CCL Industries Inc. (OTCPK:CCDBF) Q3 2022 Earnings Conference Call November 10, 2022 8:30 AM ET
Company Participants
Geoff Martin – President and Chief Executive Officer
Sean Washchuk – Senior Vice President and Chief Financial Officer
Conference Call Participants
Mark Neville – Scotiabank
Stephen MacLeod – BMO Capital Markets
Ahmed Abdullah – National Bank of Canada
David McFadgen – Cormark Securities
Daryl Young – TD Securities
Michael Glen – Raymond James
Ben Jekic – PI Financial
Operator
Good morning, ladies and gentlemen. 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.
Sean Washchuk
Good morning. Thanks, Tom. Thank you everyone for joining us on our third quarter earnings release. Geoff and I are here in Brea, California, our Avery headquarters today.
And we can turn everyone’s attention to Slide 2, our disclaimer regarding forward-looking information. I will remind everyone that our businesses face known and unknown risks and opportunities. For further details of these key risks, please take a look at our 2021 annual MD&A under the section Risks and Uncertainties. And you can also see in an update in our third quarter report to those risks and uncertainties. Our annual and quarterly reports can be found online at the company’s website, cclind.com or on sedar.com.
Moving to Slide 3, our summary of financial results for the third quarter and 9 months. For the third quarter of 2022, sales increased 11.4%, with organic growth of 8.8%, acquisition-related growth of 4.9%, partially offset by a 2.3% negative impact from foreign currency translation, resulting in sales of $1.66 billion compared to $1.49 billion in the third quarter of 2021. Operating income was $246.8 million for the 2022 third quarter compared to $223.9 million for the third quarter of 2021, an 11.6% increase, excluding the impact of foreign currency translation. Geoff will expand on our segmented operating results of our CCL, Avery, Checkpoint and Innovia segments momentarily.
Corporate expenses were up for the quarter, principally due to a higher expense for long-term variable compensation versus the prior year quarter. Consolidated EBITDA for the 2022 third quarter, excluding the impact of foreign currency translation, increased 7.9% compared to the same period in 2021. Net finance expense was $17.1 million for the third quarter of 2022 compared to $14.2 million in the 2021 third quarter due to an increase in total debt outstanding and an increase in variable interest rates on our revolving debt.
The overall effective tax rate was 22.9% for the 2022 third quarter compared to an effective tax rate of 24.1% recorded in the third quarter of 2021, primarily reflecting a higher portion of our taxable income earned in lower tax jurisdictions. 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 2022 third quarter were $163.9 million, up 8%, excluding foreign currency translation compared to the 2021 third quarter. For the 9-month period, sales increased 15%, operating income increased 7%, excluding a $3.5 million non-cash acquisition accounting adjustment to fair value the inventory from our Adelbras acquisition and net earnings increased 7% compared to the 9-month period of 2021. 2022 included results from 12 acquisitions completed since January 1, 2021, delivering acquisition-related sales growth for the period of 4.8%, organic sales growth of 10.1% and a foreign currency translation headwind of 1.9%.
Moving to the next slide on Page 4, basic earnings per Class B share were $0.93 for the third quarter of 2022 compared to $0.85 for the third quarter of 2021. Adjusted basic earnings per Class B share were $0.95, for the 2022 third quarter, a quarterly record compared to adjusted basic earnings per Class B share of $0.85 for the third quarter of 2021. The change in adjusted basic EPS to $0.95 is primarily attributable to $0.12 advance in operating income; $0.01 equity contribution from our joint ventures, $0.02 from a lower tax rate, partially offset by a $0.01 negative foreign currency translation, $0.01 from increased finance costs and an additional $0.03 from increased corporate costs.
Moving to Page 5, free cash flow from operations. For the third quarter of 2022, free cash flow from operations was $148.7 million compared to $152.4 million in the 2021 third quarter. The slight decline in cash flow from operations of $3.7 million is attributable to an increase in capital expenditures, almost entirely offset by increased proceeds on disposal and improved cash flow by operating activities. For the 12 months ended September 30, 2022, free cash flow from operations decreased approximately $91 million compared to the 12 months ended September 30, 2021. This comparative decline is primarily attributable to an increase in net capital spending.
Moving to Page 6, returns to shareholders. During the first 9 months of 2022, the company repurchased almost 3.4 million shares at an average price of $58.95, for total proceeds of $200 million. Including the 14.3% increase in our 2022 annual dividend announced in February of this year, dividends year-to-date have amounted to $128 million, representing a healthy 26.3% dividend payout ratio.
Moving to Slide 7, our cash and debt summary. Net debt as at September 30, 2022, was $1.78 billion, an increase of $529 million compared to December 31, 2021. This increase is principally a result of new borrowings to finance the company’s acquisitions during the first 9 months of this year and the repurchase of shares under our normal course issuer bid. Although the company’s net debt increased, the balance sheet closed the quarter in a strong position.
Our balance sheet leverage ratio was 1.46x, increasing from 1.06x at the end of December 2021. Liquidity was robust with almost $700 million of cash on hand, $0.8 billion of available undrawn credit capacity on our revolving bank facility. The company’s overall average finance rate was largely unchanged at approximately 2.67% at September 30, 2022, compared to 2.42% at December 30, 2021, reflecting an increase in variable interest rate on our outstanding borrowings under our revolving credit facility. The company’s balance sheet continues to be well positioned to finish the year. Geoff, over to you.
Geoff Martin
Thank you, Sean and good morning everybody. I am on Slide 8, highlights of our capital spending for the year, $288 million so far, net of disposals. We are forecasting to spend in the range of $380 million to $390 million for the year 2022.
Turning to Slide 9, highlights of the CCL segment this quarter, 13.2% organic sales growth, only partly price-led, probably the majority of that 13.2 million came from price, but there was some volume increase, too, North America and Asia-Pacific, up high single-digit, Europe up double-digit and Latin America up more than 40%. We had a strong quarter in the Personal Health Care and Food and Beverage businesses. It was pretty good at CCL Secure compared to a slow period in 2021. CCL Design was also up on recovery in automotive production volume, but that was offset by a modest decline in electronics and the slowing computer industry.
Slide 10, the joint ventures, we have had a very good quarter, net earnings up considerably, so a share of that was a very nice addition to the income stream for the quarter.
Turning to Slide 11, highlights for Avery. We saw some softness here, which came as a little bit of a surprise, but we did worry about it going into the quarter. The back-to-school season started much earlier in Q2 this year than it’s ever done due to retailers taking caution with their inventory positions with the supply chain disruption. But that same caution also affected us at the back end of the season when normal replenishment orders, which we’ve typically had in unaffected years in the pandemic going back to 2019, just didn’t happen. And many retailers earned the season early. We also saw some destocking in some of the channels, distribution channels where we sell our high-margin printable media products. Offsetting that, we had strong gains in our direct-to-consumer channels. Horticultural acquisitions was soft and slower demand, but the tapes acquisition in Brazil met our expectations. Raw materials availability, especially paper and metal rings held the sales growth somewhat.
Slide 12, Checkpoint. A solid quarter here in the MES business, we had a good period in the Americas, but that was offset by declines in Europe and Asia. Profits were down on lower volumes, unit volumes of our MAS business and our Asian supply plants. But that was offset by good results in the apparel labeling segment again on double-digit organic growth in RFID and acquisitions in that space also contributed. We did have an $11.9 million gain on excess real estate in China, which drove most of the profitability improvement you see on this slide.
Slide 13, Innovia. The volume situation was up in the Americas but down in Europe and all the down in Europe was all in our plant in Poland, where we moved an old film line that made packaging films and replaced it with the EcoFloat line, which is a strategic long-term investment. We did have some cost for that. But by far, the majority of the problem in the quarter was really the unprecedented summer energy cost spike in Europe and freight inflation. So that was really responsible for all the profit decline for the quarter in Europe. In the Americas, we were affected by the margin squeeze from higher-cost inventories as resin indices declined, reducing our selling prices, the reverse effect of what we experienced in 2021.
Outlook for the coming quarter, the core CCL business unit orders picture still remains solid. In the CCL design space, we see improving automotive output that’s likely to be offset by slower conditions in the technology space. Comps on CCL Secure were much easier in the second half of the year than they were second half of last year, but are harder in Q4 than they were in Q3. At Avery, direct-to-consumer strength remains augmented by recent acquisitions, but the distributor destocking in the core business remains potentially an offset, although we did see some improvement in that in the month of October.
Checkpoint, strong RFID growth of ALS may not be offset this quarter by apparel destocking. So we’re a bit slightly worried about the apparel supply chain and softer MAS picture in broad retail. We do expect another challenging quarter in Innovia for the same reasons we’ve just been through, but we did see some improvement again in October on the better situation with the energy markets in Europe. We have a slight modest FX headwind to contend with in the coming quarter.
So with that, operator, we would like to open up the call for questions.
Question-and-Answer Session
Operator
[Operator Instructions] And the first question this morning is coming from Mark Neville from Scotiabank. Mark, your line is live. Please go ahead.
Mark Neville
Hey. Good morning Geoff. Good morning Sean. If I can start with Innovia, Geoff. I guess two part question. First, I am just curious how much inventory you typically keep in this business in the U.S.? And second part, the surcharges that you put in place in Europe effectively is market-to-market on energy prices?
Geoff Martin
Yes. So, the reason we get the squeeze on the margins, which I think is the underlying of your question. Our pass-through of what happens on the indexes is immediate. So, if the index goes up or down, we have an immediate pass-through and that benefits us in a rising resin market because we have lower cost inventory in the system, and we get the reverse impact in a declining market. And that cost us a few million bucks this quarter and mainly in the Americas where the resin declines have been higher. What was the second part of your question?
Mark Neville
Some of the surcharges that you put in place in Europe, did that sort of get you up to where you wanted to be?
Geoff Martin
We didn’t get any real benefit for that. We did put them in place as soon as the energy market spiked. It was very sudden and very quick, as I am sure you all know. So, we did see some benefit from that in the month of October. So, we had a much better October than any of the months we had in Q3, largely as a result of the energy surcharges we put in place.
Mark Neville
Okay. And maybe just given all the volatility in commodity inputs, I mean should we be thinking – is it better to think about sort of profit dollars as a profit percentage for this business?
Geoff Martin
Yes. Well, it’s a pass-through industry. So, we get swings in the revenue line driven by pass-through. So, your point is not – it’s quite valid, Mark. Yes, the answer.
Mark Neville
Okay. And maybe on Avery, it feels like there is quite a few moving parts, primarily on the margin, is that – would that be sort of the mix in the lower direct-to-consumer?
Geoff Martin
No, the big impact has really been the destocking – on the margin side within the destocking in the printable media business. So, we had a couple of our larger – very large distributors destocked in the quarter. We have seen some reversal of that in the month of October, but it’s a high-margin business. So, when that happens, and that’s where the impact really comes.
Mark Neville
Okay. Just ask more broadly, Geoff. Obviously, you guys touch a lot of geographies, touch a lot of markets. When I listen to your commentary, it still sounds reasonably constructive with obviously, a touch of conservatism or uncertainty. But just again, just – I would love to get your thoughts sort of just broadly sort of what you are seeing in your business and sort of how you are thinking about as we move into 2023? Thanks.
Geoff Martin
Well, it’s a mixed picture. As you probably wouldn’t be surprised to hear me say. We still see some solid areas of growth. So, the month of October was pretty much a reflection of what happened in Q3. So, the CCL business continues to do well. We had a much better October in Avery than we had in Q3 because some of those impacts in Q3 reversed. Checkpoint is still hanging in there, doing quite well. And then the commodity inflation and deflation, depending on which side of the coin you are on. So, at Innovia we have, got the problem of the resins going down and the impact on pricing. And then you have got the energy markets all over the place. So, having to manage our way through that month-by-month.
Mark Neville
Thanks Geoff.
Operator
Thank you. Your next question is coming from Stephen MacLeod from BMO Capital Markets. Stephen, your line is live. Please go ahead.
Stephen MacLeod
Great. Thank you. Good morning guys.
Geoff Martin
Hi Steve.
Stephen MacLeod
Good morning. I just wanted to follow-up on Avery. You talked about some of the margin impact. So, given the fact that some of those destocking impacts have reversed in October, would you expect to see margins sort of reverting back to that 20% range in Avery?
Geoff Martin
Not until next year, because Q4 is a low quarter for Avery. So, when we get into next year, we would certainly expect to see that. And I think you might need to look at the excess margin we had in Q2. So, our margins surprised on the upside in Q2. So, if you combine Q2 and Q3, you have probably got a more realistic reflection of what’s really going on in the business because Q2 was – because of the early start of the back-to-school season, really inflated Q2 at the cost of Q3. So, that’s really one of the other underlying themes at Avery.
Stephen MacLeod
Alright. Okay. Thank you. And then just as you think about Innovia and the EcoFloat business, well, I guess a couple of questions. One is on the EcoFloat. Can you just give an update as to where you stand on those production impacts? And then you talked about Innovia results declining comparatively. I assume you mean on a year-over-year basis. Yes. Okay.
Geoff Martin
So, October was significantly better than any of the months we had in Q3 at Innovia. And EcoFloat, to your question. So, we are building that business from scratch. So, we don’t have any volume to load on to the line that we have to qualify each volume. But the interest is very significant. So, we have got inside the company at CCL, but also outside of the free converter market. We have got a lot of interest in the EcoFloat product line. So, it will take a quarter or two quarters to get through the start-up phase while we go through customer qualifications and approvals. But we are very pleased with the progress we are making.
Stephen MacLeod
Okay. Great. And then just on acquisitions, the acquisition backdrop. I know there has been a lot of macro noise out there. But I am just curious if you are seeing any easing in multiples or anything like that, how are your conversations trending?
Geoff Martin
Well, I would say we have all seen some contractions in multiples in the public space. Still some pretty hefty transactions going on in the private space. So, there has been a few public announcements about a couple of transactions in the industry, still in double-digit EBITDA margin. So, we haven’t seen any real change in the transaction multiples that are going on out there. So, we still have a good flow of bolt-on transaction deals in the pipeline, but nothing of any major scale.
Stephen MacLeod
Okay. Great. Thanks Geoff. Thanks Sean.
Operator
Thank you. And your next question is coming from Ahmed Abdullah from National Bank of Canada. Ahmed, your line is live. Please go ahead.
Ahmed Abdullah
Thanks for taking my question. On the 2023 outlook commentary and acknowledging the fact that visibility is usually between four weeks to six weeks, could you speak maybe to the magnitude of the impact that could come from higher inventory levels at customers? Are you already seeing…
Geoff Martin
The outlook commentary slide is really about the coming quarter. It’s not a 2023 outlook. It’s for the outlook on the coming quarter. So, I think it will be – the picture looks quite similar in terms of Q3. So, I think I have provided some comments there quantifying those beyond that, I don’t think we would be able to do.
Ahmed Abdullah
That’s fair. And on Avery, as we look into a possible recession in ‘23, how has this business performed in previous recessions? And is there room for you to cut costs to maintain or boost margins in the case of top line pressure?
Geoff Martin
Well, it’s a consumer staple. So, it’s a fairly resilient business to macro influences. So, we are quite optimistic about Avery for next year. We have done a few deals in the industry I think that are going quite well. So, I think it’s really the Q3 performance of Avery really has to be seen in the context of Q3 and Q2 together because it’s really driven by timing of shipments more than it’s driven by anything else.
Operator
Thank you. Your next question is coming from David McFadgen from Cormark Securities. David, your line is live. Please go ahead.
David McFadgen
Great. Yes. A couple of questions. I am just wondering where we are at in terms of putting through all the cost input pass-throughs because I am just wondering, going forward, when would we expect to see that most of the organic growth is actually volume driven versus price?
Geoff Martin
Well, I think it will be a little while yet because we – the quarterly comparatives still include a fair amount of price. But we did see volume increase in the – at 13.2%. It’s very difficult to measure in that segment. But we think it’s roughly two-thirds price, one-third volume, something like that. And to give you a rough idea, so we certainly saw unit volume increase in the CCL segment space this quarter. But I think it will be well into next year before we cycle through and get into the markets where we are not comparing inflation.
David McFadgen
Okay. And then just on MAS in Q2, it was weak. This quarter it was actually up and then Q4, it looks like you are saying it’s going to be down again. Just kind of wondering what’s going on there and what’s the MAS…?
Geoff Martin
Yes. Well, let’s say it was up slightly this quarter. It was better than it was in Q2. Some of that was price driven, was price recovery driven. But the profits were down this quarter because the unit volume was still below prior year. So, most of those products are sold into retail. So, the retail markets are not strong at the moment. But we expect Q4 to look – so far, it’s looked like pretty much a repeat of what happened in Q3 so far.
David McFadgen
Okay. Alright. Thanks.
Operator
Thank you. Your next question is coming from Daryl Young from TD Securities. Daryl, your line is live. Please go ahead.
Daryl Young
Hey. Good morning everyone. Just two quick ones for me. Around CCL Design, in the release, I think you mentioned too some new applications that were able to offset some of the weakness in the technology sector. Can you just give a little bit of detail on that? And is that expected to carry in the next several quarters?
Geoff Martin
Yes. I mean the CCL Design Electronics, the tech industry, as you probably all know, is somewhat challenged at the moment. But we have won some new applications, mainly in functional parts that we use on laptop display screens. That’s the main area of game we have had. I can’t go into more details than that. But that’s been the main source of the game. And that share gain has offset some of the decline in just the unit volume going on in the industry just in general.
Daryl Young
Okay. Great. And then with respect to Checkpoint, the $12 million gain from the China real estate sale, do you have a normalized EBIT number for Checkpoint that would have happened in the quarter without that?
Geoff Martin
Well, take $11.9 million off the number and then you got it.
Daryl Young
Okay. Got it. Thanks. That’s all for me.
Operator
Thank you. Your next question is coming from Michael Glen from Raymond James. Michael, your line is live. Please go ahead.
Michael Glen
Hey. Thanks. Geoff, some of the large CPG companies that you would do business with have seen some volume declines in the recent quarter. Are you seeing that at all in terms of the CCL Label business?
Geoff Martin
So far, not. And I would just caution you a little bit, it’s a mixed picture in the CPGs. So, in the beer sector, a lot of the world’s largest brewers reported pretty strong volume gains. So, it’s really in the personal care space, I think you are probably referring to where we saw some of the customers in that space reporting declines, not all of them. So, the ones that are more focused on the beauty care industry, some of those reported quite nice gains. So, I would say it’s a mixed picture in the CPG space. But with the customers we have on balance, we have seen so far, reasonably solid orders picture. But we read the same release as you do and have the same concerns that you do about 2023, and we will see what happens.
Michael Glen
And just to understand that a bit more, the volume of labels that you sell to, say, one of your larger home and personal care product CPG companies? Are they largely just in time, or is there any sort of inventory lag to think about there?
Geoff Martin
Well, the revenue line is determined more than anything else by mix, not by unit volume because label sizes and labels complexity really determine revenue rather than the number of units that customer sells. So, there is no translation relationship between the customer’s unit volume and our revenue volume. But so far, we haven’t seen too much softness in the HPC space. It was a strong quarter, and the order picture is still quite solid.
Michael Glen
Okay. Thanks for taking the questions.
Geoff Martin
No problem.
Operator
Thank you. And your next question is coming from Ben Jekic from PI Financial. Ben, your line is live. Please go ahead.
Ben Jekic
Thank you. I just have one question, Geoff. On account of sales with Checkpoint in China, is that a reflection of sort of efficiencies and consolidating production and less real estate, or is it some strategic sort of geographic repositioning?
Geoff Martin
Sorry, what’s the question, Ben?
Ben Jekic
When it comes to your sales of excess, can you hear me, okay?
Geoff Martin
Sales of what?
Ben Jekic
When it comes to sales of excess real estate in China.
Geoff Martin
Real estate, so we inherited a factory in Downtown Shanghai, very close to the Disney Park in Shanghai, where Checkpoint used to make and assemble its MAS product line, and we built a new factory two hours or three hours outside of Shanghai at a much lower cost place and a much nicer facility. And then we sold the real estate from the original building. That’s what happened.
Ben Jekic
Prefect. Thank you.
Operator
[Operator Instructions] And we do have a follow-up question from Mark Neville from Scotiabank. Mark, your line is live. Please go ahead.
Mark Neville
Thanks. I am just curious about the buybacks. You didn’t buy anything in Q3, obviously, a very busy first half. Just how you are thinking about – how we should think about that a bit more? Is it more just sort of opportunistic around price, more sort of weighing macro? Just how you think about it and how we should think about it? Thanks.
Geoff Martin
Yes. I think when you think about it, we have an ownership mentality here. So, if we feel the stock is undervalued. So, you saw we had a buyback at an average price of $58.95 at the time when the stock was sold, we thought the market – that was probably $10 below real value for the company. So, if we ever felt that situation arrived again, we would be buyers of the stock. So, we will have to wait and see what happens next year depending on how things unfold in the markets.
Mark Neville
Alright. Thanks Geoff.
Geoff Martin
No problem.
Operator
Thank you. And your next question is coming from Walter Spracklin from RBC. Walter, your line is live. Please go ahead.
Unidentified Analyst
Hi. This is Louis on for Walter. Hi Geoff. Hi Sean.
Geoff Martin
Hey Louis.
Unidentified Analyst
So, going into a slower economic environment, are you seeing any weakening in any of the demand segments where you have historically seen a reduction first?
Geoff Martin
You mean competitive prior recessions?
Unidentified Analyst
Correct.
Geoff Martin
Yes. I would say we haven’t seen a lot so far. We are still more wrestling with inflation volatility and energy than we are weakening demand in that respect. But we have the same concerns everybody else has. But so far, the orders picture has been decent. It’s not spectacular, but it’s decent. But we read the newspapers like you do, and we have got the same concerns as you do. But so far, we haven’t seen any early signals. So, the one area that’s noticeably weak is the tech space, the computer industry, laptops, servers, cloud computing, cell phones, that industry, we have seen some slowdown. But we have also gained share in new applications. So, we have been able to so far net that off against each other so far.
Unidentified Analyst
Okay. That’s fair. And then as moving into a weakening economic environment provide you guys with any opportunity to acquire a weakened rival?
Geoff Martin
Yes, we hope so. It has in the past. So, we have got a very strong balance sheet, as you have seen. So, we are certainly investors in times when other people are running for the hills, we like to buy. But probably need a few more things to unfold, a few more things to become clearer before those kind of opportunities arise.
Unidentified Analyst
Okay. Thanks for taking my question.
Geoff Martin
No problem.
Operator
Thank you. And there are no further questions in queue at this time. I would now like to turn the floor back to Geoff Martin for closing remarks.
Geoff Martin
Okay, everybody. Well, thank you very much for joining our call. Appreciate it, and we look forward to talking to you again early next year.
Operator
Thank you. Ladies and gentlemen, this does conclude today’s conference call. You may disconnect your phone lines at this time and have a wonderful day. Thank you for your participation.
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