2023-11-11 15:38:15 ET
CCL Industries Inc. (CCDBF)
Q3 2023 Earnings Conference Call
November 9, 2023 07:30 ET
Company Participants
Geoff Martin - President & Chief Executive Officer
Sean Washchuk - Senior Vice President & Chief Financial Officer
Conference Call Participants
Stephen MacLeod - BMO Capital Markets
Ahmed Abdullah - National Bank of Canada
Walter Spracklin - RBC Capital
Michael Glen - Raymond James
Ben Jekic - PI Financial
Presentation
Operator
Good morning and welcome to CCL Industries Third 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.
Geoff Martin
Good morning, everybody and welcome to our call. We're dialing in today from our operations in Germany, in Stuttgart. I'm going to hand you over right away to Mr. Sean Washchuk, who's going to take you through the numbers for the quarter.
Sean Washchuk
Thank you, Geoff. If everyone could turn to Slide 2. I'll draw your attention to our disclaimer regarding forward-looking statements. I'll remind everyone that our business faces known and unknown risks and opportunities. For further details on these key risks, please take a look at our 2022 annual report under the section risks and uncertainties.
Our annual and quarterly reports can be found online at the company's website or at sedar.com. So we'll move forward to Slide number 3, a summary of operations for the quarter and year-to-date. For the third quarter, our 2023 sales increased 2% with 2.6% acquisition-related growth, 5.4% positive impact from foreign currency translation, partially offset by 6% organic decline, resulting in sales of $1.69 billion compared to $1.66 billion in the third quarter of 2022.
Operating income was $256.1 million for the 2023 third quarter compared to of $246.8 million for the third quarter of 2022, a 2% decrease, 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 through the quarter due to lower discretionary expenses and short-term variable compensation expense versus the prior year quarter. Consolidated EBITDA for the 2023 third quarter, excluding the impact of foreign currency translation, increased 2% compared to the same period in 2022.
Net finance expense was $20.3 million for the third quarter of 2023 compared to $17.1 million in the 2022 third quarter due to an increase in interest rates on variable rate debt. The overall effective tax rate was 24.5% for the 2023 third quarter compared to an effective tax rate of 22.9% recorded for the third quarter of 2022 due to higher withholding taxes on foreign dividends.
The effective tax rate may change in future periods depending on the proportion of taxable income earned in different tax jurisdictions with different rates. Net earnings for the 2023 third quarter were $169.1 million compared to $163.9 million for the 2022 third quarter. The 9-month period, sales and operating income decreased 1%. Net earnings decreased 3% compared to the 9-month period in 2022. 2023 included the results from 11 acquisitions completed since January 1, 2022, delivering acquisition-related sales growth for the period of 2.2%. Foreign currency translation tailwind added 5% to sales, partially offset by a 3.2% organic sales decline.
Moving to the next slide, our earnings per share. Basic earnings per Class B share were $0.95 for the third quarter of 2023 compared to $0.93 for the third quarter of 2022. Adjusted basic earnings per Class B share were $0.95 for 2023 and 2022 third quarters. We delivered this $0.95 principally attributable to a decrease in operating income of $0.03, increase in taxes of $0.02, increased finance costs of $0.01, offset by $0.05 positive foreign currency translation and $0.01 improvement in our joint venture equity pickup.
Moving to our next slide, free cash flow from operations. For the third quarter of 2023, free cash flow from operations was an inflow of $182.2 million compared to a net inflow of $148.7 million in the 2022 third quarter. The increase in free cash flow from operations of $33.5 million is primarily due to improved working capital, higher cash earnings, slightly offset with higher net CapEx in the third quarter of this year compared to 2022 third quarter. For the 12 months ended September 30, 2023, free cash flow from operations increased $58.3 million compared to 12 months ended September 30, 2022. This comparative improvement is primarily attributable to an increased earnings, better comparative working capital management, offsetting an increase in net capital expenditures and higher taxes paid.
Moving to our next slide, our cash and debt summary. Net debt as at September 30, 2023 was $1.76 billion, an increase of $237.7 million compared to December 31, 2022. This increase is principally a result of increased borrowings and a lower cash balance at Q3 2023 versus December 2022 to fund the 8 acquisitions completed this year. Although the company's net debt increased, the balance sheet closed the quarter in a strong position.
Our balance sheet leverage ratio was only 1.37x, up slightly from 1.24 at December 31, 2022. Liquidity was robust with $773 million of cash on hand and US$0.8 billion of available undrawn credit capacity on the company's revolving bank credit facility.
The company's overall average finance rate was approximately 3% at September 30, 2023, compared to 2.9% at December 31, 2022. This reflects an increase in variable interest rates on the company's outstanding borrowings under its revolving credit facility. The company's balance sheet continues to be well positioned to move through the end of fiscal 2023 and beyond.
Geoff, over to you.
Geoff Martin
Thank you, Sean. Hello, again, everybody. I'm on Slide 7, highlights of our capital spending, $362 million net year-to-date 2023. A and we anticipate that number rising to the $440 million to $450 million range for the year as a whole.
Some highlights on Slide 8 of things we're putting our money into. We're building a big new CCL Label healthcare plant in North Carolina which is due to come on stream in mid-2024. Key focus of our plant of labels and material products for the GLP-1 blockbuster drugs that are coming on to the market which you've all seen the adverts on TV for.
Second big investment we're making is in a second RFID inlay plant in Mexico City which will be built alongside CCL Label plant in the same location but in a different building. And the main focus of this capacity will be on applications outside of the apparel, in logistics, pharmaceuticals, general merchandise and foods. But operation is expected to come on stream in mid-2024, alongside investments already in place in China should increase our capacity to make RFID inlays at 3 times over our current 2023 forecast sales.
Moving on to Slide 9 highlights of the CCL segment quarter. We had a big organic growth here last year, 13.2% in this Q3 of 2022. So it's all the high bar to reach. So 3.6% organic sales decline. We're not entirely surprised by that, almost flat in the Americas. Mid-single-digit decline in Europe, double-digit decline in Asia Pacific.
Profit gains in all sectors of the CCL segment, except CCL Design, where gains in automotive continue to be more offset -- more than offset by some weakness still in electronics markets, although we'll cycle through the change in that regard in the coming quarter. Results were augmented by FX tailwinds and solid contributions from new acquisitions.
Slide 10, results from the joint ventures. As Sean said, we got to pick up there in earnings which is good. Slide 11 results from Avery. Very solid back-to-school season in North America drove the performance here on top of solid results internationally. Our horticultural business loses money in this quarter but it was flat to prior year and we started to get into the money-making period in the latter part of the fourth quarter, the company is coming soon.
Page 12 highlights of Checkpoint. I'll draw your attention to the second bullet point. Last year, in the third quarter, we had an $11.9 million gain on real estate disposal which we highlighted to you last year. Excluding that, Q3 operating profit was up 24% and we had strong sales progress in all regions in the MAS business and also very good growth -- organic growth driven by RFID in the apparel labeling space.
Slide 13, results for Innovia. Double-digit demand drops in the pressure-sensitive label materials. Industry continues to be the challenge here, especially in Europe but also in North America. Lower resin pass-through was a significant factor also in the top line. Sales declined but profitability improved modestly on easing inflation, very good cost controls in a difficult volume market.
Slide 14. Our outlooks for the coming quarter. Core CCL business units, we expect to be more or less a repeat of what we went through in Q3. We do expect CCL Design to do better comparatively as we lap the change in the demand. Picture in the electronics industry, you feel secure should also post modest progress.
Avery results are expected to be stable. Horticulture will move into its profitable period. Checkpoint faces tough comps compared to a strong end of 2022 and RFID continues to grow. We had a pretty solid -- October a little better than we expected. So maybe that comment will be quite as soft as we initially first thought.
Innovia expect to outperform but against a weak Q4 2022, perhaps significantly at the label materials industry volume recovery gains traction. We saw a little sign of that in October in order intake, not so much in revenue there. FX tailwind should continue at current exchange rate.
And with that operator, we'd like to open up the call for your questions.
Question-and-Answer Session
Operator
[Operator Instructions] Your first question for today is coming from Stephen MacLeod with BMO Capital Markets.
Stephen MacLeod
Well, I just had a couple of questions I wanted to follow up on. Just in terms of -- you highlighted sort of 2 interesting CapEx investments on the GLP for health care? And then also on RFID. And I was just wondering if, maybe too soon but if you're able to give a little bit of color around sort of what kind of capacity in dollars those investments could produce in terms of sales.
Geoff Martin
Yes. I don't want to get into that. I think we've given you some color on the indication about the RFID capacity. We're trebling it. So we're not, by any means, the market leader in RFID. So we're certainly a top 5 or 6 player but we're planning to come up with total -- a lot faster and a lot quicker in the next year or two. So that's what that one's about. The GLP investment, it's very customer-specific, can't go into that -- any details for that reason. But it's obviously an exciting product area for our health care business to be involved in.
Stephen MacLeod
Yes. Okay, that's great. And then, just on the RFID. Are you able -- you talked about increasing capacity 3x over 2023 sales? Can you just give a -- able to give a run rate of where that business stands right now?
Geoff Martin
Not right now.
Stephen MacLeod
Okay. Okay. And then just on the CCL business, in terms of the outlook heading into Q4, obviously, you had a tough comp in Q3 but the comp eases a little bit in Q4. Would you expect based on what you know today and based on the outlook for organic sales to be up year-over-year in Q4?
Geoff Martin
Well, if they were up, it wouldn't be by very much. And they could also be down a little bit. So it's a very difficult quarter to forecast, Steve, because you've got Thanksgiving in the U.S. in November and the Christmas season in December. It's always a somewhat volatile quarter. So we might be -- we might post organic growth in Q4. We might post a small organic decline. So we'll just have to wait and see how things unfold. I think the big change is really going to be the impacts of the CCL Design business which has been declining in kind of a high single-digit rate for most of the year. That should stop in Q4 because we lapped the change in electronics. So that's probably will be the most impactful change in the coming quarter.
Operator
Your next question is coming from Ahmed Abdullah with National Bank of Canada.
Ahmed Abdullah
So on the core CCL segment outlook commentary, can you give us some more color on which geographies or customer segments you think are likely to underperform or outperform. And do you think mix plays a part here to help margins in the coming quarter?
Geoff Martin
Well, I think the most important comment I just made about CCL Design, so that's -- the business has been declining. As I said, high single digits for the last few quarters. That should stop in Q4. The Latin America region in total is the one that's been outperforming other regions in total in the CCL segment space. So I don't see any reason why that should continue to change and we'll just have to wait and see how -- what the quarter brings. And regionally, Asia will do a lot better because CCL Design will do better. So that's really one and the same thing. So we expect a flat to slightly up or flat to slightly down outcome in Q4 driven by those dynamics.
Ahmed Abdullah
Okay. And the expectation for Innovia to outperform Q4 last year, is that on top line and adjusted EBITDA.
Geoff Martin
It's on the bottom line. So we certainly won't outperform the top line because we've got much lower resin costs this year than we had last year. So top line will still be down. We do expect to make more money this quarter than we made in the fourth quarter of last year, driven by -- really driven by inflationary factors that were still present last year being largely absent now in that business, although resins have ticked up a little bit in the last month or so.
Ahmed Abdullah
Okay. And just last one from me. Where do volumes and this segment stand versus historical levels? Like are we close to a more normalized point in this quarter?
Geoff Martin
No, no. We still see a dramatic drop in the -- the big change in this business has really been in the pressure-sensitive label materials industry, so public companies in that space both reported 2020 and 25% volume drops in their businesses in North America and Europe. And that's where really we're seeing, that's what really needs to recover before we'll see volume gain. We did see some improvement in order intake in October but not so much in shipments out. So we saw a slight tick up but it's not yet running at any pace. It's getting us terribly excited but it has slightly ticked up.
Operator
Your next question for today is coming from Walter Spracklin with RBC Capital Markets.
Walter Spracklin
So perhaps we'll start with -- just with margins. I know there had been some fairly extraordinary moves in margins during the pandemic that led to certain areas of your business, Geoff, getting some strength that perhaps wouldn't be normal in speaking to CCL Secure and currency hoarding and so on. But it seems that with this year now, margins have normalized somewhat. So I just wanted to make it -- make sure that there isn't anything left that you would you prudently called it out for us last time just to make sure that we didn't go too far in any one direction but it seems CCL is back to 22% range, maybe a stick below, Avery is at 23%, Checkpoint at 20%, going to get to Innovia in a second. But within those 3 divisions, is there anything in that mix that you think is still going to iron itself out and therefore, have an impact on the longer-term kind of normal margins you would expect in those businesses?
Geoff Martin
I think you've called it right, Walter. We're through most of it. And then what's left to go through, I think won't move the needle enough. On the CCL segment, there's nothing that any one business will do that will move the needle very much that way. So Q4 is always a lower quarter for us. So sequentially, we'll see some change. But in terms of where we've cycled through the pandemic year or those sort of last 3 years, we've had, I certainly feel when we get into 2024, we'll be kind of back to normal. And there's not much left right now.
Walter Spracklin
Fantastic. And you touched on another part of my question. When you say business conditions are stable. Do you mean -- because seasonally, you do have weakness, do you expect that seasonal weakness to come down? Or do you mean stable in a dollar value that the seasonal -- typical seasonal fourth quarter doesn't come down and that it's stable relative to 1/3 in a dollar perspective. I think you meant in percentage terms that the seasonality will still continue but similar stable growth or business activity levels that you would expect. Is that right?
Geoff Martin
Yes. I think we meant stable, actually relative to the comparative quarter in the prior year. Good question. So we still expect the normal seasonal pattern but we're not expecting to see any more cadence.
Walter Spracklin
Okay. And last question here on Innovia. That one has swung around quite a bit. I know back before you had done the realignment in Mexico, you were kind of guiding towards 15% EBITDA margin and then, did very well, went up into the high teens and then it even touched into above 20% and has now since come down. Is there -- and I know resin prices has a lot to do with that but is there any margin target that you had -- it looks like 15% is where we're flattening out here now. Is that a fair number? Or is that -- is there another way we should be looking at margins within Innovia division?
Geoff Martin
Yes. It's a pass-through industry, Walter. So margins move up and down relative to what's happening to resin. So there's always a factor involved in that. But in terms of the overall performance at Innovia, we really need to see volume come back before we'll get the step change we need to see. And that's kind of all our eyes are focused on, particularly in Europe. That's so in the Americas but particularly in Europe, we need to see the label materials industry come back to more typical regular ordering patterns. So they're all saying that's going to change and improve in the fourth quarter. We did see a little bit of uptick in October in order intake, not so much in terms of order shipments but hopefully, their aspirations will prove to be correct and as we go through Q4 and certainly into next year, we'll see top line in that business improve on a volume basis and that's what we're most anxious to see.
Operator
Your next question is coming from Michael Glen with Raymond James.
Michael Glen
Geoff, just to start, one your suppliers has been speaking about a deflationary environment for label materials. I'm just wondering if you could give us a sense as to how you handle that sort of situation with your customer base?
Geoff Martin
Yes. So we -- the label materials space was very inflationary in the years of '21 and '22, in particular and that sort of began to -- suddenly been reversing. We're not back to where we were but raw material costs have been coming down. And as those raw material costs come down, they get built into the price calculations we make for the products we make and that's hundreds of thousands of transactions. So we don't know where we are in that. But that's how our business works. It takes its raw material input costs. The most recent price makes its calculations and firstly, you have new pricing. And that's basically what happens. We don't do price through -- and pass-through in the label industry because the labels change all the time anyway. So we just wait until the next change and then the pass-through happens when the next change occurs.
Michael Glen
Okay. But that -- so it's integrated into the pricing mechanism in some form?
Geoff Martin
Right. Correct.
Michael Glen
And the RFID, can you just describe just a little -- give a little more detail on the application set that you're discussing here? You're talking pharma and food, like what's sort of the end market here? I'm just trying to understand how that -- I understand you're selling into apparel right now. But what's sort of the -- what are you targeting here with this new plant exactly.
Geoff Martin
Well, some of the big retailers in the U.S. have started to mandate some of their vendors to put RFID inlays onto their products. So we've actually been mandated to do that at Avery by some of our retail customers. We want RFID label products inserted on boxes of labels and binders and index as we sell in the trade channels in the U.S. So -- but it's across a range of what these retailers are called general merchandise. So it's not grocery type products, it's general merchandise type products. So we've been doing it on things like that, electronic toothbrushes, shavers, things of that ilk. In the drug industry, it's a lot of -- it's to do with hospital supplies. Hospitals beginning to use RFID is a track and trace system in wards. So drug manufacturers who supply drugs into the hospital channel, beginning to use RFID products, automotive parts.
In the food business, it's more kind of food that's used at retail, so cold cabinets in retail stores that have individual price portions of meats and things like that in cold cabinets and have to worry about when that expiry date has been reached. Now they can scan those -- scan those products inside the grocery stores and get an automatic read on what's expired and what's not and those are pretty significant waste benefits and productivity benefits for retailers. So those are the applications we're seeing in food.
Michael Glen
So since you bought Checkpoint, how much has, like a tag, what's happened with pricing on an individual tag over that time frame, say, over the last 5 to 6 years, it must be down.
Geoff Martin
Something has changed. It's not changed all that to be honest with you; because what's happening now is what we're all realizing is these tags are custom-made for each application. So the antenna design is different. So some tags are low cost, some tags are not. And so there's not a generic price point for this stuff. And we weren't making RFID at all when we bought Checkpoint. They weren't making these products at all. We invested to give them the capability to do it. We initially done it in the core business we have which is apparel, moved into retail now into the CCL segments where we're also active with the technology and we expect to see it grow as the industry does, in general, quite significantly over the next period of time.
Michael Glen
Okay. And just one more. So your CapEx guide for the year would seem to indicate a step down in Q4. I just want to know if that's accurate.
Geoff Martin
That's right.
Michael Glen
And then, any early read on. And then, early read on CapEx for '24.
Geoff Martin
It'll be in the same range, $450 million-ish but we'll confirm that number in Q1 but it will be in the same range.
Operator
Your next question for today is coming from Ben Jekic with PI Financial.
Ben Jekic
Most of my questions have been asked but I do have 1 just to make sure. Geoff, when you said for the fourth quarter, somebody asked and you mentioned flat to slightly up or flat to slightly down. I'm assuming that is meant quarter-to-quarter.
Geoff Martin
No. That's comparatively to the prior year.
Ben Jekic
To the prior year. Okay.
Geoff Martin
Yes. And that comment was sort of CCL segment. Response to the question about the CCL segment.
Operator
Your next question is a follow-up question coming from Stephen MacLeod with BMO Capital Markets.
Stephen MacLeod
I just had 2 follow-up questions. The first is I just wanted to clarify for Innovia, did you say that sales would be -- in terms of your outlook, you're going to expect profits to be up and sales to be down. I just wanted confirm I heard that right, because last year, it looked like sales were down 11%.
Geoff Martin
That's correct. Yes, because we've got resin pass-through pretty significant resin pass-through. So unless volume returns, like in a massive wave, all of a sudden, it would be hard to imagine our sales will be up in Q4 because of the pass-through pricing in resin.
Stephen MacLeod
Yes. Okay. Okay. That's great. And then just on Avery, I know you addressed this, the margin question earlier. But I just wanted to confirm, it sort of looked like Avery is kind of running at like a 19% EBIT margin on a year-to-date basis. Is that something to expect going forward? Is that because of the horticultural business kind of taking that margin down a little bit?
Geoff Martin
Yes, it takes it down in this call because horticultural is in its loss-making seasons. So when we get into Q1, you'll see that change differently. But -- so it moves it about a little bit but there was no operating profit in the third quarter. So it was a drag. If you excluded horticultural margin, we'll definitely be north of 20%, for sure.
Operator
[Operator Instructions] We have reached the end of the question-and-answer session. And I will now turn the call over to Geoff for closing remarks.
Geoff Martin
Okay, operator. Thank you very much, everybody, for joining the call and we look forward to talking to you -- it will now be sometime next year. Thank you very much for joining.
Operator
This concludes today's conference and you may disconnect your lines at this time. Thank you for your participation.
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CCL Industries Inc. (CCDBF) Q3 2023 Earnings Call Transcript