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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 morning, ladies and gentlemen, and welcome to the 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. Donald Lang, the Executive Chairman; and joining him are Mr. Geoff Martin, President and Chief Executive Officer; and Mr. Sean Washchuk, Senior Vice President and Chief Financial Officer. Please go ahead gentlemen.
Okay. Well, good morning. Don Lang here. And welcome to our third quarter update. Just for your information, actually we are calling from our Checkpoint operations in New Jersey. As you know, we have board meetings in November at all our operations to make sure our directors are there, feel for the business and here to report the third quarter. As you know, the presentation is the same format as we've had in the past. It's on our website cclind.com and follow along, we'll identify the pages as we go through.So with that welcome and I'll turn it over to Sean Washchuk.
Good morning, everyone, and thanks, Don. I'll turn everyone's attention to Page 2 of this presentation, our disclaimer regarding forward-looking statements. 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 2017 Annual Report and MD&A, particularly the section under 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, our statement of earnings. The third quarter of 2018 was another solid quarter for CCL Industries. Sales growth, excluding the impact of currency translation, was 9% to CAD 1.34 billion, compared to CAD 1.21 billion in the third quarter of 2017. The growth in sales can be attributed to organic growth of 2.4%, 2.1% positive impact from foreign currency translation and 6.3% from acquisition-related growth. Operating income was CAD 186.2 million for the third quarter of 2018 compared to CAD 185.3 million for the third quarter of 2017. Geoff will expand on the segmented operating results of our CCL, Avery, Checkpoint and Innovia segments momentarily. Please note, we have changed our segmented reporting and have included the results of the former container segment within the new CCL segment.In the third quarter of 2018, restructuring and other items was an expense of CAD 1.3 million, primarily related to acquisition transaction costs. Restructuring and other items of CAD 2.9 million in the 2017 third quarter was associated with the Checkpoint and Innovia restructuring initiatives. Net finance expense was CAD 21.1 million for the third quarter of 2018, compared to CAD 18.9 million for the 2017 third quarter. The increase in net finance costs is primarily related to an increase in total debt as well as higher average finance rate through the comparable periods.The overall effective tax rate was 25.6% for the 2018 third quarter compared to 29.9% rate in the 2017 third quarter, reflecting the impact of the US tax reform in the Tax Cuts and Jobs Act in the current year. The Tax Cuts and Jobs Act legislation will result in an approximate 3% reduction in our annual effective tax rate. Net earnings for the 2018 third quarter were CAD 112.7 million compared to CAD 106.9 million for the 2017 third quarter.For the 9 month periods ended September 30, 2018, sales, operating income and net earnings improved 8%, 10% and 15%, respectively, compared to the same 9-month period in 2017. 2018 results included 9 acquisitions completed since January 1, 2017, delivering acquisition-related sales growth for the period of 5.9%, organic sales growth of 2.3% and foreign currency translation resulted in a 0.5% tailwind.Turning to Page 4. Basic earnings per Class B share were CAD 0.63 for the third quarter of 2018, compared to CAD 0.60 for the third quarter of 2017. Adjusted basic earnings per Class B share were CAD 0.60 for the 2018 third quarter compared to adjusted basic earnings per Class B share of CAD 0.61 for the third quarter of 2017. The adjustment for the 2018 third quarter basic earnings per Class B share included CAD 0.01 increase for restructuring and other items and CAD 0.02 for noncash acquisition accounting adjustments to fair value inventory related to the Treofan acquisition. These were expensed through cost of sales in the quarter.The improvement in adjusted basic earnings per share to CAD 0.66 is primarily attributable to the improvement in operating income of CAD 0.01, tax rate reductions of CAD 0.04, CAD 0.01 from FX, partially offset by CAD 0.1 increase in corporate expenses. For the 9-months period, basic earnings per Class B share were CAD 1.99, up CAD 0.26 or 15% compared to CAD 1.73 for the same period a year ago. The adjustment to basic earnings per Class B share included CAD 0.04 for restructuring and other charges and CAD 0.02 for noncash acquisition accounting adjustments to fair value of the Treofan inventory. The 2018 9-month improvement in adjusted basic earnings per Class B share was driven principally by the increase in operating income, which accounted for CAD 0.17, tax rate reductions adding CAD 0.08, partially offset by the increase in interest expense and corporate costs, resulting in a CAD 0.06 adjustment to basic earnings per Class B share to CAD 2.05 from CAD 1.86 per share in the 2017 9-month period.Turning to Slide 5. For the last 12 months ended September 30, 2018, free cash flow was CAD 420.6 million, almost flat to the last 12 months ended September 30, 2017. This reflects improved operating results, the impact of noncash working capital and the timing of capital expenditures for the comparative 12-month periods. Net capital expenditures were CAD 309 million compared to CAD 258 million for the comparative TTM periods.Turning to Slide 6. Net debt as at September 30, 2018 was CAD 2.04 billion, an increase of approximately CAD 268 million compared to December 31, 2017. The increase primarily reflects the increase in total debt, the CAD 303 million acquisition of Treofan, which closed in early July, offset against debt repayments during the quarter and the first 6 months of the year. Our bank leverage ratio inched up to just over 2 times. Therefore, our bank revolving and term facilities will incur interest margin at 145 basis points. The company's overall finance rate as at September 30 was 2.7%, slightly lower than the average rate at December 31, 2017, Due to a CAD 129 million repayment of senior notes, which bore interest between 6% and 7%. The company expects to continue reducing its total debt during the fourth quarter of 2018.Geoff, over to you.
Thank you, Sean, and good morning, everybody. I'm on Slide 7, highlights of capital expenditures for the year; CAD 280 million. That excludes around CAD 17 million of proceeds from capital asset sales and we expect the number for the year to be in the range of CAD 350 million for 2018 and about the same for 2019.Page 8 highlights the [ results ] for CCL. 7.5% organic sales growth, but was quite a bit stronger than we expected. Give you some more color on that in a minute. North and Latin America, both up high-single digit. Europe down slightly, but up low-single digit excluding CCL Secure. Asia Pacific was very strong, up in the high teens. Strong performances in Home & Personal Care and Food and Beverage.There's more color on Slide 9. Personal Care business had another strong quarter, very good sales, strong profitability, improvement on gains in both labels and tubes. Healthcare and specialty business improved quite a bit compared to the prior year quarter. So the trend there has been quite good. And Food and Beverage results were very strong, driven by double-digit sales increases across all product lines.In CCL Design, the electronics business had a strong quarter, good sales gains and profitability gains, aided by higher U.S. dollar, as we bill many of our customers even located in China in US dollars. Automotive results declined modestly and market for them clearly plateauing.In CCL Secure, we had strong results in the U.S., but had another down quarter in polymer banknotes and a poor result in the Mexican plant where we had 1 large customer claim that cost a couple of million dollars .On to Page 10. These are the numbers for joint ventures. There's really 2 operating businesses left here now; 1 in Russia and 1 in the Middle East. And the prior year numbers included Acrus CCL in Chile, which are now fully consolidated after we acquired an interest there. And our Rheinfelden slug business remains closed down, impacted by a plant fire, but not expected to start till Q1 next year. But very good quarters in both Russia and the Middle East.Page 11, highlights for Avery. Well, as expected, we had a difficult North American back to school season in ring binders for mass market retail channels. Cost about CAD 20 million on the top line, about CAD 8 million on the bottom line, just in the ring binder category, just to give you a flavor. So the underlying business was more or less flat excluding ring binders. Strong results in the direct to consumer product lines, modest growth in Europe and Latin America and a small decline in Australia.Page 12, Checkpoint. Another good quarter here, and this was encouraging because we had no major chain-wide rollout this quarter. There's just the underlying business. Sales were up 2% and change, low single-digit gains in the merchandise availability products and the mix being decidedly on the supply side really aided profitability. The prior year did include a reversal of a gain on the building that we've had to reverse in the previous -- in Q3 versus Q2. So that sort of flattened the gains of the prior year a little bit, maybe a couple of million dollars. Apparel labeling profitability improved significantly on a mid-single digit sales increase.Page 13, Innovia. Another disappointing quarter, driven by the same issue, rising resin costs, now also facing us in the United States. Resin went up a little over 20% in the third quarter in the U.S. compared to other parts of the world. So the U.S. kind of caught up with everywhere else. And there's also a little bit of foreign exchange gain in here. CAD 6.6 million included a CAD 2 million foreign exchange pickup on some balance sheet matters to do with Treofan. So resin inflation is really the main issue, especially in the U.S. It has showed signs of stabilizing in Europe, but was still at very elevated levels compared to history.Slide 14, a summary of all of that. So mixed quarter. Solid at CCL and Checkpoint. Avery was a little disappointing, but not much. We expect it to be more or less about the numbers we came in at. Innovia still disappointing on resin and the consolidated numbers there, you can see on Slide 14.Some outlook comments for the fourth quarter. We expect the modest FX tailwind we saw in Q3 is likely to continue at today's exchange rates. CCL's Label and also [ can and cheese ] businesses have solid order backlogs, as well CCL Design. CCL Secure will definitely sequentially improve in the fourth quarter, but climbing the mountain of last year will be a challenge. We had 1 large launch for a major country in Europe last year that won't repeat this year. And our Q4 '1, profitability in the whole segment was up 30% on Q4 '16. So matching that in the coming quarter will be quite difficult. Q4 '17 also included the commencement of 2 technology rollouts at Checkpoint, which we won't have in a real base this year. Avery comparisons, however, ease and price increases are planned for the 1st of January 2019 as they were on the 1st of January '18. So any buy forwards would not really affect comparative this year.Innovia is obviously focused on managing the resin cost price equation, and we're installing a new line at our operation in Mexico, which is completely sold out and we'll give you a bit more color on that in the Q&A. Fourth quarter last year also benefited in the adjusted EPS around CAD 0.09 from the changes in the U.S. tax legislation and that was a one-time event which won't repeat in the coming quarter.So with that, operator, we'd like to open up the call for any questions.
[Operator Instructions] Our first question comes from the line of Adam Josephson of KeyBanc.
Yes, Geoff, just a couple on Innovia. So if we're in trough conditions now with about 11% EBITDA margins, what do you think mid-cycle and peak conditions look like on an EBITDA margin basis, just based on the annualized segment sales with Treofan of about CAD 600 million.
I'd say mid-cycle, mid-teens. So if resin got really low, we might make it up into the high teens. So that will be [ miles to that segment ]. So mid-teens. And whether we'll get there in 2019, I think remains to the seen. The one reason I'm qualifying that's not so much about resin, which we do expect to decline. We've got a start of a new line in Mexico and there's always some cost to that when you're starting up a major piece of equipment like that, but that aside, we'd expect to see some relief on resin in the year ahead.
And related to that point, Geoff, oil prices have come down nearly 20% from their recent peak. I assume that's why you think resin is going to start going down, can you give me a sense of -- yes, go ahead.
It just tracks it, eventually it tracks. I mean these things are also correlated. They are not -- they don't follow each other day by day. But eventually the world has a habit of flattening out, so we would expect to see easing in resin conditions. And we've also got a lot of price increase activity to catch up on the backlog of uncollected resin increases. So we're nudging up CAD 50 million now of resin increases since the low of 2016 and we haven't recovered -- we've barely recovered even CAD 10 million of that. So we've got a lot of catch-up to do on the inflation we already have.
Got it. And just a couple others Geoff. The 7.5% organic growth in CCL, can you just give me a little more flavor for precisely what was perhaps appreciably better than you were expecting. And just any sense as to how your order backlogs trended throughout the quarter.
Yes, I mean it was strong Adam. If you exclude CCL Secure, we were up almost double digits. And so the CCL Secure down quarter reduced the growth rates a couple of hundred basis points. So it was pretty strong. Food and Beverage was the strongest, it was double-digit in everything. Personal Care wasn't far behind that and it was very strong in North America, extremely strong in China. I know there's been some commentary about things in China being a little more difficult, but it was extremely strong there. Healthcare business picked up in the quarter, that being a good sign and it's been continuing in the current quarter. And then of course we moved into the CCL Design electronics peak period. So right now, we haven't seen any changes in conditions. I think the comment I would add is Q4 last year was extremely strong. So I think we'll -- comparatively it'll be a lot different picture in Q4, because we won't have the -- we will be operating on a different comparative basis.
Got it. And one just -- last one for me, Geoff. With respect to large M&A, I know you talked in the last couple of calls about being careful with respect to that just at this point in the cycle, given how high asking prices are and given that macros are likely to get much, if any better, than it is today. Are you still of that view?
Well, I think multiples are getting a little more rational now, both in public and private markets. So that's a good sign as far as we're concerned. So we are a buyer of businesses, so I think that trend is moving in our favor and it's -- really it's a good time to buy when others are more fearful. So I think when markets go down we want to have dry powder ready and being ready to do more deals.
Our next question comes from the line of Mark Neville of Scotiabank.
Maybe just start with Innovia. Again I can appreciate sort of all the resin issues, but again, I think previously you did talk about sort of some of the pricing mechanisms and just trying to -- needing to ask that better and maybe needing to adjust some of those, so I was just curious if you've started that, how the conversations are going with customers, just maybe kind of an update there.
Yes, no, we're having a lot of discussions with customers right now and they are what I would call very disciplined conversations. So we're explaining to customers now that this is what's happened to the cost of resin. This is a new price for the film, when your contract expires, if you want to buy, I think that will be the price and I'm sort of leaving it like that. And so the [ asking ] question is with the price increases what impact will that have on volume? We think there may be a little bit, but not too much. And just given the extent we are in the hole, the math on it's pretty easy. So we're a long way away from where we should have been to collect this inflation. So we're hoping a combination of those price increases and fall in -- [ folding ] resin next year will eventually get us where we need to be. It will take a couple of quarters to play out. I don't think you'll see much impact in Q4, because we've got a lot of contracts expiring at the end of the year. And then the other qualification I'd add is, we've got the startup of that new line in Mexico and our plant there is totally sold out. So we're having quite some difficulty with keeping customers supplied, not running it optimally and things like that. So there's quite a bit of work to do at that operation to get it where we want it to be and that will take a couple of quarters to play out.
And with it being sold out, I'm just curious to pricing on that. I mean was that sold under sort of current resin conditions or how we think about that?
Sorry, I didn't catch the question.
I'm just curious the line in Mexico if it's completely sold out, I'm just sort of curious to sort of the underlying commodity.
Yes, the new line isn't sold out -- the existing lines are sold out. And the new line that's coming in is a significant increase in capacity. So they're trying to do whatever they can to hang on to the volume, because the line will start up in Q1 and they need the volume there to get the line going, because it's a very big piece of equipment. So they're having to sort of run hand to mouth and keep customer supplied, but keep the volume till when the line starts off in Q1.
Okay. I understand. And maybe just the security business, I guess we were just sort of under the impression that was an easier comp in Q3, so I think our arithmeticians might have been just a little too high, but just curious if there's anything in the quarter that maybe surprised you to the [indiscernible]. You mentioned a customer claim, but I don't know how big that was.
It's CAD 2 million. So that was really the difference. We had a small loss this year, a small profit last year and if we hadn't had the decline it would have been about flat to prior year. And the volume pickup didn't come really until -- we were expecting it to come in August, didn't really come till September. But it wasn't terribly material beyond that CAD 2 million claim that I mentioned in the commentary.
Okay. Maybe just one last one from me. Just on the Avery business, again it feels like it's all binders and you basically said that. I'm just curious, I mean is this -- and really what I'm sort of looking forward, we are looking forward at forecast. Is this really a Q3 phenomenon for this business, like you saw essentially all your binders in this quarter.
Yes, so any month we made profit in binders, June and -- June, July and August. So we lose money the other 9 months of the year and you hope you'll make it up in the 3 months of back-to-school season, and so it's a Q3 event for sure. But if you take that out of the equation, we would have been flat for the quarter. So we'd expect Q4 to be sort of looking flattish compared to keep Q4 last year.
Our next question comes from the line of Walter Spracklin of RBC.
So just on the CCL, in terms of the margin evolution you mentioned you had some nice share gains and business wins and had good growth as a result. Sometimes there is some pricing action there that worry investors. Can you give us some color as to whether was there any price discounting there or perhaps kind of segment the organic growth into volume and price?
Yes, well the best color I can give you is, so the margins in the quarter are up on prior year, so we clearly haven't done anything on pricing . And our margins would have been higher if we hadn't had the events with CCL Secure by a couple of million dollars. So there's nothing in the underlying core business there that's inflation related or pricing related. So all the core legacy businesses in CCL had a really strong Q3 in all respects.
Okay, that's encouraging. And so backing out Secure, you would expect that margin -- kind of that margin profile to continue going forward in that...
Yes, if there's any comment I would make is, what I've said on the call about Q4, we had such a huge Q4 last year and some of that was caused by -- in CCL Secure by the launch of a major European banknotes, which completely -- had to replenish all the inventory that was out there as one-time event. Most of that occurred in Q4 last year and won't be in Q4 this year.
Okay. And just turning back to acquisitions, you'd mentioned that you are kind of sniffing around a little bit more. Is there any -- could you give -- what seems to attract you most right now, is it a geographical focus that you have in looking to build up in certain regions, or is it more a divisional focus where you'd like a little bit more scale in perhaps some of your smaller divisions?
Well, it's direct to consumer acquisitions in the Avery space, technology acquisitions in the Checkpoint space and label businesses that are either product driven or geography driven at CCL Label, probably geographic expansion in CCL Design, probably in the electronics industry growing in China in automotive, so all of those.
Our next question comes from the line of Stephen MacLeod of BMO Capital Markets.
Just wanted to circle back around on the CCL business just generally. When you think about the Q4 outlook, would you expect that potentially overall growth is down year-over-year?
Not on the top line. So I think it might be a mix in Q4, might be slightly impacted by the banknote order we had last year. That was really a onetime event. So that's more driven by that. So I think top line will be in good shape, it's really more driven by the high margin nature of that order not being in this year's base.
Right, okay. And can you -- is it possible to give a little bit of color just to remind us what the size of that might have been, the impact in Q4 '17?
Well, I think we'll probably give you some guidance about that offline Steve. So I don't want to get into commentary about customers and impact of that in Q4, but it's of the order of CAD 5 million of EBIT, something like that.
And when you look at the Innovia business, can you talk a little bit about the decline in the flexible packaging demand?
Yes, well, that was really deliberate. We decided to exit some very low, almost no margin business we had in our large plant in the U.K. And so we took some decisions to exit some loss making product lines. So that's really was the main driver for that. And the margins we make in the packaging space is significantly below others, so that's really the basis of our decision. We didn't really have much impact on the bottom line. It was really the top line exit.
Okay. Okay, that's helpful. And then when you think about Avery going forward, I mean binders has been a bit of an undesirable category for a while and I'm just curious, when do you expect potentially for the binder business to sort of flatten out?
Well, not much, not that much of it left. So we expect to have a better year next year, because we are just less vulnerable than we used to be. So most of our exposure to it has really largely gone. And it's become an industry punch ball, it's been used as a loss leader for retailers and people in the back to school industry for some time now, and that's kind of got worse as the categories got more mature. So we've stated it because it's important to some of our trade partners and we've said, look, we'll supply you at the price point that makes sense and if it does and you want to buy, we're here. If you don't and you want to go offshore, then be our guest. And we let the price decide what the outcome is, and that's what we did this quarter and we have no regrets. If we look at Avery's cash flow, it's actually a little up on prior year, because the impact that business has on a cash flow in building inventory and storing up in warehouses is quite considerable. So we're not crying too much there about -- by the loss of share there and sort of in the long term will focus more on the other categories.
Yes, of course. Okay. That's great, Geoff. And just finally, can -- I just wanted to clarify the numbers you gave around the resin price delta. I think you said resin price is up about CAD 50 million from the...
Yes. So if we take the low -- the endpoint of 2016 to where we are today, so we bought the same amount of resin in 2018 and we bought at today's price, the difference is CAD 50 million and we've recovered rather less than CAD 10 million in price increases.
Okay. And would it be safe to assume that any further price recovery -- and I know you put through some price increases, but it sounds like that won't really come until maybe the middle of 2019.
I think you'll see some impact in the Innovia segment in Q1, and -- because we've taken actions there and we'll see the impact of that in Q1. Might take a little longer at Treofan. Treofan has just really experienced what we had in Europe at Innovia, this part of the resin took a bit [ lead ] in the U.S. in May, and so we bought significantly higher prices in Q3 than they bought in Q2 and have been some time prior to that. So they've got some work to do to recover that. But we're also in an environment where we need volume to start the line up. So it's a more complicated equation with Treofan, because you need revenue to start the line up.
Our next question comes from the line of Scott Fromson of CIBC.
So you mentioned market share gains, can you give some color on which companies or types of companies you're taking market share from and perhaps geography?
Not really. I mean it's a highly fragmented industry, Scott. We have thousands of competitors all over the world. So I don't think we'd impacted any one company to any great extent anywhere. So we think about the gains at the customer level, and so that's where we focus on. But we've been growing in the HPC space close to double-digit globally and that industry is not growing at that rate. So that's probably the best color I can give you. So I don't know, probably the average global customers growing at 3% to 4% and we've been growing at 8% or 9% for a couple of years now. So there's only one reason you can do that and that's share gain.
And I assume that you are seeing the benefits of supplier consolidation among the big -- like CPG type companies.
Yes, it's more things we've created, the innovations that we've done in our label product categories that have helped our customers differentiate themselves. We are not really doing anything where we are taking share based on -- well, you make product A, we want to make it too and here's our price. We haven't done any of that. It's about creating applications for our products that didn't exist before and increasing the size of the market and taking share. This is not price-based, it's already innovation and technology based.
That's good. Just on the gross margins, are you able to quantify the impact of direct labor inflation on…
It's very small...
I guess maybe my second question is -- next question isn't so relevant. How much of the CAD 350 million of annual CapEx guidance over the next 2 years is earmarked for automation and similar kind of labor adjustment projects?
None.
None, okay.
Yes. I mean it's just not a factor, it's a -- you know labor is -- if we go to our most expensive jurisdiction, which will be sort of Germany and Scandinavia, our direct labor expense is a small -- less than 10% of sales for sure. So the impact is -- compared to other things in our business, in raw material sensitive industries. So that's where our focus is. It's always about reducing cost of raw materials more than it's ever about reducing the cost of labor. So the equipment we buy is always more productive . So we're always buying the latest and greatest to increase productivity. We certainly focus on that. But looking at absolute raw labor savings, that's not something we spend a lot of time or energy on.
Okay. And a final question, just going back to, I guess, probably home and personal care and food and beverage, are there any particular product categories that have exceeded expectations?
Yes. We see -- probably the one underlying trend in our industry in the consumer products decoration world. So labels that make brands look more fancy on the supermarket shelf. So we're seeing outsized growth in the sleeving category, so right across our product lines. So sleeving has moved into the personal care space in quite a big way. It helps food and beverage customers premiumize brands. So it's really capitalizing on that sort of premiumization phenomenon. Most of those companies are really growing by price-based revenue initiatives and selling premium position brands to high income consumers and these kinds of labor products help them do that. So that's where we are seeing the outsized growth.
So I assume that would be shrink more than sleeves?
Shrink sleeves, yes. The shrink and sleeves is the same thing -- shrink sleeves.
Our next question comes from line of Maggie MacDougall of Cormark.
So I wanted to circle back on Innovia. You mentioned you've had discussions underway with your customers on pricing for a little while now and they're continuing, and I'm wondering if you know whether or not some of your competitors are doing similar types of -- or having similar types of discussions.
Well, that would be up to them, but they buy resin in the same market that we do. So they're going through exactly the same experience as we do, I mean when you buy these kinds of raw materials, there isn't much of a negotiation, you have very large chemical companies telling you this is the price, so that price applies to us and everybody else in the industry. So I think what they do is really up to them, but we decided what we're going to do and we'll see what the outcome is.
Okay. And so I guess the question was really more so meant to understand whether or not there should be any concern around market share losses if you are raising prices and competitors are not.
Well, I think at this point the resin hold is so big, if we have a little bit of market share -- we have to cede bit of share to get the price point we need to bet the margin where we want them to be, though. So be it.
Okay. And then you've commented a little while about Treofan, the U.S. resin price up in Q3 and so they are sort of experiencing the same thing now that Innovia has been experiencing. But it sounds like perhaps pricing there needs to be somewhat measured, simply because you've got the new line starting up in Q1 and you need to load the volume up. Is that an accurate understanding of the dynamics?
That would be correct.
Okay. And so then just one final bigger picture question. Outside of Innovia you guys have very efficient pass-throughs on any type of inflation and you've got excellent market positioning, you've just discussed new applications, increasing the size of the market due to innovation and so on. So I'm wondering if you think it may be possible that if we get broader inflation in the U.S. or in other economies, if that could be perhaps a boost to your organic growth and margin, over and above what some of your competitors or maybe what we might consider comps in the packaging space might see?
Yes, I think -- the question is around Innovia, and whether we can get the price cost equation correct. I think it's the same thing we went through for many years in our can business, where we have had made no comment about that relative to the rising costs of aluminum, which also have risen 30% or so in the last couple of years. So there we've got very efficient pass through mechanisms and we spent quite some time with our customers educating them on that and now have an industry where that's, I would say, rational in terms of what happens when there's raw material movement. So I think at Innovia we want the same kind of -- same kind of disciplines in place when there's movements in these raw material indexes. So it's more of a spread pass-through business, rather than debating at which point the raw materials will be moved along or not. So there would be some -- in terms of revenue, clearly if you raise prices 10% or 15%, well, obviously that's what's the corresponding effect on the top line.
Our next question comes from the line of Michael Glen of Macquarie.
Geoff, just a clarification. In terms of how resin impacts the currency printing business versus the specialty films business…
At this period, Michael, the resin content is very small. The value-add beyond the resin is enormous. So if resin goes up 50%, you might have to raise your price 5. I mean it's a 10:1 ratio.
Okay. Do you have pass-throughs on the currency side?
We do in some of the contracts, not in others, but if you did or didn't, it doesn't really make a big difference. The amount of resin in the notes is really full.
Okay. And then on CCL, so one of the largest suppliers for label and graphic materials highlighted that they're taking some price actions for raw material pressure. Are you not seeing anything within your supply chain on label and graphic -- on label materials at this point?
Yes. I mean the label industry is going out with price increases right now, and we have to bear in mind, in that industry we have millions of SKUs and literally millions, and they change size and shape and number of colors and everything else, literally, day-by-day. So it's fairly easy to finance any changes in cost pass-throughs there as needed. And another thing that our team is very good at is making sure they have alternatives available either changes in specifications for the materials or regional changes, taking about age of price points in different parts of the world and making sure the impact of those price increases are minimized. So we've seen no impact in the third quarter of any raw material cost inflation in the CCL space. So it really has been restricted to Innovia, a little bit at Avery, because there the products don't change. So if you have raw material inflation at Avery, eventually you have to pass it through and that's why we are going out with a price increase at Avery in the early part of next year.
Okay. Just on -- so CCL, the Label, the margin was flat year-on-year. You did a 7.5% comp. Should we -- with that level of comp in that business, should we think about the ability to have margin expansion?
It's not that kind of an industry, Michael. I mean we've 140 plants and there isn't one big factory that churns its stuff out and then when you get a revenue raise, it just sort of drops straight through. It's much more mix sensitive than it is volume sensitive. So the reason our margins are probably a little bit below what you might have expected is really entirely driven by CCL Secure, not driven by anything else.
Okay, got it. And on the ring binder business, you highlighted a CAD 20 million top line impact and an CAD 8 million bottom line. Is that the implied margin then for that business?
It is the incremental margin loss in that business. So it was very profitable in the months of June, July and August. And then had 9 months of losses. So you would have kind of very nice margins for 2 to 3 months and then you would lose money for the other 9 and then you add up the 9 and the 3 and see where you come out for the year. So when you look at the margin for the year, it's single-digit EBITDA margin for the year, very low single-digit operating income for the year for the last 2 or 3 years. But all that money is made in about 10 weeks, so in those 10 weeks you have it. That's the way we used to historically make a lot of money, but this year not.
Okay. And for Q4 in Avery, can you help me understand the swing factor there again, it was just…
So there's no -- so we had no ring binders last year, we had no ring binders this year. So it's not in the equation at all. That's really for you to see what's going on in the underlying business in the full quarter. So [ as a matter of fact where ] I can tell you, our revenue is up a little bit, our profit is up a little bit, because we have no back to school effect in there.
Is there a point in time where you think that the digital business can overcome the negative comp in the binder business?
Yes, well, we're getting -- the binder business is really receding of the issue right now. So we've got a bit of churn going on. You've probably read in the papers about some of the players in the retail space in that industry, the Office superstores and a couple of the people in the wholesale channel. So there's been some M&A activity in the channels causing a little bit of churn right now. We are not too bothered about that. So that's really the mass market channel and the ring binder effect that we are pleased to see the back of them. We'll have a much, much better situation this time next year than we had going into Q3 this year.
Our next question comes from line of Elizabeth Johnston of Laurentian Bank.
Just continuing on Innovia, just to ask another question on that topic. In terms of the pass-throughs, can you review for us the passes that you have in place now? On an average can you say that they are...
I couldn't do that Elizabeth. We have a lot of customers in that space, every contract is different. There is no average. They tend to run for a year or so. And then there's various expiration points that happened -- and some have happened already, some are happening between now and the end of the year. So as they come up for renewals, we are a lot more organized this year than we have been in the prior year. So there's a lot more organized activity around that than there ever has been.
Okay. But within that...
I think the causes to watch on this will be Q1 next year, particularly when we see what happens with our legacy Innovia business. That will be the important causes to watch.
Okay. But just in terms of those one-year -- those contracts during that year, is there are mechanisms in place to pass on pricing.
Yes, we are changing all the mechanisms that are in place. So as these contracts expire we are negotiating a lot of things, including the nature of the mechanism. So there's a lot of things underway with customers, both on the resin cost, the spread and what happens in future about mechanisms. So it's had an extremely far out detailed review and there's a lot of activity in place happening customer by customer around the world.
Okay. So longer term, over multiple years, then you would expect over time to be able to tighten the pass-throughs, generally speaking, is that correct?
Yes, we don't see any reason why this would be any other different. I mean, I referenced our can business, we have the same challenge with aluminum in the past, and we've now sorted that out and we've got a very disciplined process in place, so that it's routine, it's mechanical. And aluminum also went up a lot the last couple of years and we haven't talked about it, because we didn't need to. So we have to do the same with Innovia.
Right. And when it comes to the split right now for that segment, Innovia including Treofan, a split between U.S. and Europe, it is still more heavily weighted towards Europe in terms of top line revenue?
No, no, no, because Innovia ships a good chunk of it's raw materials to the United States, that's about half-half now.
Okay, great. And then with respect to your comments about the Flexible Packaging sales decline we saw that I guess in Q2 as well. What are your thoughts on the growth outlook organically speaking for Innovia…
Well, we are more concerned about cost price equation there. So if we not getting the margin spread, we'd rather exit the business. So that's what we're doing. So we're just going product by product, customer by customer, looking at the cost and looking at the spread and deciding what business we want, what business we don't. We are not really too much concerned about the top line, we are much more concerned to make sure we get the right spread in place, so we have a solid base to operate from.
Okay. So are there businesses within that segment that you're still currently reviewing?
Correct.
Okay, great. And just maybe a broader question on packaging. I mean certainly we've seen pressure in Europe for consumer as an industry to reduce the amount of packaging, are you seeing any risk to Innovia's results, specifically films or other...
Not really, because both Innovia and Treofan are very focused in the label segment and a lot of the films we use in that space are used to help our customers reduce container scrap. So the use of the primary packaging. So when a product is a primary package that's where we see the biggest sustainability initiatives. A lot of our label products aid the recycling of the principal container and that's where our main initiatives are focused on. So we don't see any real threats to our film label business as a result of these initiatives you're hearing about from Europe. If you're making plastic bags or these kind of products, it is obviously very different, but for labels we don't see any evidence of that.
So potentially even a benefit to them?
Correct. Yes, our film label business growth right now is in the mid-teens globally. So just looking at pure film and pure labels it's in the mid-teens. And I would say that's a reflection of what's going on in the label market, it's not a reflection of what we do. It's just a reflection of that industry.
Okay, great. And just one more from me. On Treofan, you mentioned the expansion which is coming online in the fourth quarter, is that right?
No, no. Q1 next year.
Q1. Okay. And beyond that do you have any need at this point, do you see any expectation to further expand operations there?
No. The focus on Innovia will be to get the EBITDA margins where they should be, to get the plant scaled up successfully in Mexico and to get our last U.K. plant having the right spread profile, it's got a good solid investment base and to get things -- get a solid base before we do anything more of ventures in films.
Our next question comes from the line of Ben Jekic of GMP Securities.
Few questions. Geoff, just on Innovia's margins, you mentioned, I think one of the analysts asked you on margins sort of mid-cycle and peak cycle and you mentioned mid-teen. Is that mid-teen EBITDA or mid-teen EBIT?
No. I think the answer to the question we gave was mid-cycle mid-teens and low cycle in resin, so when resin prices are low, high teens. And I've been talking EBITDA, not EBIT.
And then just one question on Avery. So if I understand, the reduction -- the ongoing reduction in the office product is sort of starting to reach an equilibrium. What is the capacity of this business, and I'm talking more kind of 2 or 3 years out, what is the capacity of this business to grow -- in terms of the growth rate? And then what is the capacity of this business in terms of operating margin? Where would you like to…
I think what we've said is we're not going to be growing in Avery for a little while until these things have all worked themselves through, but we still had a 20% operating margin in Q3 of this year and we'll be in the low 20s for the year overall. And we don't expect Avery to be a growth business next year. We probably won't see the degree of reduction we had this year and there's always a potential for margin expansion outside of this event in Q3, where the normal profit margins for back-to-school ring binders is there, and this year it was absent. It's really no more complicated than that.
Right. And my question on CCL Secure, you seem to have picked up some smaller mandates, I think in Latin and Central America. But kind of as a bigger picture, is there any trend going on, whether it's geographic or that is sort of indicating that central banks are more ready to use polymer in the future?
So well, I think it's -- I can't comment about what any individual central bank is going to do, but it's very clear now that a number of countries adopted it and the small countries interested and we'll have to wait and see what unfolds. And when there's news to report to you about something material -- I wouldn't read too much into any individual small countries in Latin America being terribly material. The 3 major countries in Latin America for currency are Brazil, Mexico and Argentina. Argentina is paper, Brazil is paper and Mexico is paper pulp polymer and the other countries are relatively small in terms of the usage. So I wouldn't read too much into wins in small countries, because the big ones that really count.
And our next question comes from a follow-up from the line of Adam Josephson of KeyBanc.
Geoff, just following up on, I think, a question Stephen asked about CCL in 4Q. I know you said top line will be up, but just given how difficult the comp is, do you expect bottom line to be up?
No.
Down?
Flat to down. If we could -- if we matched last year we'd be pretty pleased, because we had this big impact in this one-off order and it was just a very, very strong quarter last year right across the board. And the operating income was up 30%. So if we match that this year we'd be very pleased.
Same question for Innovia. The comp is pretty easy and you've added Treofan, but obviously...
There will be a lot of noise in the Treofan accounting. So we had a CAD 2 million foreign exchange gain in Q -- in the quarter that just closed. We'll have that reversed in October, because the peso weakened. So there will be some noise in Q4, so we wouldn't expect them to be making a big contribution in Q4.
Okay, so not up much in total year-over-year?
Correct.
Okay. And couple other ones. Just…
Avery flat, Checkpoint flat, something like that.
And same with Innovia?
Yes.
Okay. And with CCL for that matter. And then you have the tax benefit reversing. So you're not going to have that CAD 0.09 this year?
Yes, so we had CAD 0.09, which we disclosed last year and I was pointing that out this year. So you have to pull that out of last year's number to have a starting point.
You will be back at a 25%, 26% tax rate this quarter, where you will remain at that rate? And then…
Tax rate was in there. Do you remember what it was [ substantial ]?
I think it was 17% last year.
Yes, it was very low last year.
Yes. Just on China and just emerging markets more broadly, Geoff. I know -- one of your larger suppliers called out weakness in China. God knows how many other companies have called out weakness in China this quarter. You had just blockbuster results there. So it seems like there is this massive divergence between the industrial economy, which is clearly getting worse in a consumer economy, which sounds like it's getting better. I mean do you understand what's going on there?
Well, I would just say -- I think the domestic consumption economy in China is in good shape. So Chinese consumer is buying consumer staples. I think if you looked in the underlying results of most consumer products companies in China last year -- last quarter, they all had healthy growth in China, but a lot of -- very large number of them, not everybody, but a very large number there and we certainly saw that. So we were up a little over 20% in China. So it was very strong. So -- but the exporting side, the car Industry has peaked and maybe going head down, the electronics OEMs, the cellphone market is kind of flattening out a bit. So things like that and not in its good shape. But I think the domestic consumer staples business, we haven't seen any sign of any difficulties in that space.
Geoff, and just one last one on Innovia. You've had so many questions on it, just given the volatility in the earnings with the resin line. On a -- through the cycle, because obviously you bought into that business over the past couple of years -- through the cycle, how would you compare the returns, the expected returns in that business to what you have in the CCL segment?
Well, it's a different kind of a business Adam. You don't have to invest as much when you buy a line. It's a big one-time investment and then you have a return on capital in that line that can be quite interesting, but it probably has a lower margin profile, lower EBITDA and lower EBIT margin. But when you look at it in terms of return on fixed capital and working capital, it looks like it could be quite interesting. So I think it's -- but we're still figuring some stuff out and we certainly can't operate the way it's operated in the past with playing games with resin. I mean that's -- we have to get out of that and have a more rational basis to operate out there. But certainly when you look at it in returns -- in terms of return on capital, we think it should have a similar profile to our other industrial businesses.
And I'm showing no further questions at this time, I would now like to turn the call over to Mr. Geoff Martin for closing remarks.
Okay. Well, thank you for joining us on the call everybody and we'll look forward to talking to you again in -- at the end of Q4. Thank you very much.
Ladies and gentlemen, thank you for participating in today's conference. This concludes today's conference. You may all disconnect. Everyone have a great day.