Core & Main, Inc. (NYSE:CNM) Q3 2023 Earnings Call Transcript

Core & Main, Inc. (NYSE:CNM) Q3 2023 Earnings Call Transcript December 5, 2023

Core & Main, Inc. beats earnings expectations. Reported EPS is $0.73, expectations were $0.68.

Operator: Hello, everyone and welcome to the Core & Main Q3 2023 Earnings Call. My name is Seb and I’ll be the operator for your call today. [Operator Instructions] I will now hand the floor over to Robyn Bradbury, VP, Finance and Investor Relations. Please go ahead.

Robyn Bradbury: Thank you. Good morning, everyone. This is Robyn Bradbury, Vice President of Finance and Investor Relations for Core & Main. We are excited to have you join us this morning for our fiscal 2023 third quarter earnings call. I am joined today by Steve LeClair, our Chief Executive Officer; and Mark Witkowski, our Chief Financial Officer. Steve will lead today’s call with a business update, followed by an overview of our recent acquisitions and long-term value creation targets. Mark will then discuss our third quarter financial results and full year outlook, followed by a Q&A session. We will conclude with Steve’s closing remarks. We issued our fiscal 2023 third quarter earnings press release this morning and posted a presentation to the Investor Relations section of our website.

As a reminder, our press release, presentation and the statements made during this call include forward-looking statements. These statements are subject to risks and uncertainties that could cause actual results to differ from our expectations and projections. Such risks and uncertainties include the factors set forth in our earnings press release and in the filings with the Securities and Exchange Commission. We will also discuss certain non-GAAP financial measures, which we believe are useful in assessing the operating results of our business. A reconciliation of these measures can be found in our earnings press release and in the appendix of our investor presentation. Thank you for your interest in Core & Main. I will now turn the call over to Chief Executive Officer, Steve LeClair.

Steve LeClair: Thanks, Robyn. Good morning, everyone. Thank you for joining us today. If you’re following along with the third quarter investor presentation, I’ll begin on Page 5 with a brief business update. Core & Main delivered another quarter of strong results. Sales in the third quarter were just ahead of the prior year and up 30% from the third quarter of fiscal 2021. Demand from our customers remains resilient, and we continue to execute our organic and inorganic growth initiatives. Municipal repair and replacement activity in the third quarter remained stable on a year-over-year basis. Despite still being below prior year levels, new residential lot development improved sequentially from the second quarter. There continues to be a shortage of existing homes for sale, which is driving a need for new lot development and new home construction.

Many national homebuilders have been reporting resilient results by providing incentives such as interest rate buy-downs to ease affordability challenges and attract prospective buyers, which provides tailwinds for our business. We began to see nonresidential volumes stabilize late in the third quarter due to our balanced exposure across various nonresidential project types. We continue to see good growth in highway and street projects, an increasing trend of mega projects across the country, both of which are included in our nonresidential end market and have offset some of the softness in multifamily and warehouse work. Price contribution to net sales was flat for the quarter when compared to the prior year. Most of our products are either highly specialized or made specific for our sector, which provides a resilient pricing framework for our industry, especially when roughly half of the demand for our products and services is non-discretionary in nature.

Gross margin in the third quarter was 50 basis points lower than last year as inventory costs continue to catch up with the current market prices. And while we expect to see additional gross margin normalization in the fourth quarter, we have confidence in our ability to offset a portion of it through underlying gains from our margin initiatives. Cash generation is a key strength of our business. We have delivered nearly $1.1 billion of operating cash flow over the last 4 quarters. This cash flow has provided us with significant capacity to reinvest in organic growth, pursue strategic M&A and return capital to shareholders. We opened 2 new greenfields in the third quarter, 1 in Spokane, Washington and another in Fontana, California. These new locations extend our product offerings in underpenetrated markets, building on our commitment to make our products and expertise more accessible in every region we serve.

Greenfields are a powerful way for us to expand geographically, and we are well positioned to do so given our scale and talent pool. Each time we had new location, we are adding new sales resources and reducing the average distance and time for us to serve our customers’ orders. This enhances our overall value proposition giving us the opportunity to gain local market share. We have opened 4 greenfields so far this year and will continue to use greenfield as a lever to drive above-market growth in attractive markets going forward. We continue to target attractive M&A opportunities using our disciplined approach, announcing 3 new acquisitions after the quarter. In Virus Cape, Granite Waterworks, and lease supply company. So far this year, we have signed or closed 8 acquisitions with combined annualized net sales of over $330 million.

These acquisitions enhance our product offering and help us achieve a leading position in desirable markets. We are committed to our goal of driving 2% to 4% annual net sales growth from M&A each year over the next several years and I will provide more details on our recent acquisitions shortly. Lastly, on capital deployment, we executed one share repurchase transaction during the quarter and another after the quarter deploying nearly $300 million of capital to retire 10 million shares. We have deployed $770 million of capital so far this year to repurchase and retire 30 million shares in total. Our capital allocation strategy is clear. We expect to continue investing in organic growth and margin enhancement, execute on r robust M&A pipeline, to return excess cash back to shareholders through share repurchases or dividends.

Now turning to Page 6, I’ll provide an overview of our recent acquisitions. And Viruscape is a leading provider of geosynthetics and erosion control products operating out of one location in Ohio. Since 2003, the team at Enviroscape has established in sales as a trusted partner within the geosynthetics market due to their expertise and reputation for first-class service. Their specialty products complement our existing business, and this opportunity provides additional capacity to expand our geosynthetic reach and capabilities. Granite Waterworks is a leading distributor of pipes, valves and fittings and storm drainage products for contractors and municipalities in Central Minnesota. Since 1990, their experienced team has consistently delivered high-quality products and personalized service to the customers from their Wake Park, Minnesota location.

The local relationships and commitment to dependable service that Granite Waterworks will bring to Core & Main will greatly amplify our capabilities and presence throughout Minnesota. Lee Supply is a leading specialty distributor and fabricator of high-density polyethylene pipe and other related services, including HDPE fusion equipment rentals and custom fabrication capabilities. For nearly 70 years, Lee Supply Company has been delivering innovative solutions and providing top-quality products to municipalities, contractors and other environmental and industrial customers. They operate out of 4 locations in Pennsylvania, South Carolina and West Virginia, primarily serving the Eastern United States. Their products and fabrication capabilities significantly enhance our HDPE product offering while providing our customers with additional expertise in fusible pipe applications.

Each of these businesses offer expansion into new geographies, enhance our product lines and add key talent while aligning with our strategy of advancing reliable infrastructure across the U.S. Our pipeline of potential acquisitions remains robust, and we expect to continue adding and integrating businesses to support our growth. Given the fragmented nature of our industry and our modest market share, we have a significant opportunity to continue growing through acquisitions for many years to come. On Page 7, we highlight the value creation story we discussed at our recent Investor Day. Our long-term growth algorithm starts with our end markets. We have diversified end market exposure between municipal, non-residential and residential construction markets nationwide.

We maintain a balanced mix of sales between new development and repair and replacement projects. Each of our end markets have grown in the low single-digit range historically. We expect the fundamental demographic trends and drivers of growth in our markets to continue. We expect multiyear tailwinds in the residential and nonresidential end markets. When coupled with healthy municipal budgets, and the potential for significant federal proceeds. We believe end market volume growth over the long term will be between 2% to 4% per year. We’ve also demonstrated a history of organic above-market volume growth, producing 3 points of market outperformance over the last 5 years. And we believe that our long runway of growth opportunities in underpenetrated geographies and underpenetrated product lines, coupled with our industry-leading capabilities and operational excellence will continue to drive organic above-market growth in the range of 2% to 4% annually.

Our M&A pipeline is robust, we continue to acquire businesses in our highly fragmented markets through bolt-on and complementary acquisitions. We are confident we can continue to drive another 2% to 4% of annual net sales growth from M&A over the next several years. Collectively, our end markets, above-market growth capabilities and M&A strategy resulted in average annual net sales growth ranging from 6% to 12%. In terms of margins, we expect to continue executing on our private label, sourcing optimization and pricing analytics initiatives while leveraging our scale, productivity and operational excellence to drive 30 to 50 basis points of adjusted EBITDA margin expansion annually. We believe that our profitable growth, agile business model, and focus on efficiency will continue to generate strong operating cash flow at a rate of 60% to 70% of adjusted EBITDA, underpinned by a strong balance sheet to provide robust capital deployment.

We are better positioned than any other distributor in our industry to capitalize on these growth levers, and we are excited about the opportunities ahead. As part of our Investor Day event, we released 5-year financial targets and provided additional details on the growth, profitability and cash flow initiatives we have in place to continue operating this business with success while driving shareholder value. I’d like to thank everyone who either attended in person or listen virtually. If you haven’t seen it yet, the replay is posted on the Investor Relations section of our website and I highly encourage you to watch it to get a deeper understanding of what makes our business so special and the opportunities that we have for long-term profitable growth.

With that, I will now turn it over to Mark to discuss our financial results and full year outlook. Go ahead, Mark.

Mark Witkowski: Thanks, Steve, and good morning, everyone. Our third quarter results reflect our operational excellence and the resilience of our business model. We maintain a healthy balance sheet and are prudently deploying capital to the highest return opportunities. We’re leveraging our sustainable competitive advantages and financial position to drive future growth and value creation. I will cover a few topics with you this morning. First, I’ll recap our third quarter earnings, followed by an update on our cash flow and balance sheet highlights. Then I’ll provide our updated financial outlook for fiscal 2023 and a preliminary framework for fiscal 2024. I’ll begin on Page 9 with highlights of our third quarter earnings.

We reported net sales of just over $1.8 billion for the quarter, which was just above the prior year period and consistent with our expectations. Price contribution was flat for the quarter while organic volumes were down low single digits. The cumulative effect of acquisitions over the past year contributed approximately 3 points of growth to net sales. Gross margin of 27% was 50 basis points lower than last year as inventory costs continue to catch up with current market prices. Our local teams have executed very well to sustain our margins by optimizing inventory levels, reacting with discipline to market prices and continuing to drive our gross margin initiatives. Selling, general and administrative expenses increased 4% to $240 million for the third quarter.

The increase in SG&A reflects the impact of acquisitions and cost inflation. Interest expense was $20 million for the third quarter compared with $16 million in the prior year period. The increase was due to higher variable rates on the unhedged portion of our senior term loan. We recorded income tax expense of $39 million for the third quarter compared with $40 million in the prior year period, reflecting effective tax rates of 19.8% and 18.3%, respectively. The increase in effective tax rate was due to a decrease in partnership interests held by non-controlling interest holders. We recorded $158 million of net income in the third quarter compared with $178 million in the prior year period. The decrease was primarily due to lower operating income.

Diluted earnings per share in the third quarter was $0.65, which was in line with the prior year period. Diluted earnings per share decreased due to lower net income, offset by lower share count following the share repurchase transactions executed throughout the year. Adjusted EBITDA decreased approximately 5% to $260 million, and adjusted EBITDA margin decreased 90 basis points to 14.2%. The decrease in adjusted EBITDA was due to the reduction in gross margin and the impact of cost inflation on SG&A. Turning to Page 10, we delivered excellent operating cash flow in the third quarter of $373 million, reflecting over 140% conversion from adjusted EBITDA. We continue to optimize inventory levels now that supply chains have improved. On a year-over-year basis, net inventory was down about $325 million or roughly 28%, even with higher product costs, inventory acquired through acquisitions and new inventory to support greenfields.

We expect strong operating cash flow conversion again in the fourth quarter as we continue to optimize inventory levels and deliver a normal seasonal reduction of working capital. Net debt leverage at the end of the quarter was 1.5x, and our available liquidity stands at more than $1.3 billion, providing ample liquidity to continue investing in growth and returning capital to shareholders. The share repurchases we executed in September and November were done concurrently with public secondary offerings by our largest shareholder. As a result of these transactions, we retired 10 million shares while increasing our public float. As Steve mentioned earlier, we have deployed $770 million of capital for share repurchases so far this year, and we’ll continue to evaluate share repurchases as opportunities arise.

Before we head to Q&A, I’d like to update you on our outlook for the remainder of fiscal 2023 on Page 11 and provide a preview of our views on fiscal 2024. Our sales results through the third quarter have largely played out as expected. Looking ahead, we expect normal seasonal volume trends in the fourth quarter, which tend to be impacted by colder weather and shorter daylight hours. Municipal repair and replacement activity in the fourth quarter is expected to remain stable on a year-over-year basis. We expect new residential lab development growth to improve sequentially and benefit from easier year-over-year comparisons. Furthermore, we expect nonresidential volumes in the fourth quarter to be flat to slightly down on a year-over-year basis, similar to what we experienced in the third quarter.

Price contribution to net sales growth was flat in the third quarter, and we expect it to be roughly flat again in the fourth quarter, resulting in low single-digit price contribution for the full year. We expect additional gross margin normalization in the fourth quarter as we cycle through the rest of our low-cost inventory. However, we now expect full year gross margins to be better than previously anticipated due to strong performance across our margin initiatives and synergies from M&A. Taken all together, we are narrowing our expectation for fiscal 2023 net sales to be in the range of $6.65 billion to $6.75 billion. We’re raising our expectation for adjusted EBITDA to be in the range of $890 million to $910 million due to our margin performance in the third quarter as well as confidence in our ability to better sustain margins through the end of the year.

We are also raising our expectation for operating cash flow conversion to be in the range of 110% to 115% of adjusted EBITDA and due to our disciplined inventory optimization efforts. As we look beyond this year, we plan to provide our full year outlook for fiscal 2024 during next quarter’s earnings call. However, as we sit here today, we generally expect end market volumes to be roughly flat to up low single digits depending on the broader economic conditions, including the effects of interest rate movements and progress on the federal infrastructure proceeds. We remain committed to our market outperformance driven by our organic and inorganic growth strategies. From a margin perspective, we anticipate further margin normalization that wasn’t fully realized this year to impact our results in the first half of fiscal 2024, while we continue to drive our margin initiatives to offset these impacts.

Our focus will continue to be on the areas within our control, including customer service, technical expertise, productivity and pricing execution. We will continue deploying capital and initiatives that will result in accelerated growth including executing on our M&A pipeline and delivering on our organic growth strategies. We will maintain significant liquidity and expect to continue driving shareholder value through share repurchases or dividends. We are well positioned to outperform the market in this complex demand environment, creating value for all our stakeholders. We look forward to helping our customers build more reliable infrastructure as we close out fiscal 2023. At this time, I’d like to open it up for questions.

Operator: Thank you. [Operator Instructions] Our first question today comes from Joe Ahlersmeyer from Deutsche Bank. Please go ahead.

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Q&A Session

Joe Ahlersmeyer: Yes. Thanks very much for taking my question and congrats on the strong results.

Steve LeClair: Thanks, Joe. Thanks for the question. Yes. We can hear you, now. Thanks.

Joe Ahlersmeyer: Hey, sure. Okay, great. Yes. Thanks a lot for the early insights into next year’s volumes flat to have low singles. That’s pretty good. I’m interested in just kind of getting into what the different thoughts are around the end markets, maybe at the low end of that and at the high end of that, kind of what you see R&R on resin and new res doing next year?

Mark Witkowski: Yes. Sure, Joe. Thanks for that question. And yes, we did – for 2024, we think overall, the end markets or this – at least at this point, looking to be kind of flat to low single digit. And as we talked about, our municipal base, which is roughly 40% or so of the business, we believe, is going to continue to be very stable going into next year in that kind of low single-digit range. We’re coming off a really weak residential year, as we’ve talked about on prior quarter’s calls. So we do expect some growth coming out of resi. Now that does assume that we do see mortgage rates in an environment where maybe those come down a little bit. Here is the Fed stabilizes some of the rate movements that they have been looking at. And then from a non-residential exposure, like we talked about, that’s a very broad exposure for us. And while there is different pockets within there, we believe that’s going to be flattish as we go into 2024.

Joe Ahlersmeyer: Understood. Thanks a lot for those detail. And then just thinking about the share repurchase commentary. I’m wondering, a year where going forward, M&A activity may be below your annual target in any given year, would you be sort of more programmatic about letting that excess capital flow to repurchases? Just kind of thinking about your philosophy around letting cash build and letting leverage come down.

Mark Witkowski: Yes, Joe, the way we’re thinking about capital deployment right now is, as you’ve seen, we’ve really generated some really strong cash flow here throughout 2023, expect 2024 and beyond to be really strong cash flow generation years for us. And with our current debt leverage at about 1.5x. So I believe that provides us ample capital to be able to deploy not only to M&A, which heard Steve talk about the healthy pipeline that we have, but also give us that opportunity to be opportunistic with share repurchases as opportunities arise there. And then beyond that, potentially being able to do dividends at some point in the future. So we’re going to look to do all those things to return capital to shareholders. We think those are all attractive opportunities for us, and we will continue to look at it that way.

Joe Ahlersmeyer: Alright. Thanks for all the detail. Goodluck in fourth quarter.

Steve LeClair: Yes. Thanks, Joe.

Operator: Our next question is from David Manthey from Baird. Please go ahead. Hello, David, your line is now open. Could please check and unmute. Unfortunately, we are not able to hear anything from David’s line. So we will move on to the next question. The next question comes from Kathryn Thompson at Thompson Research Group. Kathryn, please go ahead.

Kathryn Thompson: Hi, thank you for taking my question today. So looking forward into next year and thinking tagging on the question on M&A. First, could you give a little bit more color in terms of how the appetite may have changed for targets as you go into next year? What’s the difference? And how do you feel about M&A environment next year? And then have your priorities changed in terms of types of end markets given the changing landscape for mega projects? Thank you.

Steve LeClair: Hi, thanks, Kathryn. Yes, as we look at certainly the existing pipeline that we had and that we’ve executed on this year and what we’ve got in store as we look through in the future here, we really haven’t seen much of a change at all and what our appetite is. We continue to see great businesses out there across a broad spectrum, whether they are simple bolt-ons or getting us access to new products and new categories for us. So I think we will continue to build on that. And so we don’t really see a change in that in our appetite for that. And then – I’m sorry, can you give me your second part of that question again?

Kathryn Thompson: And it’s really how has the appetite changed? Or have there been any changes in terms of your targets in terms of being more or less open to M&A?

Steve LeClair: Yes. I would say that business environment – yes, the business environment, many of the sellers have operated in and many of our competitors have operating have been pretty challenging. So I would say we’re starting to see that break loose a little bit more. And certainly, if you look at the volume of deals that we’ve done this year, we think that’s pretty indicative of what we see in the pipeline ahead. We’ve been – if you look back over the last several years, it looks pretty consistent in terms of the amount of volume we’ve been able to do accretively to each year in that 2% to 4%. We’re certainly in the high end of at this point. And I think we continue to see that going into certainly ‘24 and beyond.

Kathryn Thompson: Okay. And then finally, we’re getting from – just based on our industry context, getting a wide range of feedback in terms of – on the non-res, in terms of cancellations or pushing out of projects. But in general, on your lighter non-res you are seeing some pushout or cancellations, but for large or not. What are you seeing in terms of project delays and/or cancellations in the more in the traditional non-res end market? Thank you.