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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good afternoon, ladies and gentlemen. Welcome to the CCL Industries' Second 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. Joining him is Mr. Sean Washchuk, Senior Vice President and Chief Financial Officer. You may begin.
Thank you, operator, and it's Sean Washchuk is joining me on today's call. I'd like you to reference the website presentation on www.cclind.com. Go to the Investor Relations tab and you'll find the presentation for today's call neatly laid out there for you. I'll hand the call over to Sean, who will take you through the numbers.
Thanks, Geoff. I'll turn everyone's attention to Slide number 2 of the presentation. I'll remind everyone that our business faces known and unknown risks and opportunities. For further details of these key risks, please take a look at our 2018 annual report in the MD&A under the section Risks and Uncertainties. Our annual and quarterly reports can be found online at the company's website cclind.com or on sedar.com. Turning to Slide 3, before we begin, we'll just talk a little bit about IFRS 16, the new accounting standard that came into place for leases. The standard requires historically accounted for off-balance sheet leases to be put on the balance sheet as a liability with a corresponding right-of-use asset. Therefore, there is no longer a lease or rental expense resulting in an increase in EBITDA, but an amortization expense for right-of-use asset resulting in a slight increase in operating income and imputed interest charge related to the amortization of the lease liability resulting in no impact to profit before tax. At June 30th, we had $154.6 million of right-of-use assets with $159.4 million of associated lease liabilities. This added $3.3 million to operating income year-to-date with a corresponding $3.3 million of finance cost, so 0 impact to earnings. There was $22.4 million of additional EBITDA on right-of-use depreciation in lieu of lease expense. There is no impact on the cash flows for the company. Turning to Slide 4, statement of earnings. The second quarter of 2019 was another solid quarter for CCL Industries. Sales growth, excluding the impact of currency translation, was 7% to $1.35 billion compared to $1.26 billion in the second quarter of 2018. The growth in sales can be attributed to organic growth of 2% and 5% acquisition-related growth. Operating income was $198.7 million for the second quarter of 2019 compared to $199.6 million for the second quarter of 2018. Geoff will expand on the segmented results in a moment. In the 2019 second quarter, restructuring and other items was an expense of $2.1 million, primarily for severance costs associated with the Innovia U.K. operations and other acquisition-related transaction costs. Restructuring and other items was an expense of $3.6 million in the 2018 second quarter, principally for the Checkpoint restructuring and other acquisition-related transaction costs. Net finance expense was $20.6 million for the 2019 second quarter compared to $20.8 million for the 2018 second quarter. The overall effective tax rate was 25.6% for the 2019 second quarter compared to 25.5% for the 2018 second quarter. Net earnings for the 2019 second quarter were $121.3 million compared to $121.1 million for the 2018 second quarter. For the 6-month period, sales improved 7%, operating income improved negligibly, while net earnings improved 2% compared to the same period in 2018. 2019 included the results of 11 acquisitions completed since January 1, 2018, delivering acquisition-related sales growth for the period of 5%, organic sales growth of 2.4% and foreign currency translation was a tailwind of just 0.4% to sales. Turning to Slide 5, basic earnings per Class B share were $0.68 for the second quarter of 2019 compared to $0.69 for the second quarter of 2018. Adjusted basic earnings per Class B share were $0.69 for the 2019 second quarter compared to adjusted basic earnings per Class B share of $0.70 for the second quarter of 2018. The adjustment to the 2019 second quarter basic earnings per Class B share included $0.01 for restructuring and other items. The decline in adjusted basic earnings per share to $0.69 is primarily attributable to a reduction in operating income of $0.01, an increase in corporate expense of $0.01 offset by an increase of $0.01 in equity earnings. For the 6-month period, basic earnings per Class B share were $1.38 compared to $1.36 for the 2018 6-month period. The adjustment to basic earnings per Class B share included $0.02 for restructuring and other items. 2019 6-month improvement in adjusted basic earning per Class B share was due to the increase in operating income, equity earnings, a decrease in corporate expense accounting for $0.03, with a net impact of interest expense and a change in effective tax rate partially offset the improvement by $0.02 resulting in adjusted basic earnings per Class B share of $1.40 from $1.39 in the 2018 6-month period. Turning to Slide 6, cash flow from operations, for the second quarter of 2019, free cash flow from operations was $106.3 million compared to $108.4 million for the comparable period in 2018. Cash inflow from operations which included working capital improvements in the second quarter of 2019 were offset by increased net capital expenditures of $28.5 million for the comparable 3-month periods resulting in a $2 million decline in quarterly free cash flow from operations. Turning to Slide 7, net debt as at June 30, 2019, was $2.1 billion, an increase of $177 million compared to December 31, 2018. This increase primarily reflects the increase in total debt as a result of $159.4 million of additional lease liabilities as well as the new bilateral loan facility and a reduction of cash on hand. Our bank leverage ratio was approximately 2x, reflecting an increase in net debt without a proportionate increase in EBITDA. Therefore, our bank revolving credit facility will incur interest rate margins of 125 basis points. The company's overall finance rate was 2.62% at June 30, 2019, lower than the 3% average finance rate at December 31, 2018, due to an increase in interest rates, interest rate margins on the comparably variable drawn debt. Management expects to continuing de-levering the company's balance sheet through the balance of 2019. Geoff, over to you.
Thank you, Sean. On Slide 8, highlights the capital spending for the year and this excludes right-of-use asset additions for IFRS 16 and excludes $5 million in disposals. So $211 million year-to-date. We expect it to come in on or around, and around being a little under the $350 million for the year ahead. Slide 9 highlights the CCL. Organic growth rate of 2.3%, a little below what we would have expected going into the quarter and I'll give you some color on that in the Q&A. 0.9% acquisition growth and nominal currency effect. Regionally, Europe was up mid-single digit. Latin America up double digit, Asia Pacific was up low single digits and North America declined low single digits. A bit more color on Page 10, Home & Personal Care results declined, but it was against an absolute blowout quarter this time last year, it was a record. And also, an unusually soft U.S. aerosol demand. So that's part of the Home & Personal Care business' extremely low quarter, particularly in the United States. And we also had a slow quarter in Latin America in labels. Healthcare & Specialty results declined in North America due to the product mix. It was mixed in Europe and improved in emerging markets, down a little overall. Food & Beverage continued to grow nicely but the growth rate moderated and we had some capacity expansion costs and some pricing challenges which impacted profitability. CCL Design, electronic sales were up in the mid-teens on double digit organic growth in acquisitions and that offset a slightly slower quarter on modest lower demand in North America and Mexico and some start-up costs. A very strong quarter in CCL Secure, in both polymer currency and security products. So it was a pretty mixed picture, but I guess a way to look at it, in many ways the improvements we had at CCL Design and CCL Secure offset part of the downsides in the Consumer & Healthcare side, but not all of it. We'll come to that later in the Q&A. Page 11, the joint ventures had a good quarter here, particularly in the Middle East. And our Rheinfelden slug plant that supplies CCL Container with slugs were still closed down. We do expect that plant to restart in the coming months. Slide 12, results for Avery, good quarter, 2.5% organic sales growth. And that was despite a later start than we anticipated in the North American back-to-school season and that's certainly been reflected in a very strong July for the start of our business. Direct to consumer product lines also continued to grow at a double-digit pace, so pretty good quarter at Avery. Checkpoint, tough comp against last year. Just point out prior year quarterly profit increase in 2018 over 2017 was 42%, so we had a very tough comp. Lower EAS hard tag sales was really the driver for it, especially in the United States. Apparel labels also were relatively slow in the base business, but RFID continues to grow. Innovia, this was a success story on Page 14. Very good quarter, continued the trend we saw in the previous one. The sales growth was all acquisition-driven. Pricing and mix offset lower volumes in the legacy Innovia business. But in legacy Innovia, everything was on our side. Mix improved significantly, largely on good sales to CCL Secure, pricing and productivity actions, favorable resin environments and foreign exchange gains on the weak British pound on export sales from our large plant in the northern part of the U.K. to the United States. Treofan did contribute positively but only modestly. We did start up the Mexican new big BOPP line with limited impact, but it was late in the month of May. So with that, Operator, we'd like to -- well, we'll give you a quick few comments on the outlook before we do that. Things to think about for the coming quarter, CCL Secure is well placed to continue the improvement we've seen in Q2 against what was a weak quarter this time last year in the summer period. The base CCL global business faces much easier comps. As I mentioned earlier, Avery is poised for a very good back-to-school on an extremely strong July. Checkpoint comps also eased significantly in the second half, and again, we saw that in July. Innovia progress is expected to continue. And the impact of the new BOPP line will be much clearer after we've had a full quarter of it. FX looks like it's pretty nominal at today's exchange rates. So with that, Operator, we'd like to open the call for questions.
[Operator Instructions] Our first question comes from Adam Josephson from KeyBanc. Your line is now open.
Geoff and Sean, good afternoon. On the quarter, can you talk about the cadence of sales, Geoff, in the quarter overall by market, by geography? Just to give us a sense of what changed as the quarter progressed?
I think it was we had a good April, a good May, a soft June, and we've now had a strong July. So it's been a weird 4 months. So April and May were both pretty good, June was weak, and July has bounced back. So it's hard to really read anything into it. It's not abnormal for us to have a funny period in June in the HPC business. We have one of our largest customers has its yearend in June, so sometimes we see some inventory cutting. One of our other large U.S. HPC customers shut a lot of its plants early for the July 4th holiday. So it's been a strange period. Good April, good May, soft June, strong July, that's probably all I can tell you.
I appreciate that. A couple of your large suppliers called out weakness in Europe, particularly in 2Q. You're calling out weakness in North America in your CCL business. Can you just --
Mainly driven, Adam, by our -- that's where our can business is and that's where a lot of the softness was. Our label business was pretty much okay. It was really driven by really unusually slow quarter in our can business in the U.S.
Why do you suppose that was, Geoff?
I think it sometimes happens in that business. We had a record first half of last year. I mean just at one point I think we had an 18-week lead time for aerosol cans this time last year. And then people overorder and try -- because there's only 2 or 3 suppliers of these products in the U.S. And then people build up inventory and then use it. And then we had quarter after quarter after quarter of declining sales. And then in July it just began to bounce back again. So it's not uncommon in aerosol cans. But we didn't see anything different about Europe versus the U.S. Excluding aerosol cans, they looked quite similar.
Just last one for me, Geoff, on Checkpoint, how did the results, forgive me if I missed this, but the results compared to your expectations, were they much different? And if so, what changed?
It was really on the EAS hard tags which is a high margin product line for us. So that was definitely softer than we thought it would be going into the quarter. And again, it rebounded in July. So why everyone wanted nothing in June and wanted everything in July, it was the reverse this time last year. Hard to understand, but sometimes things happen.
Thank you. Our next question comes from Stephen MacLeod from BMO Capital Markets. Your line is now open.
Thank you. Good evening. I just wanted to dig in a little bit on the CCL segment margin. Could you just talk a little bit about some of the impacts on the quarter and how you see that evolving through the balance of the year?
Yeah, well the quarter was driven by the things I've called out, Home & Personal Care was down, but CCL Secure was up. Food & Beverage was down, but CCL Design was up. And Healthcare & Specialty was down slightly. So those are the 5 components of that business with different margin points in each. But the Home & Personal Care has a slightly better than average margin and the decline there was big enough it couldn't be offset by the growth in the two other things I called out.
Okay. When you think about July just having picked up, are you seeing relative strength to June across sort of all the businesses?
Yeah, I mean it's like it's almost -- I mean July is normally a soft month for us because we have the July 4th holiday in the U.S. So if you looked at our results for the months of June and July, you'd have said, Geoff, you've got them around the wrong way. And that's literally how it panned out. They're very -- I mean we've never seen a July like it and we've never seen a June like it. So quite why it would be that way, I don't know. We did have some workday slow -- there was one less workday in June this year than last year, but quite why it dipped as much as it did in June and why it rebounded in July is not something I can really explain. But it's certainly what happened. At Avery, we did expect Avery to be a bit better than it was going to be in June and that was definitely around just late shipments in back-to-school that we saw that in spades coming back very strong in July.
Okay. Then just on the Q3 outlook, I just wanted to confirm, so looks like last year's comp, last year's organic sales growth was roughly 7.5%, but it looks like you sort of called out like easier comps for CCL Secure and the base CCL --
Yeah, that's right. Last year we had a really tough quarter in CCL Secure, so this year the comps for CCL Secure are much easier. So that's why I think it will be -- I don't know if we'll have 7% organic growth in Q3, I'm not saying that, but the situation around CCL Secure makes that a little bit easier than it was this time last year.
Thank you. The next question comes from Mark Neville from Scotiabank. Your line is now open.
Good evening, guys. I just wanted to dig in again to the label. I know we discussed it quite a bit, but I guess I'm just still scratching my head a little bit. I hear everything you're saying, but again, just sort of some of the puts and takes. You talked about the lower Home & Personal Care, maybe the Food & Beverage, the profitability being down, it's been a really strong performer, so maybe just a little more color on that?
Yeah. So we still had good growth in Food & Beverage but it wasn't double digit like it's been for I don't know how many quarters in a row now we've had double-digit growth in Food & Beverage. It wasn't double digit, mid-single digit in Food & Beverage this quarter. We've also invested in quite a few new capacities coming online, new sleeve lines, new pressure-sensitive label plants, we've got quite a few new capacity additions. Because this time last year, we were completely sold out, everything firing on all cylinders, almost all of it sold actually. So we've got the impact of those capacity planning coming online. Then we've got some also some competitive pricing things going on there which certainly hurt us a little bit in June. But again, I would say July was sort of a flip side positive surprise. It's been a strange 8 weeks.
Okay. I guess when I read your sort of outlook, it sounds pretty positive. Again, sort of despite sort of what you might have seen in June. So I'm just -- yeah, I don't know what I'm asking, but sort of just maybe your visibility into sort of -- again, I guess the labels it's not going to be too long, but sort of maybe visibility into the second half and sort of how anomalous June or the quarter might have been?
Well, it's hard because in the label business we work on pretty short lead times. The backlog in that business is rarely more than a month. So when you've had 4 -- we had a good April, a good May, a soft June, a strong July. And I think we look reasonably set for August, but September is a long way off in our business. So hard to really comment beyond -- we're certainly seeing a market that's somewhat more volatile that it was the last 2 or 3 years for sure. Probably wouldn't surprise many people, that comment. But they're more nervous about when you see a month like June come along as soft as it was and then you see a complete rebound the next month, it makes you a little more uncertain about how things are going to be 2 and 3, 4 months down the road.
Maybe just one last one then. I guess you're talking easier comps, Secure should have a good quarter. Again, it sort of sounds like better topline and improved profitability for Q3 as well, so I guess margin as well as topline for the label business?
Yes, so certainly absolute dollars of profit. I mean, but margin I wouldn't comment on. Just wouldn't comment. It's more mix driven than anything, and that's very hard to forecast. But certainly, we would expect Q3 to be better than Q2 in the CCL segment.
Thank you. Our next question comes from Maggie MacDougall from Cormark. Your line is now open.
Hi. I was hoping to change gears here and talk a little bit about the startup in Mexico at Treofan. Would love to hear how that's gone for you so far and what the game plan is for the next few months to get it running commercially.
It is running commercially. It started making commercial goods, commercial quantities of film on the first day it started up. So the extrusion line went very well. But that has to be bedded down, so we didn't see enough in Q2 to comment really on the financial impact. It wasn't terribly material. I would say, my gut feeling is if you think last time we were on this call we gave you a range of 1 to 10 what it might cost in the second half, probably would narrow that range now down to 3 to 5 or something like that. We have enough confidence to say this is going to go better than the worst end of the range if that's helpful to you.
Yeah, so are you base loading that facility with volumes from the preexisting plant?
Correct. Yes. So once the other lines, a very old line is being phased down which is transferring volume from one part of the plant to the other to run much, much more efficiently than it does on the old equipment.
Okay. And the capacity there that you've added, is there a net capacity addition? My understanding was there is. That will double the capacity, is that correct?
No, no, it doesn't double it, but it's certainly more than 50% more than the plant had when we made the investment.
Okay. And are there any costs associated with decommissioning that we should be thinking of?
No.
Okay, great. The other question I wanted to touch on was just in the MD&A, Healthcare was the segment in Canada that was called out as declining and we haven't talked about that yet. It was a bit surprising to me. So is there any reason for that to have happened or was that an anomaly as well?
Just the generic drugs producers. So there's a price war going on in the United States between all suppliers of generic drugs in the U.S. So Novartis and Teva and all the Apotex here domestically in Canada, they're all in the middle of big price war in the United States. And that's making life very difficult for them and consequently difficult for us.
Okay. So you would expect that to have some continuing effect potentially?
I would say so. It's been going on for a while. It'll be anniversaried by the end of the year, but it's certainly been there for well over a year.
Thank you. Our next question comes from Ben Jekic with GMP Securities. Your line is now open.
Two relatively quick questions. I just wanted to focus a bit more on the pricing challenges in the Food & Beverage business. And Geoff, if you could maybe elaborate, is that competitiveness that you mentioned, is it coming more from Europe or North America, emerging markets?
I won't get into that. I think we've made it clear what's happened and we're not going to get into commenting about individual regions or individual customers. But there has been some pricing pressures in parts of that business that impacted profitability a bit. And when you have, if you're growing double digit, it may have been there before actually, but when you're growing double digit you don't notice it. When that growth rates comes down by 500 basis points, it's more difficult to deal with.
Okay, thank you. And then the second question is on Avery. It seems like little by little we are seeing sort of sales and definitely the operating income perking up. So I wanted to ask for an update on the relationship between the sort of lower margin sales and the DTC and other higher margin -- what is the level currently of the high margin and how far do you have to go in terms of the product mix?
We're pleased with the results so far this year and we're expecting another good quarter in the one that's upcoming.
Thank you. Our next question comes from Scott Fromson from CIBC. Your line is now open.
Hi, just a question on Innovia. We've seen the profitably increase quarter over quarter even on lower sales. Is there a specific strategy to cut back on lower profit contracts? Is this a trend that we can see continuing?
Yeah, I think we've certainly taken some action on marginal business at the bottom end for sure. And the reason, the main reasons the profitability is rising, it's much more driven by the richness of the mix. And that's really about the amount of security film we're making. Because that's the highest margin product line we have in the mix. So the more of that we sell, the better it is for profit. The British pound foreign exchange gain is a material item. So we make a good portion of what we sell in the United States is made in the U.K, so you have the U.K. pound costs and U.S. dollar selling prices, so that's a big factor. Resins I wouldn't say have gone down very much. They've gone down a little, but they certainly stabilized which means the pricing decisions we made suddenly have had impact because resins remain stable. And of course, we've had much better productivity particularly in the big plant in the U.K. So when you add all those things together, it ends up being a pretty dramatic improvement.
That's great. Now what kind of trend would you see with the new Mexican line coming on?
I think we're still getting our arms around Treofan. It's coming up sort of first anniversary in Q3 of the acquisition, still getting our arms around it. Lot to do in the Mexican operation. We're very pleased with it, but there's probably some of the prune and improve job to do in the mix down there for sure and a lot of operational things to do in the plant to make it run better. We're knee-deep in working all that through. But there's definitely some tailwinds coming there too, so hopefully we'll continue to see that making better and better contributions as the coming quarters go ahead. So I think the only concern we have is this operational impact from the startup of the line, but it was pretty immaterial in Q2 and in the month of July it was also pretty immaterial. So hopefully that's why I said we're hoping the range will come down more in that $3 million to $5 million impact as opposed to that $1 million to $10 million.
Thank you. Our next question comes from Elizabeth Johnston from Laurentian Bank Securities. Your line is now open.
Good afternoon. I just want to ask a follow-up question on Innovia. And I know you went through come of the key items here that impacted certainly profitability this quarter. Are you able to give us a sense of magnitude, specifically with respect to the resin pricing? I mean there's a change every year.
Resin pricing, but relatively small. So the impact there is about the price increases that we put through and the fact there wasn't any resin increase meant that price increase has restored some of the margin that we had lost when prices were rising costs and then we could pass them along. I'm not going to get into calling out what that is in dollars. Otherwise, I'd be doing that every quarter added forever. But it was not a huge impact. The British pound exchange rate, I can tell you that's about $3 million for the first half of the year, so the drop in the pound over January 1 through mid-June was about $3 million of the profit improvement.
And when you refer to sales mix, this pertains to some of the product rationalization rather than --
Yes, it's more driven not by product rationalization, it's more driven by the fact we had a very good quarter in the -- the more CCL Secure is successful, the better that has quite an impact on the mix of the profit margin we make at Innovia. And we had a strong quarter at CCL Secure, so if we have a strong quarter there with a lot of film being used that translates into the same impacts at Innovia.
So when it comes to looking ahead, should we expect depending on the level of Secure business and relative stability of resin pricing that we could see on an ongoing basis a fair amount of variability quarter to quarter on the margin. Is that reasonable?
I wouldn't say -- I think -- when we've had variability there because we had this sort of skyrocketing resin that came through at a pretty rapid clip in the year, back half of 2017 and all of 2018. So that's not, doesn't happen every period of time. So if we have that happening again we'll have the same challenges. Hopefully, we'll manage them better next time. And you have the same benefit when resin drops very suddenly. But they're not sort of frequent events. But whether we do well or not, is really driven, the CCL Secure thing is certainly a factor, but not going to get into quantifying that.
Okay, maybe one last one on this topic. If I were to, given what we know right now, do you think that the second half of 2019 in terms of profitability would look similar to the first half?
I would say so, yes.
[Operator Instructions] We have a follow-up question from Stephen MacLeod from BMO Capital Markets.
Thank you. I just had one follow-up question. You mentioned in your prepared remarks that your organic sales growth in CCL was lower than expected and then in the Q&A it sounds like it was because of a weaker June. Can you talk a little bit about like what would your organic growth expectations have been coming into the quarter?
I would have said we would have probably expected -- last year we grew 3.3 and we were at 2.3 this year, so we'd expect at least another point on the topline. So the can business was down quite a bit, so that was a good chunk of that difference. And we're seeing that rebounding a bit, certainly did in July and the order backlog looks much better than it did 3 months ago for August and September when we're looking forward into Q2. So that's a chunk of it. I would have said probably a point higher than we actually turned out.
Okay. So would that be like a reasonable expectation for, I don't want to paint you in a corner here, because I know the order backlogs are low, but or sorry, short. But would that be like a reasonable expectation for kind of where you would expect a starting point to be for Q3?
Something in that zone. I mean I would be kind of surprised if our profits were down like they were in Q2 in the CCL segment in Q3, I'd be kind of surprised at that. I don't think we're going to have a blowout quarter in Q3 on the CCL side. I think we will at Avery. I think Checkpoint will do much better. And I think Innovia will continue to do well, and I think you won't see the decline you saw in Q2. Subject to how things go in September. If you had asked me this question beginning of Q2, which you all did, we had a good April, we had a good May and then June was soft. So I think we'll have at CCL this year, we've had a good July, I think we'll have a good August, but September is a little ways off.
Okay. So just characterizing the CCL Segment, you would expect -- you would be surprised if CCL dollar EBIT was down year-over-year but you would expect it to be up quarter-over-quarter?
I don't think it will be up materially.
Thank you. And I am showing that is our final question. I would now like to turn the call back over to Mr. Geoff Martin, President and Chief Executive Officer for further remarks.
Thank you, Operator, and thanks to everybody for coming onto the call and we'll look forward to talking to you in November. Thanks very much. Bye-bye.
Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone, have a great day.