RPM International Inc. (NYSE:RPM) Q2 2023 Earnings Call Transcript

RPM International Inc. (NYSE:RPM) Q2 2023 Earnings Call Transcript January 5, 2023

RPM International Inc. reports earnings inline with expectations. Reported EPS is $1.1 EPS, expectations were $1.1.

Operator: Good morning. And welcome to the RPM International’s Fiscal 2023 Second Quarter Earnings Conference Call. All participants will be in a listen-only mode. After today’s presentation, there will be an opportunity to ask questions and please note that this event is being recorded. I would now like to turn the conference over to Matt Schlarb, Senior Director of Investor Relations. Please go ahead.

Matt Schlarb: Thank you, Cole. And welcome to RPM International’s conference call for the fiscal 2023 second quarter. Today’s call is being recorded. Joining today’s call are Frank Sullivan, RPM’s Chairman and CEO; Rusty Gordon, Vice President and Chief Financial Officer; and Mike Laroche, Vice President, Controller and Chief Accounting Officer. This call is also being webcast and can be accessed live or replayed on the RPM website at www.rpminc.com. Comments made on this call may include forward-looking statements based on current expectations that involve risks and uncertainties, which could cause actual results to be materially different. For more information on these risks and uncertainties, please visit RPM’s reports filed with the SEC.

During this conference call, references may be made to non-GAAP financial measures. To assist you in understanding these non-GAAP terms, RPM has posted reconciliations to the most directly comparable GAAP financial measures on the RPM website. Also, please note that our comments will be on an as adjusted basis and all comparisons are to the second quarter of fiscal 2022 unless otherwise indicated. We have provided a supplemental slide presentation to support our comments on this call. It can be accessed in the Presentations and Webcasts section of the RPM website at www.rpminc.com. At this time, I would like to turn the call over to Frank.

Frank Sullivan: Thanks, Matt. I will begin today’s call by sharing commentary on our consolidated performance for the second quarter, Mike will provide details on our financial results and then I will turn the call back over to Matt to provide some business updates, and then, finally, Rusty Gordon will conclude our prepared remarks with our outlook for Q3. After our prepared remarks, we will be pleased to answer your questions. In the second quarter, we continued to build on recent momentum to deliver both record second quarter sales and adjusted EBIT. This represents the 10th consecutive quarter of record revenue and four consecutive quarters of record adjusted EBIT, an impressive accomplishment in today’s uncertain economic and volatile climate.

An important factor in achieving these results is our MAP 2025 Operating Improvement Program. Across RPM, associates have embraced MAP 2025 principles of collaboration and efficiency to successfully implement initiatives and help drive top and bottomline growth and performance. MAP 2025, which officially began at the beginning of this fiscal year is off to a strong start and we are on track to meet or exceed our first year EBIT target improvement of $120 million from MAP initiatives. This hard work was evident in our second quarter results where we achieved strong revenue growth, as well as significant adjusted EBIT margin improvement. Importantly, we achieved these positive results despite meaningful macroeconomic headwinds, including intensifying weakness in Europe, FX headwinds and a slowdown in some of our end markets.

Turning to the next slide. Revenue growth was broad based with all four of our segments achieving record second quarter sales. This was accomplished primarily through the implementation of pricing increases in response to continued inflation. We also generated volume growth in several of our businesses that benefited from continued reshoring and infrastructure spending, as well as from improved material availability. Importantly, we not only generated strong sales growth but also expanded margins to achieve record second quarter adjusted EBIT on a consolidated basis at three of our four segments. This was driven by the successful execution of margin enhancement initiatives across the organization. The one outlier segment that did not achieve record second quarter adjusted EBIT was the Construction Products Group, which was most acutely impacted by macroeconomic headwinds, because of its relatively outsized exposure to Europe and to new residential home construction in North America.

Looking at sales by geography on the next slide, Europe is clearly the laggard among the regions we serve with sales down nearly 12% for RPM and unit volume down even at a greater rate. This was driven by weak macroeconomic conditions, including persistently high inflation, additionally FX weighed heavily on our results in Europe. FX translation also negatively impacted our sales in emerging markets, so we still achieved healthy growth in these regions. Thanks to the hard work of our associates to align our businesses and products with growing end markets, and to successfully increase prices in response to cost inflation. Demand in North America remained strong through the second quarter with growth in all of our segments, growth in the region was fueled by price increases in response to continued inflation and strengthen our businesses to serve customers who are reshoring manufacturing to the U.S. and it serve infrastructure-related activities.

Better material availability also contributed to organic growth in a number of our businesses in the quarter. I will now turn the call over to Mike Laroche to discuss our consolidated and segment financial results in more detail.

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Mike Laroche: Thanks, Frank. Sales increased 13.4% excluding FX, which was at 4.1% headwind. The result was a 9.3% increase in reported sales to a second quarter record of $1.79 billion, compared to $1.64 billion in the prior year period. Organic sales growth was 12.4% or $204.1 million and acquisitions contributed 1% to sales or $15.7 million. As mentioned, FX decreased sales by 4.1% or $67.6 million. Our consolidated adjusted EBIT increased 36.4% to a second quarter record of $214.7 million, compared to $157.3 million reported in the prior year period. Second quarter adjusted EBIT margins expanded 240 basis points compared to the prior year period. We achieved this expansion despite significant foreign currency translation headwinds and continued cost inflation.

Adjusted diluted earnings per share were a second quarter record at $1.10, representing an increase of 39.2%, compared to the $0.79 in the prior year period. Turning to the next slide. Our Construction Products Group generated second quarter record net sales of $634.1 million, an increase of 3.2% compared to the prior year period. Organic sales growth was 6.9%, with acquisitions contributing 1.5% and foreign currency translation reducing sales by 5.2%. Sales growth was driven by the restoration times for commercial roofing, facades and parking structures. Admixtures and repair products for concrete continued to gain share during the quarter. Price management in response to continued cost inflation also contributed to CPG’s revenue growth. Partially offsetting this growth, demand was weak in Europe and new residential home construction, both areas where CPG has a higher exposure than the RPM average.

Demand in these two areas was particularly weak at the end of the second quarter. These headwinds, along with the negative impact from FX, unfavorable mix and reduced fixed cost leverage at plants, including the Corsicana, Texas facility that was acquired in fiscal 2022 2nd quarter, resulted in adjusted EBIT declining 12% to $80.4 million. As a reminder, unadjusted EBIT declined 40% in the quarter versus the prior year period. That was primarily due to a $41.9 million gain from the sale of real estate assets in Q2 2022 that did not recur this quarter. This gain was excluded from adjusted EBIT in Q2 2022. As you can see on the next slide, the Performance Coatings Group achieved record fiscal second quarter net sales with revenue of $335.2 million, an increase of 10.8% compared to the second quarter of fiscal 2022.

Organic sales increased 15.4%, acquisitions added 0.6% and foreign currency translation was a 5.2% headwind. Flooring Systems, Protective Coatings and FRP grading, all generated double-digit revenue growth. Manufacturing customers fueled the increase, including demand for those who are reshoring their production to the U.S. such as pharmaceuticals, food and beverage, EV manufacturing and electronics companies. Good demand in energy markets and price increases in response to continued inflation also contributed to the growth. Adjusted EBIT increased 16.6% to a second quarter record of $46.2 million. The growth was driven by positive volumes and price increases. Partially offsetting these positive factors, foreign exchange translation was a headwind to adjusted EBIT.

Turning to the next slide. The Specialty Products Group reported record second quarter sales of $212.1 million, an increase of 9.5% compared to the prior year period. Organic sales increased 11.5%, acquisitions added 0.9% and foreign currency translation was a headwind of 2.9%. Second quarter sales were led by strength in the food coating and the additives business as a result of strategically refocusing sales management and selling efforts. In the disaster restoration business, the response of Hurricane Ian contributed to strong sales growth and its ability to quickly meet increasing demand was aided by prior operational improvement investments. Price increases in response to continued inflation also contributed to the sales growth. SPG generated record second quarter adjusted EBIT of $30 million or an increase of 43.2%, compared to adjusted EBIT of $20.9 million in the prior year period.

The increase was driven by strong sales growth and benefits from MAP 2025 initiatives. Moving to the following slide. The Consumer Group grew sales 15.3% to $610.4 million, which is a record for the second quarter. Organic sales increased 17.5%, acquisitions contributed 0.4% and foreign currency translation was a headwind of 2.6%. The Consumer Group sales growth was driven by price increases to catch up with continued cost inflation and strong sales growth in North America. Adjusted EBIT increased 180.3% in the fiscal 2023 second quarter to $94.2 million, which was a second quarter record. Successful implementation of MAP 2025 initiatives, many of which were enabled by improved material supply, as well as strong sales growth were key drivers to the increase in profitability.

As a reminder, the Consumer Group experienced extraordinarily low profitability in Q2 2022 as a result of an explosion at an alkyd resin suppliers plant that caused severe supply disruptions and from high material cost inflation that was not offset by commensurate price increases. This contributed to the strong second quarter of 2023 year-over-year growth. Now I’d like to turn the call over to Matt to discuss capital allocation.

Matt Schlarb: Thanks, Mike. During the second quarter of fiscal 2023, we paid cash dividends of $54.2 million or $1.68 per share on an annualized basis. On a per share basis, this represents an increase of 5% compared to fiscal 2022 and is the 49th consecutive year we have raised our dividend. Over the course of these 49 years, our strategically balanced business model has given us the ability to continually generate steadily improving cash flows and return over $3.1 billion to shareholders via dividends during this period. With regard to investments in working capital, for several quarters we have talked about increases in working capital driven by higher raw material inventories that were designed to improve supply chain resiliency.

As material availability has significantly improved, we have begun normalizing our purchases of raw materials in Q2 2023 and we expect these actions to contribute to improved working capital levels in Q3 2023. On the topic of M&A, we have completed six acquisitions so far in fiscal year 2023. These have been small deals and we have remained disciplined as multiples from any potential targets have been elevated above historical levels. With the recent rise in interest rates and changes in economic forecasts, multiples appear to be normalizing and we have a strong pipeline of potential acquisition targets. We expect to continue to be active in M&A and have the financial flexibility to do so, but we will retain our disciplined approach to valuations with a sharp focus on value creation.

Looking ahead, while long-term visibility remains limited, we expect economic headwinds to persist in the fiscal third quarter of 2023. Although we are not immune to economic challenges, the balanced portfolio of businesses I just referred to has historically helped us navigate economic slowdowns. Our varied businesses tend to perform differently throughout the economic cycle, which helps reduce the volatility of our results and insulate us from downturns. Additionally, several of our businesses are positioned to continue to benefit from positive reshoring and infrastructure spending trends, which we expect to continue in the future. We have also positioned our businesses to primarily focus on maintenance and restoration markets, which tend to be less economically sensitive than new construction or OEM demand.

As you can see from slide 12, approximately two-thirds of our revenue is generated by demand for maintenance and restoration products and services. The reason maintenance and restoration demand tends to outperform new construction during times of economic slowdowns is demonstrated by the example on slide 13. When compared to buying or building new, our products offer a compelling value proposition during periods when budgets are in sharper focus. This is true not only for Consumers but also commercial and industrial customers as well. As an example, within our Consumer segment, Rust-Oleum offers a suite of complementary and easy-to-use products that owners can utilize to renovate their bathrooms at a fraction of the cost of a typical bathroom remodel.

Rust-Oleum also offers products to renovate other areas of the house, including kitchens, garages and furniture. With that, I’d like to turn the call over to Rusty to cover our guidance and outlook.

Rusty Gordon: Thanks, Matt. As Matt mentioned, we expect the headwinds that we have recently experienced to continue in the third quarter of fiscal 2023. These include slowing overall economic activity, rising interest rates, reducing construction activity and negatively impacting existing home sales, which have declined for 10 consecutive months. The bull up effect as some customers temporarily moderating purchases to normalize inventory levels as material availability has improved, a strong U.S. dollar compared to the third quarter of fiscal 2022, and lastly, continued year-over-year cost inflation. Through a combination of these headwinds, results in November and December have been meaningfully below the prior months in fiscal year 2023.

At this point, it is too early to determine how much of the recent slowdown is due to weakening economic conditions versus the short-term impact of inventory normalization. Customer feedback on the reduced demand has been mixed as has recent economic data. Taking all these factors into account, we anticipate third quarter fiscal 2023 consolidated sales will increase in the low single-digit to mid single-digit percentage range compared to the prior year record results. By segment, we expect PCG to be the leader with sales up in the high single-digit to low double-digit range compared to the prior year record results. The strength is being driven by growth in businesses serving manufacturers who are reshoring their production to the U.S., including strength in energy-related markets.

Additionally, PCG is expected to benefit from CS 168 initiatives, which are part of our MAP 2025 Commercial Excellence Program. Consumer sales are expected to increase in the mid single-digit range compared to prior year record results, led by pricing increases in response to year-over-year inflation Additionally, now that our material availability has increased, we have begun implementing new marketing and advertising initiatives, which we expect to benefit growth in the coming quarters. Partially offsetting this growth, we expect that the low levels of housing turnover will have a negative impact on Consumer volumes. SBG sales are expected to be flat to prior year record results. Here strength in food coatings and additives, and disaster restoration equipment in response to recent winter storms is expected to be offset by volume declines at businesses serving OEM customers, which are more economically sensitive.

As an example, some OEM customers have extended shutdowns of their facilities above and beyond the usual holiday timeframe for the first time in several years. We anticipate that CPG sales will decline in the low single-digit to mid single-digit range compared to the prior year record period as it continues to be weighed down by a weak European economy and softening construction activity. With the softening macro environment, we are reducing production at some of our plants to be better balanced with expected demand. As a result, we expect to reduce inventories, which have been temporarily elevated to navigate supply chain challenges and positively impact our cash flows. We also expect that these actions will lead to lower fixed cost absorption and be a headwind to earnings.

Taking all this into account, we anticipate that third quarter fiscal 2023 adjusted EBIT will be in the range of $75 million to $85 million, compared to the prior year record amount of $80.6 million. Included in this guidance are the expectations for year-over-year headwinds from FX and cost inflation. This concludes our prepared comments. We will now be pleased to answer your questions.

Q&A Session

Operator: And our first question today will come from John McNulty with BMO Capital Markets. Please go ahead.

Frank Sullivan: Good morning, John.

John McNulty: Yeah. Good morning, Frank. Thanks for taking my question. So I guess the first one would just be on the raw material environment. It looks like a lot of base chemicals coatings raw materials, construction raw materials as it started to slide. I guess can you speak to what you are seeing in the raws that you are buying today and how much they may be coming off? And then, I guess, tied to that, is it fair to assume that you don’t have that in the 3Q guide just, because of your FIFO accounting and it probably doesn’t impact you yet, you probably get the benefit more in the May quarter, I guess, how should we be thinking about that?

Frank Sullivan: Yeah. I think that’s correct. So in the second quarter year-over-year inflation was up about 17%. It was down sequentially in the quarter about 3%. We are experiencing better recovery on the spot market as you are suggesting today, but because of FIFO accounting, that’s not going to show up until the end of the fourth quarter or into the first quarter of next year. I can give you a couple of data points. Again, we are seeing sequential improvements, but there’s still some significant areas of inflation year-over-year, metal packaging is up 59% in the quarter, alkyd resin were up 30% in the quarter versus the prior year. But we are in the marketplace starting to see sequential improvements.

John McNulty: Got it. Got it. Fair enough. And then I guess on the destocking side, I guess, can you help us to think about, it sounds like there’s a little bit of confusion out there and even your customers aren’t necessarily sure how much of its destocking versus actual demand. I guess, can you give us a little bit more color as to which channels may be seeing kind of the heaviest level of destocking and the negative impact of that and where things maybe are kind of running more hand to mouth and more kind of in line with demand, I guess, how should we be thinking about that?

Frank Sullivan: Sure and it’s a great question. Historically, when we would talk about destocking or any of our peer competitors or companies that deal in Consumer markets, it tended to be understood as a reference to inventory adjustments by major retailers, big box consumers discount. In this case, it’s really inventory adjustments across the whole supply chain. So with many of our customers in industrial markets, we are in a similar fashion. Supply chains were so broken, you saw people buying what they could get. While our inventory is higher than it should be, in the quarter, we have seen a meaningful improvement from higher than usual raw materials to finished goods, which is the proper step of a cash conversion cycle. And so across our customer base, you are seeing people take actions to readjust inventory levels from kind of the extraordinary actions people had to take over the last year and a half or two years in light of supply chain disruptions.

So, specifically, in the third quarter, Rusty referenced the Specialty Products Group and we have seen for the first time for the last couple of years some of our OEM customers did not take their usual shutdowns during the Christmas to New Year’s timeframe. In this case, they have, and some are extending it into January and part of this is inventory level adjustments as opposed to necessarily recessionary moves. So there’s some volatility there that’s going to play out with more certainty in the next couple of months.