Avery Dennison Corporation (NYSE:AVY) Q4 2023 Earnings Call Transcript

Avery Dennison Corporation (NYSE:AVY) Q4 2023 Earnings Call Transcript January 31, 2024

Avery Dennison Corporation beats earnings expectations. Reported EPS is $2.61, expectations were $2.15. AVY isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Ladies and gentlemen, thank you for standing by. During the presentation all participants will be in a listen-only mode. Afterward, we will conduct a question-and-answer session. [Operator Instructions]. Welcome to Avery Dennison’s Earnings Conference Call for the Fourth Quarter and Full Year ended on December 30, 2023. This call is being recorded and will be available for replay from 5:00 p.m. Eastern Time today through midnight Eastern Time, February 6. To access the replay, please dial 800-633-8284 or 1-402-977-9140 for international callers. The conference ID number is 22028081. I’d now like to turn the call over to Mr. John Eble, Avery Dennison’s Vice President of Finance and Investor Relations. Please go ahead, sir.

John Eble: Thank you, Frank. Please note that throughout today’s discussion, we’ll be making references to non-GAAP financial measures. The non-GAAP measures that we use are defined, qualified and reconciled from GAAP on schedules A-4 to A-9 of the financial statements accompanying today’s earnings release. We remind you that we’ll make certain predictive statements that reflect our current views and estimates about our future performance and financial results. These forward-looking statements are made subject to the Safe Harbor statement included in today’s earnings release. On the call today are Deon Stander, President and Chief Executive Officer; and Greg Lovins, Senior Vice President and Chief Financial Officer. I’ll now turn the call over to Deon.

Deon Stander: Thanks, John, and hello, everyone. In the fourth quarter, we again delivered sequential earnings growth, with earnings up significantly compared to prior year and in line with our expectations. We grew volume sequentially and compared to prior year in both segments, significantly expanded margins, generated strong free cash flow and delivered significant growth in Intelligent Labels. Looking at the full year, while market conditions in 2023 turned out to be very different than we anticipated, and we did not deliver on our initial expectations for the full year. I am pleased with how we navigated the challenging environment. We protected margins as the industries we serve experienced significant destocking, improved service for our customers, deepened our insights on the drivers of demand and inventory throughout the value chain, continue to shift our portfolio towards high-value categories as we delivered on our growth opportunities, particularly in Intelligent Labels and generated strong free cash flow, highlighting the strength and resilience of our overall franchise.

During this period, we leveraged our core strengths of productivity, cost management and capital stewardship and increased our potential in Intelligent Label solutions to minimize the impact of the low volume environment on our bottom line. More broadly, we see the reduction of excess inventory throughout the value chain as a good thing. As it positions our industries and business to return to a more normalized growth trajectory in 2024 and demonstrate the growth power of our Intelligent Labels platform in particular. Importantly, the macro uncertainty and volume impacts in 2023 have seen customers increasingly looking for help to solve some of the most complex industry challenges, such as labor efficiency and supply chain effectiveness, waste reduction, circularity and transparency and helping better connect brands and their consumers.

It is clear physical items will need a digital identity to solve these challenges and customers are increasingly turning to Avery Dennison as the leader to help them better connect the physical and digital worlds. Looking forward, a more cautious outlook is prudent particularly in the near term as economic indicators are still mixed and geopolitical risks remain elevated. That said, I’m confident that 2024 will be a year of strong earnings growth. Inventory destocking in our label business is largely complete. Apparel volumes will likely recover in the second half, and we expect significant growth in our high-value solutions, in particular our Intelligent Labels platform as adoption accelerates across new categories and apparel rebounds. Now a brief summary of the year by segment.

Materials group delivered strong margins and volume improved sequentially each quarter as inventory destocking continued to moderate throughout the year. As you can see on Slide 6, label volume in North America and Europe where inventory destocking was most prevalent, continued to improve at a steady pace throughout the year. As I previously indicated, we believe inventory destocking is complete in Europe and now largely complete in North America. In the fourth quarter, volume was better than we had anticipated in Europe and slightly lower than we had anticipated in North America. And demand in these regions continues to be mixed on broad macro uncertainty and slow consumption of goods. As inventory destocking concludes, we expect volume will again improve sequentially in the first quarter, a trend we have seen thus far in January.

Overall, emerging market label volume was up low single digits for the year with increased momentum in the back half, particularly in India and China. Solutions group sales were up low single digits for the year, up high single digits in the second half as strong growth in high-value solutions and the impact of acquisitions more than offset a decline in base solutions. Volume and margin continued to improve throughout the year, particularly in the back half of the year as new programs in intelligent labels ramped, apparel destocking began to moderate. While apparel imports continue to be down significantly both compared to prior year in 2019, the trend in North America started to show signs of improvement in Q4, which can be seen on Slide 6.

Following a relatively mixed holiday season, retailers and brands continue to factor muted sentiment into their near-term sourcing plans. We anticipate this combined with the Suez and Panama Canal shipping issues will likely see apparel industry volumes normalize mid-2024. As you can see on Slide 7, enterprise-wide intelligent labels grew low double digits in 2023, reaching roughly $850 million in revenue, including currency translation. Non-apparel categories, including logistics and food continue to ramp significantly throughout the year and were up roughly 75% for the year. In logistics, the team successfully executed the largest RFID program single wave rollout in the industry’s history, making greater shipping accuracy for our customer possible.

Our execution in these key rollouts in new categories is delivering significant value for our customers and compelling proof points for broader segment adoption. This growth was partially offset by a decline in apparel as retailers and brands reduced inventories throughout the year. As we continue to see adoption in categories like logistics, food and general retail as well as a rebound in apparel, we are targeting to deliver 20% or more growth in our Intelligent Labels platform in 2024, further advancing our leadership position at the intersection of the physical and digital. As I indicated, our ability to help address industry challenges, such as labor efficiency, waste, transparency and consumer connection in very large volume categories like logistics and food is increasingly resonating with customers.

We continue to invest to capture the significant opportunity ahead as we grow the size of the overall industry. We continue to refine our strategies raising the bar for ourselves in the process to ensure we continue to deliver superior value creation for all of our stakeholders. The ability of our teams to drive these strategies over the long haul, while adapting to an ongoing dynamic environment has been exceptional. As you can see on Slide 10, our focus over the long-term is the success of all of our stakeholders. As such, we’re making solid progress towards our long-term sustainability goals and Greg will shortly walk through our progress against our long-term financial objectives. Stepping back, the underlying fundamentals of our business are strong.

We’re exposed to diverse and growing markets with clear catalysts for long-term growth. We are industry leaders in our primary businesses with clear competitive advantages in scale and innovation. We have a clear set of strategies that have been key to our success over the long-term across a wide range of business cycles and we are uniquely positioned to connect the physical and digital to help address some of the most complex problems in the industries we serve. We remain confident that our strategies, along with our team’s ability to execute in any environment will enable us to continue to generate superior value creation through a balance of GDP-plus growth and top quartile returns over the long-term, including delivering strong earnings growth in 2024 as we continue to unlock our significant growth opportunities and our core businesses rebound.

I want to thank our entire team for their continued resilience focus on excellence and commitment to addressing the unique challenges at hand. And with that, I’ll hand the call over to Greg.

Greg Lovins: Thanks, Deon. Hello, everybody. I’ll first provide some additional color on our fourth quarter results and our performance against our long-term targets, then walk you through our 2024 outlook. In the fourth quarter, we delivered adjusted earnings per share of $2.16, in line with our expectations, up sequentially and up 31% compared to prior year, driven by benefits from higher volume and productivity. Compared to prior year, sales were up 3% ex-currency and 1% on an organic basis. As higher volume was partially offset by deflation related price reductions. Adjusted EBITDA margin was strong at 16% in the quarter, up 3 points compared to prior year, with adjusted EBITDA dollars up 29% compared to prior year and also up sequentially.

We generated strong adjusted free cash flow of $218 million in the fourth quarter and nearly $600 million for the full year. With our working capital metrics on target to end the year, resulting in more than 100% adjusted free cash flow conversion. We invested $285 million in fixed capital and information technology in the year, paring back investments in our base given the lower volume environment while continuing to invest in our high-value categories, particularly Intelligent Labels. And our balance sheet remains strong with a net debt to adjusted EBITDA ratio at year-end of 2.4%. We’re continuing to execute our disciplined capital allocation strategy, including strategic acquisitions and continuing to return cash to shareholders. In 2023, we returned nearly $400 million to shareholders through a combination of our growing dividend and share repurchases, and we deployed roughly $225 million for M&A.

Turning to segment results for the fourth quarter. Materials group sales were down 4% ex currency and on an organic basis, driven by low single-digit volume growth, which was more than offset by deflation related price reductions and product mix. Inventory destocking downstream from us continued to moderate. As you can see on Slide 6, label volume in North America and Europe combined, continued to improve, particularly in Europe. Volume also continues to improve through the first four weeks of this year. Looking at label materials, organic volume trends versus prior year in the quarter North America was down slightly more than we anticipated. Given destocking in the fourth quarter at our customers and with retailers and brands managing their year-end working capital.

We believe inventory destocking in North America is now largely complete. Europe was up high single digits as we began to lap the destocking, which started midway through the fourth quarter in 2022. Asia Pacific was up low single digits and Latin America was up low teens following a softer Q3 and up mid-single digits for the second half. Also compared to prior year, graphics and reflective sales were up mid-single digits organically, performance tapes in medical were down low to mid-single digits. Materials group delivered a strong adjusted EBITDA margin of 16.2% in the fourth quarter, up 340 basis points compared to prior year driven by benefits from productivity and the net impact of pricing and raw material input costs. GAAP operating margin was 12% in the quarter, which included an impact from the significant devaluation of the Argentine peso in the latter part of the year.

This impact was adjusted out of our non-GAAP financials. Regarding raw material costs, we saw low single-digit deflation sequentially in the fourth quarter and expect just modest deflation sequentially in the first quarter. As I mentioned in the last couple of quarters, following a period of significant inflation, these lower costs are largely being passed along in price reductions to our customers. Shifting now to Solutions Group. Sales were up 19% ex-currency and 14% on an organic basis, with high-value solutions up more than 20% and base solutions up mid-single digits. Base apparel solutions were up sequentially and roughly comparable to prior year. Intelligent label sales grew more than 30% in the quarter. Non-apparel categories, particularly logistics and food grew significantly, up roughly 110%, as new programs continue to roll out with apparel categories comparable to prior year.

Adjusted EBITDA margin of 18.2% was up 180 basis points sequentially and up 230 basis points compared to prior year, driven primarily by higher volume. Now shifting to our long-term performance. Slide 9 of our supplemental presentation materials provides an update on our progress against the long-term financial targets that we communicated in 2021. And recall that this represents our fourth set of long-term goals after meeting or beating our previous three sets. The consistent execution of our key strategies enables us to continue delivering against our targets with an overriding focus on delivering GDP-plus growth and top quartile return on capital over the long-term. Through the first 3 years of the cycle, sales growth on a constant currency basis was 8% annually, above our target in GDP, driven by higher prices and volume.

We expect strong volume growth in 2024 with some deflation-related price reductions as previously noted. Compared to 2020, adjusted EBITDA dollars have grown roughly 7.5% annually excluding currency translation. Adjusted EBITDA margin was 15.1% in 2023 with the second half of the year at 16%. Looking forward, our guidance for 2024 would indicate a roughly 9% EBITDA CAGR by the end of this year, excluding currency translation. Adjusted EPS grew roughly 5.5% annually over the past 3 years, excluding currency translation, short of our target of 10%, due primarily to the inventory destocking in 2023. With strong earnings growth expected this year, we anticipate making progress against this target in 2024. And as always, our focus will continue to be the optimal balance of growth, margins and capital efficiency to drive incremental EVA over the long-term.

Our return on total capital was 12% in 2023 including higher costs in the year for restructuring charges, legal fees and the impact of the Argentine peso devaluation. We expect our ROTC will be back up in the mid- to high teens in 2024. Given the diversity of our end markets, our strong competitive advantages and resilience as an organization to adjust course when needed, we’re confident in our ability to make strong progress against these targets in 2024. Now shifting to our outlook for 2024. In the first quarter, we expect adjusted earnings per share to be roughly similar to the fourth quarter of 2023. With continued underlying sequential improvement at least partially offset by the seasonality of solutions in both apparel and logistics and the return of some of the temporary cost measures we took in 2023 with incentive compensation as an example.

As 2024 progresses, we expect our earnings will improve sequentially, driven by the normalization of label volume earlier in the year, the normalization of apparel volume mid-year Significant growth in intelligent labels as apparel rebounds and new programs rollout and ongoing productivity actions. For 2024, overall, we anticipate adjusted earnings per share to be in the range of $9 to $9.50, up 17% at the midpoint. We’ve outlined the full year contributing factors on Slide 18 of our supplemental presentation materials. To highlight key drivers of the midpoint of our guidance compared to prior year, we anticipate roughly 3.5% organic sales growth with high single-digit volume growth, partially offset by deflation related price reductions. We estimate overall productivity, including restructuring savings, will offset higher employee costs including wage and benefit increases and higher incentive compensation following lower payouts for 2023.

We expect to make selective strategic growth investments, particularly in high-value solutions and we estimate net non-operational items, tax, interest, currency and share count to be roughly neutral. In summary, we continue to improve our results as we advance our growth initiatives and our markets normalize. We expect a strong rebound in 2024 through a variety of environments and we remain confident in our ability to continue to deliver exceptional value through our strategies for long-term profitable growth and disciplined capital allocation. We will now open up the call for your questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] Our first question comes from Ghansham Panjabi with Robert W. Baird. Please proceed.

Ghansham Panjabi: Just going back to your comments on Europe being a little bit better — could you first of all Deon expand on that? And then, second part of the question is really specific around intelligent labels. You obviously had a very lumpy rollout during the back half of last year, clearly very successful and so on and so forth. And I’m just curious, will there be similarly lumpy sort of customer rollouts in 2024 as well? Or would it be more so a reflection of just the natural uptick of your business there?

Deon Stander: Thanks, Ghansham. Yes, we did see slightly stronger volumes in Q4 in Europe and we continue to see that trend in early January as well. And I think as you recall last time, Ghansham, we said that we thought that destocking had largely ended at the end of Q3. And the growth in Q4, which we’d anticipated has started to come through. I will also make the point, though that European retail volumes are still muted. In fact, they are the decline in the third quarter. And I think it just underlines the broader macro uncertainty out there. But despite that, as we see the inventory destocking ending both in Europe and North America, we anticipate the recovery of that volume specifically in the normalization of our labels business.

Turning to intelligent labels. We saw the growth really in the business in the second half of the year for intelligent labels largely impacted by apparel and the destocking in apparel as well as some muted sentiment around apparel for the whole year. And then you clearly saw the growth we saw in our non-apparel categories, up 75% for the year and accelerating as we went through the back end of the year, particularly over 100% in the fourth quarter, largely on logistics and food. As we look into 2024, we’re still targeting that 20% plus growth rate as we move through this year. And I think three things are going to have to happen in that regard, Ghansham. So one is we’re going to continue to see those new programs that we launched during last year, both in apparel, food, logistics and other categories, annualize as we go through this year.

Those are in-flight and will happen. There is a degree of seasonality that will come, particularly in logistics, which tends to have a higher fourth quarter than first quarter. And then we’ll also continue to see, as Greg indicated, the normalization of our apparel volume during the second half of the year, that will also start to reignite some of the growth we’ve seen typically in apparel. And then, the final piece is there will be new programs that we will continue to launch across all segments, not just apparel, both in logistics, food and apparel. And I’ll give an example of just 1 of those, Ghansham, just to help qualify it, we’re right now involved in food with a bakery trial with a very large U.S. retailer, grocery retailer and we’ve been able to clearly demonstrate that not only can you have an impact on food waste reduction for perishable items, but also significant labor efficiency improvement.

And we’re anticipating that those results will start to lead to broader adoption as we go through the 2024.

Operator: Our next question comes from John McNulty with BMO Capital Markets. Please proceed.

John McNulty: So a question on the material space. So 4Q, you had a nice solid margin lift even with destocking continuing to impact the business at least in North America. I guess how should we be thinking about the potential for margin step up from that level as we look out to 2024?

Greg Lovins: Yes. Thanks, John. As we’ve talked about, when we set our targets, our long-term targets back in 2021, we’re looking to get materials kind of at the level they were in 2020, which is around 17% EBITDA. I think we did a good job in the back half getting above 16% and improving margins despite the destocking with a lot of the productivity actions the team was driving there. So our focus here in ’24 is continuing to make progress towards that 17% EBITDA target, not necessarily suggesting we’ll get that exactly in 2024, but we’ll continue to make progress there and expect to be able to deliver on our long-term target in 2025.

Operator: Our next question comes from Anthony Pettinari with Citigroup Global Markets. Please proceed.

Bryan Burgmeier: This is actually Bryan Burgmeier, sitting in for Anthony. Thanks for taking the question. I appreciate all the detail on the guidance and organic revenue growth guidance. As prices kind of come down, which I think is embedded in your guide consistent with raw material prices. Do you expect labels can maintain positive [Technical Difficulty] cost. So as price comes down, do you think that will kind of match input costs one for one, or do you think there’s a little bit of opportunity for Avery to pick up some margin or do you kind of have to get back a little bit more price? Thanks.

Greg Lovins: Yes. I think as we’ve been talking about over the last few quarters, given just the sheer magnitude of the inflation that we saw in ’21 and ’22. We’ve been largely passing through the deflation we’ve been seeing since, I guess, around the second quarter of 2023 through pricing. So our expectation is right now, we’re seeing a little bit of sequential deflation in Q1, not a lot and we’d have a little bit of price down to go with that. But mostly price year-over-year will be carryover of the impacts from the prior year would be our expectation. Now that will depend on what happens with material costs as we move through the rest of the year. But overall, our view is, given the amount of deflation and the amount of pricing we put through in ’21 and ’22, that we’ll be passing most of that back as we see deflation through pricing.