Core Natural Resources, Inc. Q1 FY2021 Earnings Call

Thank you. Good morning, and thank you for your interest in Cornerstone Building Brands. Joining me today are Jim Metcalf, Chairman and Chief Executive Officer; and Jeff Lee, Executive Vice President and Chief Financial Officer.

Thanks, Tina. Good morning, and thank you for joining us. We're excited about 2021 and our solid first quarter start. I'm proud of the outstanding job our team has done to successfully manage through a dynamic market environment and capitalize on strong market conditions. Our commitment to execution and value creation for all stakeholders resulted in record net sales and EBITDA growth. Demand for residential products was strong during the first quarter. Overall company net sales increased approximately $145 million or 13% over a healthy prior year, as a result of volume growth and price. Volumes were 9% higher despite three fewer ship days and the weather impacts in the south. Volumes from the Windows and Siding segments were 16% better than the first quarter in 2020. Also, on a comparable ship day basis, residential volumes were favorable by more than 20%. Steel prices are at a record high, which we believe is partially influencing our demand within the commercial segment. As we discussed during the last call, the rate of incoming orders has accelerated as customers try to get ahead of further steel increases, pulling some demand forward. As a result, volumes were slightly favorable to prior year on a comparable ship days basis.

Thanks, Jim, and good morning. Our relentless drive for exceptional results led to another quarter of record earnings and year-over-year margin expansion. We continue to deliver strong financial performance by leveraging our national scale and expansive product offering, which highlights the strength of our business model. Starting on Slide 7, net sales were approximately $1,267 million, 13% higher than pro forma prior year, reflecting continued strength within the residential end markets and improved pricing in response to rising commodity and other manufacturing costs. There were three fewer ship days in the fiscal first quarter of 2021 compared with 2020. Adjusting for the difference in days, net sales were 18% higher than the prior year. We generated $139 million of adjusted EBITDA, $41 million more than the pro forma first quarter 2020 driven by $29 million from higher volumes. Adjusted EBITDA margin was 11%, an increase of 230 basis points from pro forma prior year. This improvement reflects our success in effectively managing through a dynamic raw material environment while staying disciplined on executing our strategy towards profitable growth.

So I guess, Jim, clearly, if I look at every raw material out there, it seems like over the last 12 months, they're higher. But specifically things like lumber are one of the outliers. I guess, the good news for you guys is you don't use a ton of lumber? But that being said, is there any way to quantify looking at your various product categories both non-res and res, how much more competitive you guys have become as a result of lumber maybe increasing faster than steel or aluminum or resin?

Thank you, Lee. We think what we really like about our product portfolio, particularly on the residential side, is when you look at vinyl windows, it's a perfect fit for what's happening in the residential market as you have the flight to the suburbs. The entry-level homes, the first-time homebuyers are looking at costs, and our windows really fit well for that portfolio as well as our vinyl siding, which has the sustainability standpoint. So we think, as you can see with the increased volumes we're having particularly on our residential side, it is a perfect fit for what's happening in the macroeconomics of residential. We're pretty excited about the next year or so. We think it puts us in a competitive position over other products. Then on the non-residential side, you look at lumber versus steel; it's a different type of construction. Steel generates less waste on the job, it's engineered. It is a product that we think is more sustainable for the environment, which is important for the non-residential side, particularly from a durability standpoint. We think we're positioned well both residentially and commercially with steel on the commercial side versus lumber, as well as our vinyl portfolio both windows and siding.

Yes, that sounds great. And then just one more from me: can you give us an update on the most recently announced price increases by segment and the timing of any additional known price increases you plan to put through? And I guess lastly, how far away from sort of an equilibrium do you think we are in terms of how much more you need to catch up in each of the various product categories over the next six to nine months?

Yes, let me just break it down into residential and commercial modes. On the residential side, as you know, we have a pretty strong backlog as we're discussing. So the price increases that we have announced and put into the system will start flowing through even more in the second quarter; we haven't fully realized all of our price appreciation on the residential side for both windows and siding that have been announced in the market. On the commercial side, it really depends. The building cycle is much longer. In fact, we announced a 15% increase just this week on the building segment, and the long lead times won't be impacting the financials until the second half of the year; because of the long lead times for building components, we have introduced numerous price increases that have a shorter lead time in weeks versus months. So we have price increases in the components arena as we speak.

So I wanted to start out on your Commercial segment, and certainly on the operating profit line, better performance than I expected. Can you just remind us last year what you did there in the Commercial segment in terms of delayering, footprint rationalization, etc.? And from your expected cost takeouts this year, how much of that amount is focused on commercial?

Yes, thank you very much, great question. As we've talked over the last couple of quarters, we not only delayered the organization, but we had a tremendous focus on manufacturing efficiencies. We're really proud of the team on the commercial side for their efficiencies in manufacturing, but also we’re very proactive in staying ahead of the pricing. As I just mentioned on the last question that Lee had. We really set up the commercial business for this year. As we mentioned there is some, we believe there is some pull-forward in the commercial business. But we feel good about the second half of the commercial business with what we're seeing with the architectural index and some of the infrastructure spending that the government has been talking about. We feel pretty good about the back half of the commercial business. We're focused on price over inflation as we said; there is going to be some slight compression in the second quarter. But we think that the back half of the year will really help the margins of the commercial business.

And Julio, just to give you a little bit of breakdown by segment, so a lot of our focus on cost-outs is inside of our Windows segment. There are a lot of opportunities and a lot of automation that we have put in place, and we will continue to realize those benefits in 2021. The investments that we are making will continue into 2022 as well for Windows. Specifically for the commercial business, about 30% of our cost savings will be derived from our commercial business. Most of that will be inside of the cost of goods sold line item for the business. There are a lot of good initiatives; there are a lot of projects that are out there that make us more efficient and safer for our employees. We will also be taking some of the labor out on jobs that traditionally people don't want, or we have a lot of, we work in material areas associated with those. A lot of great projects are in place, and in many cases, the equipment has been ordered. So we feel good about that cost-out initiative.

And just to be clear, that 30% of the cost takeouts focused on commercial, that would be for this year?

That is correct. Yes, we've got the cost-out guidance of about $75 million to $80 million worth of cost-outs and about 30% of that is going to come from our commercial business.

And I guess the $7 million unfavorable impact in the quarter in commercial. Jeff, I think I heard you say in the prepared remarks that you expect price-cost neutrality for that segment for the full year. Based on Jim's commentary, I guess you expect continued headwinds next quarter, but maybe some makeup in the back half of the year. Is that fair?

Yes, that's correct. As we go forward with our price announcements, what took place really inside of the first quarter was a sharper curve than we anticipated. Our price announcements have continued to rise. We had a little bit of pressure as we go into Q1 and Q2. But we've managed through this in the past. If you go back and look at 2018, for example, we saw a sharp rise about 25% inflation inside the back half of 2018 and it came down in the first half of 2019. Through that cycle, we were able to get margin enhancement and get price over inflation. But in sharp inflationary environments, it's difficult to catch that inflation as fast as it’s rising. So we feel good about that. We think that in the third and fourth quarters, depending on what steel does, if we see steel turn and go back in the other direction, then that's typically when we start to get the benefits. If steel continues to linger, then we've done the right things and made the right actions in place to offset that, but we won't necessarily see a benefit from that until steel turns the other direction.

Okay. And if I could just sneak one more in here just on your recent acquisition of Prime Windows. You talked about expanding West Coast presence and focusing on structures of 15 stories. So, just thinking about that, could you talk about how it kind of complements the portfolio as a whole? And if those high-rise type windows would be margin accretive to the overall segment? Thank you.

Thank you, we're really excited about having Prime Windows join us. Stepping back, as we look at acquisitions, which we've talked about in the past, they need to be strategic and accretive. We're really looking at Prime Windows as both of those. It filled a geographic void that we had in the Colorado and Washington area. Its end-to-end used markets are very dealer-focused, which is a higher margin business for the windows business. It also gave us a little bit of additional capacity which we do need as well as talent. We're really excited about having that. The 15 stories is something we haven't had the product offering to do that. So we're going to learn from that. There could be some other opportunities for us, but we think that Prime Windows is an important component of our growth strategy. Our whole M&A strategy is really to lead the consolidation in key product categories and really in fragmented markets. We think we have some additional opportunities as we look at the market. It fills a geographic void and puts us in a market that we have not been in while being accretive to both the window business portfolio and the company overall.

I just wanted to start with kind of competitive dynamics on the residential side. One of your larger peers in windows talked about taking share with the ability to cut down lead times. But if I look at your growth, it suggests you're doing the same. So I was hoping you could talk about where your lead times stand in windows today. And whether you feel like you've been a share-gainer against smaller competitors across your footprint and what you might attribute that to?

Kurt, that's a great question. We're really focused on knocking down our backlog and reducing our lead times. Our lead times on windows are probably two to three times longer than normal. We're very focused, as we said, on putting in additional capacity with the Sacramento facility. Our automation projects from last year really helped us with the increase in the first quarter. Typically, when we implement automation for our 1500 Series line, it increases capacity anywhere from 10% to 30%. We're excited about growing our business. We want to work our backlog down. We are not where we should be on lead times, but we feel we are gaining market share with strategic customers due to our lead times in relation to the rest of the industry. We are working hard on the labor side; it's not a machine time issue. We have the appropriate machine capacity; the key is labor. We're focused on bringing in additional labor and implementing more automation projects so we can continue to grow our business and outperform the market.

And Kurt, maybe just to add to that a little bit as well. As we think about our residential business, and I don't know which competitor you're referring to, but our volumes in the first quarter grew 16% year-over-year, and we feel good about that. Like Jim said, the capacity we put in place and the efforts we made towards labor in the second half of 2020 enabled us to achieve the performance of 16% growth in the first quarter. We think we've got great momentum and will continue to focus on the challenges inhibiting us from growing more. As you look at our guidance for the second quarter, we've guided our residential businesses to be up around that 20% range. That shows the momentum we have, and we feel confident in our market presence.

And maybe kind of sticking with that point and just putting a little more color on it. If we think about the automation project and also the challenges on the labor side, the windows year-over-year comparison gets easier in Q2. Do you think you can sequentially improve windows revenue as the year progresses if demand is there, or do you feel like as we get into the back half you're still going to be pretty tight on what you can do in terms of continuing to grow that?

Yes, Kurt, let me start that question. As we look specifically at our windows segment, we were up 15% in volume inside the first quarter. We didn't break out our guidance by segment, but we are up. As I look at the second quarter, the expectations are above 20% for our window segment. We do expect momentum inside that business. We've been gaining traction since the July timeframe of 2020 by adding skilled workers and becoming more efficient. In some cases, we are using additional dollars from overtime to ensure that we get those shipments out. So we feel good about our momentum, and the first quarter results demonstrate our ability to increase revenue. We expect to see this increase in the second quarter as well with our guidance.

And then on the siding side, I mean you've talked about how you feel you're one of the only vinyl players that's really investing back into the business. How would you characterize your performance here in Q1 versus the rest of the market? And what are you most focused on in terms of potentially growing your share of the vinyl market going forward?

We're really excited about our siding business. As you can see, the results are extremely strong. We had a record year last year and continue to have record performance. We're not only investing in the plants but continuing to invest in our siding plants and extruders. We also have a good, better, best portfolio of luxury vinyl siding in our business. We're very happy with the production; the manufacturing team is evolving continuously, and we've streamlined scheduling for longer runs. We can ship more and service our customers' needs. We have strong demand, but we feel we are the service provider in the industry. While our lead times are not where we want them to be, we're servicing our customers well by providing the right product portfolios. As Jeff mentioned in our prepared comments, we're investing in new product development and have launched test markets. We feel that by not only investing back into the plants but into marketing and customer portals, we aim to be the easiest siding company to conduct business with.

And Kurt, just a couple of numbers around that as well. As you can see on Slide 8, inside of our Siding segments specifically, 19% growth came from volume. We felt good about our ability to meet that demand in Q1 and as we look to EBITDA, one of the impressive aspects of that business is the volume leverage we're gaining there. We had a margin expansion of 260 basis points, although gross profit margins were down slightly due to pricing pressure and inflation in that business. However, by effectively taking out some SG&A costs, we managed to drive favorable performance for our Siding segment.

Okay, that's really helpful. And just my last question on the Commercial segment, could you talk about which end market segments you're seeing improved momentum in? As you mention customers trying to get ahead of steel price increases, what would need to be seen to grow more comfortable that the demand pickup you're experiencing is truly sustainable versus transitory and price related?

The end use markets seeing improvement are primarily warehouse and data centers. We're starting to see some retail returning as well, but those are the key areas, particularly the big mega warehouses that are supplying a lot of demand. We also track the fallout rate of orders to ensure they are legitimate orders. The order fallout rate is easier to monitor for the components business due to its short lead times while buildings are trickier to identify in terms of true versus pulled forward demand. We analyze the complexity of incoming jobs, evaluating whether they require high engineering input. Currently, many orders are straightforward as customers focus on meeting demand efficiently. We utilize a few metrics to distinguish between real demand and pull forward orders. Though we are cautious about pull forward, our leading indicators, especially in the architectural index, inspire optimism for the back half of the year, particularly as residential construction has strengthened.

Thanks for taking the questions. Back to the price-cost side: Are you seeing that inflation in shortages of PVC and aluminum, steel, etc. continuing to worsen today such that future price increases may still be necessary? So we're not kind of in the same boat with gross margin pressures in the second half? Or does it appear that these issues have stabilized at high levels and pricing just needs to catch up?

I think it's truly a tale of two stories here. First on the PVC resin, which had a big impact from the storms we mentioned that affected Texas and the Southeast markets. We believe that is working its way out and should be resolved in the second quarter with no significant shortages anticipated in the back half of the year. One strategic advantage Cornerstone has is our scale; we have subject matter experts in PVC resin, aluminum, and steel who maintain close relationships with our suppliers. With our scale, we get treated very well. As for steel, we observe the index closely. We anticipate that steel costs will continue to rise; however, we will stay ahead of our costs through our pricing strategy. So, we feel that while PVC resin shortages are more short-term, steel pricing will be a continued concern.

Got it, okay, very helpful color, and thanks for going across all the product categories there. Then back on the metal buildings side, just in light of the steel inflation, that is interesting commentary that the inflation is actually pulling ahead some volume from your perspective? Can you tell from your customers if there are areas or products within the commercial business where that inflation is causing customers to hold back, awaiting normalization and prices or perhaps finding substitutes?

We saw a little bit of that in the fourth quarter, but right now, the big question our customers have is whether we can supply the product they need. Pricing has become secondary in our discussions; particularly on the building side, they are planning orders for the third and fourth quarter, engaging in engineering work now. Discussions about alternative raw materials have not surfaced, particularly concerning lumber prices. We are cautiously optimistic; we are in a better spot in the commercial business than we have been in over a year. The leading indicators from the architectural index and the trends suggest a solid market for the metal buildings business in the second half of the year. The components business is fast-turning, and we are extremely busy; we are also ahead of inflation on our components business, with no pushback regarding alternative sourcing from our customers.

Makes sense. That's great color. And then the last one, just back on the Prime Windows acquisition: any color on the multiple pre, post-synergies, etc.? Additionally, how do you think about the balance of continuing M&A versus delivering?

Now, let me take that question. So Prime is, as Jim mentioned, very strategic for us geographically and also from a capability standpoint. From a revenue perspective, we believe it’s about $61 million for 2020, and we prioritize acquisitions that are margin accretive. This acquisition follows suit; however, without disclosing specific purchase price details or multiples, we are confident it will contribute positively to Cornerstone's margins as we realize synergies and leverage our scale. We’ve demonstrated this with previous acquisitions. We can turn this into an attractive business with the efficiencies we put in place.

Just to reiterate on our capital allocation, we want to reinvest in automation and back into our plants, which we've talked about as critical to our operations and serving our customers. Secondly, as Jeff noted, we are focused on M&A as well as organic growth. This includes investment in new products, like in our siding business, which covers luxury vinyl siding and our good, better, best approach to growth. Third, we maintain our commitment to improving our balance sheet; our target remains at 2 to 2.5 times leverage. We've made progress and indicated in the call; we are not where we need to be yet. But with a target of three-quarters to a turn each year, we are focused on each of those three areas of capital allocation.

Matt, just wanted to follow up on that point as well. If you look at Slide 10 with our leverage ratio projections, we finished the first quarter at 4.6 times. Our guidance puts it between 3.9 times and 4.1 times. We will continue to reduce that leverage ratio and have made significant progress, from 6.3 at the first quarter of 2019 post-ESW acquisition down to 5.3 in 2019, and 4.9 times currently, with projections at 3.9 to 4.1.

Thanks for taking the call; a follow-up here. Just on the commercial front, it looked like metal coil coating and metal building products were actually fairly strong with IMP quite a bit weaker. Is there anything to call out there in terms of the divergence or why the recovery would be maybe different among those product lines?

Yes, that's a great question. The commercial business includes buildings, components, IMP, and coil coating. If you look back a year ago, many architectural jobs were put on hold. We're now seeing growth, and our backlog for IMP is very strong. That segment was hit hardest by COVID-19. Regarding IMP, there were supply issues in the quarter due to storms that impacted that business, but we see that as a temporary issue. It's a great product, as it reduces labor and is considered a higher-end product. We believe with the architectural indicators we’ve discussed, we are optimistic about the growth of that business.

And then just a two-parter on debt and interest expense. As we look ahead and think about using cash to repay debt, will the priority be paying down the term loan, and second, regarding interest expense, recognizing there may be some costs in the second quarter with the note redemption, how do you think about the run rate interest expense in the back half of the year?

Yes, good question. As we look at paying down debt, we will assess whether it's best to pay down the term loan or the notes at the time, ensuring we consider long-term and short-term needs. Regarding interest expense, you're right; we had about a $26 million redemption premium that we paid to retire the $645 million 8% senior notes, which will not recur. This will reflect in our Q2 expense. For the full year, we've guided about $200 million in interest expenses; in 2022, we expect that to improve again without that redemption cost. I anticipate it will be around $170 million to $175 million in interest expense for 2022.

Thanks again for joining our call this morning. We are very excited about our outlook. I look forward to connecting with you after the call if you have additional questions. Have a great day. This concludes our call.

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