rate of increase has stopped. Speed, it was accelerating at.

And then the other factor we have to think about in that space is RFID and the strength of RFID. So that's a pretty significant offset to that. But correction in the inventory situation is well documented by all the players in the space. So it's undeniable, that's how it is. But the nature of that space is they sell in season. So at some point, you haven't got the inventory you have for the season you're in and it correct. So I think by the time we get into the spring and summer, we should be back in a normal situation.

[David McFadgen, Cormark Securities]

Okay. I mean when I look at your business, at least in the past, it was very recession resilient, but you didn't have area at that time. So I'm just kind of wondering what your thoughts are on Avery and how that would do in a recession?

[Geoffrey Martin, President and Chief Executive Officer]

I think Avery will hold up pretty well. It's -- the business has changed in the 10 years or so that we've owned it. So we bought a lot of new businesses that are performing significantly better than the old legacy business. And so that's an upside. And then some categories in Avery that have still got to come back. So we've begun to see in some of the legacy product lines as there's a more gradual return to work, a demand increase there. So that's still a factor.

Parts of the badge business that are really involved around business conferences, which were on the way pretty much all of last year. They started now to come back. So we still got some uptick cycles to come in Avery to get back to sort of pre 2019 prefunding levels. So I would expect our every business to perform well in 2023 and have a good start, that's 70% has in January.

[David McFadgen, Cormark Securities]

Okay. And could you provide the same commentary for Checkpoint story?

[Geoffrey Martin, President and Chief Executive Officer]

Yes. I think in Checkpoint, it's the same similar to the situation in Q4. We expect our MAS business to do pretty well. it's -- people are still focused on store security and protecting merchandise. That's nothing to do with when you're in a difficult retail sales position or not. And the apparel supply chain will eventually correct and then we'll be back to where we were pre-pandemic.

[Operator]

[Operator Instructions] Your next question for today is coming from Daryl Young at TD Securities.

[Daryl Young, TD Securities]

Good morning, everyone. First question will just be on the M&A environment, if you're seeing any improvement or any availability as we've continued to extend into this higher interest rate environment?

[Geoffrey Martin, President and Chief Executive Officer]

Yes. We've certainly seen more interest in businesses for sale at multiples we wish to pay, our pipeline is quite good at the moment and LBO transactions are challenged in the private equity space in our industry because the debt financing is very difficult for the private equity firms to get a hold of to do these kinds of deals at the moment. So that's all helping the market situation for businesses we would like to buy. So we're quite encouraged by that.

[Daryl Young, TD Securities]

Okay. Great. And then just in terms of the CCL segment, profitability. I mean you gave some good color already around CCL Secure and CCL Design. If you strip those out, was the core label performance effectively in line with traditional profitability and volume price mix?

[Geoffrey Martin, President and Chief Executive Officer]

Yes. I would say healthcare -- HPC Healthcare & Specialty and food and beverages all had strong fourth quarters, strong on the top line, strong on the bottom line, all it's a very, very good call for all three of those businesses. So I think in CCL Design, the delta profit number was quite large in the electronics space due to the situation in China. So that was the big driver and then the slow order CCL Secure were pretty both pretty big offsets.

[Daryl Young, TD Securities]

Okay. And I think in the past, you've said that on the labels -- the core labels, they're a pretty small percentage of the cost structure for the CPGs. But are you expecting any headwinds on pushing price through or price gains just given they're going to be very cautious around their price volume mix in light of the weak...

[Geoffrey Martin, President and Chief Executive Officer]

I don't think we'll have any difficulty getting the price points we need. I think in the label industry, the inflationary period we went through in last year seems to have come to an end. So moving into more of a deflationary cycle on the raw materials side there. So that's a good news story. And where we do have some cost increases like in the aerosol business, metals have started to rise again.

We've got very clear pass-through mechanisms in that space, and the business is performing very well, and demand is solid. So I don't see anything to be concerned about in those 3 businesses. So what we're hopeful is to see the situation of CCL design in the electronic space once the supply chain gets back to normal in China, we do think there's probably some inventory destocking there and most of the OEMs would like to have more inventory out around the world than they have.

And although their business is in great shape, stockouts sort of problem because of availability of inventory. So we would expect the supply side of that equation to improve as we go through particularly Q2. So January, we had the early Chinese New Year. So the year really only started in China by the second week in February.

[Operator]

You have a follow-up question coming from Stephen MacLeod at BMO.

[Stephen MacLeod, BMO Capital Markets]

I just have a follow-up regarding Innovia. And I'm just wondering if you can help us sort of think about the margin profile as you work through the year, particularly as you get through the high-cost inventories and run through some price declines as you give some of that price back. Just curious if you could help us think about how that shapes the margin.

[Geoffrey Martin, President and Chief Executive Officer]

Yes. There's a lot of moving parts in that, Stephen. I don't know that I can help you much more than -- we'd expect Q1 to be a little better than Q4 because we've got some of the inflationary issues calming down in Europe. So that's a good news story. I think the demand picture will be similar in Q1 as it was in Q4. I don't think we'll see much improvement in that. Then we'll have a pickup as the year unfolds in Poland, where we've got the EcoFloat line starting up.

So that's going to accelerate as we go through the year. We've got a lot of interest in that product from many of the consumer packaged goods customers from a sustainability standpoint. And then in the Americas, we'll have the benefit of rising resin market. So we -- once we work through those Q1 high-cost inventories, we squeeze they will disappear.

[Operator]

We have reached the end of the question-and-answer session, and I will turn the floor back over to Geoff Martin for closing remarks.

[Geoffrey Martin, President and Chief Executive Officer]

Okay, everybody. Well, thank you very much for joining the call, and we look forward to seeing you and hopefully at Sunnyvale, the Glen, Snowy Toronto this morning. Thank you very much for attending the call.

[Operator]

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.