Eagle Materials Inc (EXP) Q3 2021 Earnings Call Transcript

Good day, everyone, and welcome to Eagle Materials Third Quarter of Fiscal 2021 Earnings Conference Call. This call is being recorded. At this time, I would like to turn the call over to Eagle's President and Chief Executive Officer, Mr. Michael Haack. Mr. Haack, please go ahead, sir.

Thank you, Lisa. Good morning. Welcome to Eagle Materials conference call for our third fiscal quarter of 2021. This is Michael Haack. Joining me today are Craig Kesler, our Chief Financial Officer, and Bob Stewart, Executive Vice President of Strategy, Corporate Development, and Communications. We are glad you could be with us today. There will be a slide presentation made in connection with the call. To access it, please go to www.eaglematerials.com and click on the link to the webcast. While you're accessing the slides, please note that the first slide covers our cautionary disclosure regarding forward-looking statements made during the call. These statements are subject to risks and uncertainties that could cause results to differ from those discussed during the call. For further information, please refer to this disclosure, which is also included at the end of our press release. Let me start today by acknowledging that we had another solid quarter of increasing earnings in what is shaping up to be an exceptional fiscal year for Eagle Materials. Our results reflect that we are entering into a cyclical phase for our businesses where the demand for all of our products is strong. There are two overarching reasons for this. One relates to market conditions, which are on an improving trajectory in most respects. The second relates to Eagle's high-performing low-cost geographical advantage of our operations that can take advantage of these market opportunities. Let me start with some foundational comments about market conditions. Housing construction is an important driver for both sides of our business, and single-family starts are especially important for Gypsum Wallboard. There are positive short-term, mid-term, and long-term dimensions to the robust housing-related demand for our materials. As for the short term, Wallboard is installed on walls and ceilings in the later phase of the building construction process after framing has occurred. This means that the recent increase in starts and permits will have the greatest impact in the months ahead. The pandemic has resulted in a surge in home buying. Pent-up demand has been swelling over more than a decade of underbuilding and is now being realized. What’s more remarkable is that even with the improved rate of home construction, we as a nation still do not have a balanced supply and demand picture for housing. Home inventories on the market remain at all-time lows. We believe the annual housing supply-demand imbalance is unlikely to be rectified by new constructions before 2022. This is in part due to the phase of what is possible for home builders to get into production. This supply-demand pressure will challenge housing affordability, but given the commitment to keep interest rates low for an extended period, it should translate into multi-year construction, a continuation of a favorable mortgage rate environment. Another important segment for us is repair and remodeling. Research shows that purchasers of existing homes spend money on remodeling materials in the wake of their home purchases to make the home their own and to fully conform to their needs and tastes. Longer-term trends also favor our geographic positioning. The migration from states such as California, New York, and New Jersey, to states in the southeastern U.S. from Carolina to Arizona and in the U.S. heartland, including Texas and Colorado, is expected to continue. This migration aligns well with our network of facilities within Eagle Materials. We have the inflated capacity required to meet the demand growth for Wallboard without additional capital investment. We expect to benefit from higher volumes, higher margins, and restrained costs as our ownership position adjusts raw materials and paper. Now, let me turn to the market outlook as it relates to the Heavy side. Infrastructure spending drives about half of the U.S. cement demand, with residential being the next most important driver. State budgets have been the lion's share of infrastructure spending for many years. We do not want to minimize the pressure that some state budgets are experiencing, but our analysis of the sources of state revenue including sales taxes, property taxes, income taxes, and corporate taxes suggests to us that many states and cities would not be severely affected as some might fear. This is especially relevant for many of the states in which we operate. What our analysis shows is that income and sales tax, which account for more than half of the state and local revenues, fell in Q2 but surged above pre-COVID levels in Q3. The states still have choices on how to allocate this money. But we maintain our expectation that even without federal support to states and cities, trend demand for cement will be sustained in low single digits across much of our footprint. Of course, state DOTs could receive further federal support with the new administration, and this would provide an uplift to infrastructure construction activity. To be clear, that multi-year federal funding generally takes years to materialize and translate into demand for our products. Non-residential construction is the smallest segment for heavy, and we continue to see short-term pressure. Non-residential construction continues to be depressed by the potential dangers posed by many indoor activities. The pipeline for office projects has been significantly and is also very geographically dependent. Spending on manufacturing buildings is beginning to see some improvement, and warehouse construction trends are strong in many of our geographies. Now, let me address the second factor mentioned, which is the high-performing, low-cost network we've created to take advantage of the market opportunities that are presenting themselves to us. Opportunities that, in our view, should continue for some time. The only limitations in our ability to capture these opportunities are in cement. We are operating at very high levels of capacity utilization today, and we are facing a tightening cycle that would challenge our resourcefulness to squeeze out every bit of production through optimization of grinding, season storage, and marketing selection. Whereas in Wallboard, we have headroom for earnings expansion through volume and price growth. Going forward, we expect price will be the most important earnings growth lever for us in cement. Against this positive backdrop, uncertainties about the pandemic and getting it under control remain. Because of this, I do not have an update today on the timing for this spin, and I won’t until there is increased visibility that we are past the potentially more disruptive effects of the pandemic. We are hopeful that vaccines will be a game changer. The optimist in me believes that risks for the business lean towards the upside and the best is yet to come. With the introduction of context for our results, let me turn it over to Craig to discuss the financials.

Thank you, Michael. Eagle's third-quarter revenue was $405 million, an increase of 18% from the prior year. This increase primarily reflects contributions from the Cosmos cement business we acquired in March, adjusting for the acquisition and the sale of our Northern California concrete and aggregates business. Organic revenue improved 7%, reflecting increased cement and Wallboard sales volume and prices. Third-quarter earnings per share from continuing operations were $1.94, an improvement of 87%. As we highlighted in the press release, prior-year results include a $0.47 per share asset impairment charge. Excluding the non-routine charge, third-quarter EPS increased 28%. Turning now to segment performance. Let's look at heavy materials results for the quarter highlighted on the next page. The heavy materials sector includes our cement, concrete, and aggregate segments. Revenue in the sector increased 21%, driven primarily by the contribution from the Cosmos cement business. Organic cement sales prices improved 4%, while organic sales volume was flat with our facilities continuing to operate at very high utilization rates. Operating earnings increased 31%, again reflecting the addition of the Cosmos cement business, and organic operating earnings increased 8%, primarily reflecting higher net cement sales prices. Our concrete and aggregate business continued to benefit from higher organic sales volume and lower diesel fuel costs, with margins improving significantly from the prior year. Moving to the light materials sector on the next slide. Third-quarter revenue in our Wallboard and Paperboard business was up 8%, reflecting record third-quarter Wallboard sales volume and a 1% increase in Wallboard sales prices. As we highlighted in the earnings release, the quarterly average Wallboard price doesn't fully reflect the price increase that was implemented midway through the quarter. For perspective, the December average price was $152 per thousand square feet versus the quarterly average of $148. Quarterly operating earnings in the sector increased 1% to $48 million, reflecting the increased Wallboard sales volume and prices, partially offset by higher input costs, namely recycled fiber costs. Looking now at our cash flow, which remains strong during the first nine months of the year. Operating cash flow increased 69%, reflecting earnings growth, disciplined working capital management, and the receipt of our IRS refund. Capital spending declined to $46 million. Finally, a look at our capital structure. During the quarter, we continued to prioritize debt reduction as a primary use of cash, providing significant financial flexibility in light of pandemic-related uncertainties and potential opportunities. At December 31, 2020, our net debt to capitalization ratio was 41%, down from 60% at the end of our fiscal year, and our net debt to EBITDA leverage ratio was well below 2 times. We ended the quarter with $143 million of cash on hand, and total liquidity at the end of the quarter was $888 million, and we have no near-term debt maturities. Thank you for attending today's call. We'll now move to the question and answer session. Lisa?

Your first question comes from Trey Grooms from Stephens.

Hey, good morning. Thanks, and congrats on a great quarter. So I guess first off on the Wallboard business volume, it was very strong, and it seems like you outperformed some of the industry numbers that we've seen even for your region. So I guess number one is do you feel like there was any pre-buy going on in the quarter given the price increases that were announced, or do you think this is mostly driven by the improvement we've seen in new residential demand, and is there any, or do you feel like there was any market shifts or anything like that in the quarter? I think I know the answer to that but market share shifts just given the outperformance.

Yes. Thanks, Trey. It’s a good question. Similar to the last couple of quarters, I would tell you that if you look at the regional breakdown of both housing starts and the Wallboard shipment data across the country, we once again benefited from a very strong regional footprint and where we are generally in the southern half of the U.S. So that remains consistent from where we have been in the last several months. And then in terms of just underlying demand for Wallboard, it has been very strong, and as Michael commented, 80% to 85% of Wallboard is driven by residential construction activity. The most important part of that is new residential construction, and even more specifically, within that, single-family construction activities is what really drives Wallboard demand at the end of the day. We've all seen the recent housing start data and housing permit data that has continued to be very strong, which sets up really well for Wallboard, and that's why you're seeing the strength probably for the Wallboard business right now.

Got it. Okay. And then on the pricing from your October increase, it looks like it's gaining traction, especially given the details you provided around the quarter-ended price, I believe was 152. So a pretty good sequential improvement. So as we're looking forward and I know you guys have a January increase, I'm sure it's too early to really have a sense for what's going on there just yet, but bigger picture as we are looking forward I know you guys are looking for higher volume, you're looking for higher margins in Wallboard. You're getting some traction on pricing. Demand looks good. So how should we be thinking about the longer-term pricing picture for Wallboard as we're looking over the next year or two years as demand continues to improve?

I think you have pointed out several of the important aspects, and the most important part of that is the demand outlook and where single-family construction activities are really picking up momentum, momentum we haven't seen in many, many years. And I don't want to over exaggerate the move back out to the suburbs and single-family construction activity but as we have said before, single-family construction consumes more than two times the amount of Wallboard, and single-family construction activities are incredibly important. That's what will be the opportunity for further pricing from here.

Yes. Okay. Well seems like a good setup. And then on cement, last one for me, and then I'll hop out and pass it on, but on the JV volume being down, I think 6%. Can you talk a little bit about that and the drivers there? It sounds like in most markets you guys are seeing some pretty decent demand. So can you talk a little bit about what was behind the 6% down in JV and then what you're seeing in that market currently?

Yes. I can take that one. When we look at the Texas market, that plant has been one where we’ve seen fluctuations. Some low fluctuations, not a significant portion of our portfolio, but arguably, they are converting more into construction-grade material as we view that as a lever back and forth. Hence, some of the demand decrease you see is due to some of the reduction of oil well drilling this time and as we work to migrate that into the construction-grade material that we provide; you should see that picking up a little bit more and closing that gap.

Your next question comes from the line of Brent Thielman with D.A. Davidson and Company.

Great. Thank you. Congratulations as well. I had a question on the cement business. You made the comment that you continue to operate it at very high levels of capacity utilization, and as far back as I can remember, I think you guys have been in that position. I guess my question is, is there a desire to expand the capacity of some of these assets right now? Are you seeking to make any preparation for that?

Well, if you might remember, in some of the previous calls, we did some expansions during this year, and we actually set record cement shipment numbers in our businesses not last quarter, but the quarter before I should say. We did a expansion at our Sugar Creek facility with grinding capacity. We've also done some work around our networking and distribution channels with it. Right now, when we look at a lot of our assets, we are at capacity. That doesn’t mean we're not trying to squeeze out every single ton from every facility we have. We do have some strategic projects to look at expanding capacities; it's just not in the existing facilities. It's just not ones that are significant volume additions. Thus, our comments were that we're at nearly full capacity until some of these projects come in, and then capacity is not going to grow significantly from our existing structure.

Okay. I appreciate that. And then you guys have obviously paid down a lot of debt. Leverage ratio is coming down. Any thoughts on kind of growth initiatives right now? I know you guys are still making preparations around the separation. How do you think about potentially looking at M&A today versus a couple of quarters ago?

Yes. Every time we are always looking at M&A, and M&A has to meet several thresholds for us. As you're probably well aware, we're very disciplined in where we play and how we view the businesses. We will always look at opportunities that make sense for us, that fit into our network, and that cover returns that we think we could improve those businesses. So we're always open to that side; just the opportunity has to be right for our business.

Understood. And I guess coming back to cement, I'll give it a shot. Just curious if you offer any commentary on any price initiatives planned for calendar '21, and I'm curious if you think just given the fact that you guys and others in the industry are operating at such high levels of capacity, do you think the industry can get back to sort of the traditional plan of two price increases this year?

That can be really dependent on our customer base and what the demand profile looks like moving forward. As we said in our comments, we see the demand being very strong this year. Typically, in the industry, cement price increases come in the early summer/late spring timeframe, so we are working with customers on those and having those discussions now, and as those unfold, we'll be able to provide you more insight on where those reside in the coming quarters.

Okay. Last one for me, just any perspective you have in terms of change administration and potential regulatory implications to come. Obviously, there are different views on things than in the prior regime, so I am curious what you're watching from Washington on that front.

Yes. That's a good question. One of the things that has made a lot of highlights is the Infrastructure Bill, and we are continuously watching that. We do want to be pretty frank, and you can see in my comments that we think the states are strong by themselves, but a federally funded infrastructure bill would be a significant benefit to us, and where we want to be cautious with that is that those bills are multi-year and take a lot of planning upfront, which translates into demand for our products down the line. We do think that that is a potential possibility with the new administration, and we're going to watch that closely.

Sorry, Michael, I was just referring more from the EPA environmental front. I mean anything on that end that you guys are closely monitoring?

We always continuously watch that and monitor that. Our core values are to do more with less. So we are continuously monitoring that side, and all of our plans have permit levels and limits that we follow stringently and try to drive value out of those while doing more with less concerning fuels, additives, and everything else. So we continuously watch what the new administration may change in those metrics, and we'll keep our eye on that, but we're well prepared for it.

Thank you. Good morning, everyone, and congrats on the results as well. Just going back quickly on the previous question. Do you have any existing plans in place to reduce CO2 emissions? That's my number one question. And then the number two question will be have you been looking at blended cement basically to be able to reduce at least the fact that we understand that some DOTs, including the one in Texas, are now allowing for lower clinker factors in cement. So are you looking for any opportunities to reduce it by using other substitutes?

Yes. When we look at cement as a whole, we've always been interested in that. Tied to your first part of the question on your ton of cement and CO2 emissions, we can do some blended cement and incorporate some additives into it. We have a flat business. We do Portland, and we have always been looking at how to reduce CO2 emissions. Part of that is through blending cement, and we also have plant operations that fall into certain categories. So we have been looking at all aspects of that for several years, and we plan to continue doing so going forward.

Good morning. On an organic basis, your concrete and aggregates revenue is up, I think, 13% year-over-year. I'm just wondering if you can break that out between volume and price and in terms of what's driving that strength if it's fair to say that's exposure to residential. Is that kind of growth cadence maybe possible over the next couple of quarters, or is there a reason it would accelerate or decelerate?

Yes, Anthony, good question. I will make a couple of comments. First, consider that our concrete and aggregate business is really in three markets today: Northern Nevada, Kansas City, and Austin. We are in a few markets where a change in one part of it can really impact the average. So you're right that we saw a good result, with frankly the improvement coming from both volumes and pricing on an organic basis. We just had some really good performance metrics in a couple of our markets, not to mention that on the margins side, lower diesel fuel costs really helped us, and our teams have done a fantastic job of some operational efficiencies as well. So far, we have done very well. It looks like housing will continue to be strong for us, which is favorable for our concrete and aggregate volumes.

Okay. That's helpful. And then is it possible to quantify the benefit you saw from hydrocarbon deflation in the quarter, and is there a way we can think about the impact of that in Q4 either lessening or reversing just based on how these costs are trending in January so far?

So when you say hydrocarbon, we have seen benefits. Overall, for the quarter, it was under a million dollars in total for the quarter. On the Wallboard and paper side, where we generally use natural gas, those costs have been pretty flat for the year, now sub-$3 a million. It fluctuates a little bit within that range, but it has improved dramatically over the last three or four years.

I'm wondering if you could talk about infrastructure. We've seen lettings activity slowing over the course of this year. And the last time we had discussions about infrastructure bills that drove to further slowdown in lettings. Can you just talk about what you're seeing in your markets in terms of the pace of the DOT activity and if the hope for federal money is driving any change in the pace of lettings either to date or from here?

Yes, Jerry. In my comment section, I was alluding to some of that, is that we see the states are responsible for a lot of the infrastructure building spend, and the sales tax receipts from all of our analysis look to be at or near pre-COVID levels, and some of these are higher than pre-COVID levels. There wasn’t a significant drop in any of our markets, or even at a lot of our markets on that side. So we see that the states are taking responsibility themselves. As it comes to the federal side, those take longer to materialize. Those would be some extra benefits that the states will get with support from the federal government if a bill is to be passed. But again, the timeline for those projects coming into play is after the engineering work is done and construction starts, which translates into demand for our products down the line, similar to housing starts; a couple of quarters down the road before we'd see any significant impact on that side. But for the states we operate in, we feel fairly comfortable with what the outlook is for this next year.

Okay, and then on Wallboard, in the past you folks had a single price increase a year, and obviously, you put two increases in over a short period. Can you just talk about your pricing philosophy and message to customers going forward? When are you telling customers who generally expect price increase announcements? How much lead time do you expect to give them? If you could just talk about how the framework has changed compared to a couple of years ago when we had a single price hike?

Yes, Jerry. Look, I think I would tell you that the demand environment is more important than the cadence of the price increase. As you point out, years ago we went to an annual price increase environment set up, and that was the right timing for the situation we were in. Given the demand environment that we find ourselves in today, there's no doubt that the cadence of pricing has changed, and that's very consistent with the demand environment we see today. So I wouldn't use past experiences to totally rely on the cadence of pricing.

Yes. Well, we won't go into exactly how we negotiate with customers. It's just going to be demand-driven from here. And so far the demand environment has been very supportive of our overall business.

Okay. Thank you. And lastly, I appreciate the update on the separation. I am wondering if you can just expand on your prepared remarks and just talk about some side posts or some areas that you're working on to complete the separation, and if you care to comment on any updated thoughts on net debt allocation between the businesses.

Yes, the separation is obviously a standing discussion point at our board meetings. We will be having another discussion about this at that time. So I really don’t have any further comments or any clarification around that separation at this time until after we have a board meeting and discuss it, but we discuss it in every single board meeting. As soon as we clear the path forward, we will be announcing that up.

Good morning, Michael, Craig. Thank you guys for taking my question. Can you all talk about weathers delivery times on the Wallboard side, or maybe describe what you all are seeing in inventory levels at the dealer level more broadly across the industry?

Yes. Thanks for the question. I think a couple of thoughts there. One is the supply chain, and I'll speak more broadly for anything supplying the whole building business right now. It is being stressed in a way that it hasn't seen in many, many years. It's one thing to navigate a million housing starts, and another thing to navigate a million and a half or more housing starts. So when you are talking about appliance as a Wallboard, that supply chain is being stressed, and so lead times are extending a little bit in that environment. Other than that, I wouldn't say there are any other significant changes.

And then turning back to the M&A environment. You mentioned having an always-on outlook. Would you say you're looking more at the heavy side or on the lighter side, or are there equivalent opportunities? Maybe where there are more opportunities now?

Yes. As I said, we are always looking at a lot of opportunities that come available and we are very selective in what we choose. We have a long-term strategy to grow our heavy side of the business, and our strategy has not changed over the last few years at all. So we look at opportunities on both sides of the business, but we really focus on the heavy side of the business for the maximum growth opportunities.

Hey, good morning, guys.

Good morning.

What is your Wallboard capacity? I mean when we see housing starts and permits up 30%, just trying to think through how much you can grow your Wallboard shipments?

Yes. I think we disclosed this obviously in our form 10K. It's just shy of 4 billion square feet with five plants, four of which are located west of the Mississippi, sitting on natural gypsum deposits which are extremely valuable right near the facilities, and the other plant is in South Carolina with a long-term synthetic substance supply contract there. What you have seen is the housing demand picking up; that's pushing demand, pushing utilization rates, but there is a finite shipping range from which you can ship from. So that is one thing if you look at growth in Wallboard demand; we have been very fortunate that it has grown stronger in our market than in several others.

But I mean you could conceivably see a scenario where we are at that 4 billion?

Look, I think we are not there yet. We still have room to go at our facilities, particularly in Oklahoma and New Mexico. However, utilization rates have certainly picked up in the last couple of months.

And then Craig, what should we expect for Cosmos volumes in the March quarter?

Yes. The market for that plant operates as more of a northern market. So I would say it's a similar environment as Illinois and Kansas City, where we see strong activity in June, September, and even in the December quarter, but this upcoming quarter, the March quarter, is always about winter and the environment that we find ourselves in. So far, winter has been pretty mild for most parts of the country; that could change. However, January is always the slowest quarter for the cement business due to more seasonality.

I would have to ask about March.

To clarify, we only took ownership of that asset around March 6, so we only had it for a very small portion of the quarter, and you're still going to have a year-over-year comparison issue that will help you.

Hey guys, this is actually Collin on for Phil. Just wanted to touch on the cost in the Wallboard business. It looks like maybe more than offset some of that margin benefit from the higher operating leverage and higher prices. I was just wondering if you can talk about the different drivers there and how you're thinking about the headwinds going forward and, I guess, just the feasibility to offset these costs with those price increases.

Yes, Collin, keep in mind the price increase was only implemented halfway through the quarter. So we really didn't see the full benefit of the price increase this quarter. In terms of owning the cost side, there was input cost increases predominantly in the recycled fiber costs, but we did see those creep up a little bit year-over-year this quarter. It's too early to tell where those prices are going to go longer term, but that was predominantly what was driving this quarter's cost increase.

Got you. And then just on the paperboard business, external volumes were flat, internal volumes were down 3%, but you're adding a high-speed capacity. Demand for Wallboard appears strong and just appears to be getting stronger as we head into calendar year 2021. Can you just walk us through the divergence in volume trends between the Paperboard and the Wallboard business?

Yes, that happens from time to time just given inventory levels at the Wallboard plants versus at the paper mill. You can see that cadence dislocate for a period of time, and it has to do with buying patterns that both we do internally and some of our external customers. As we've said, that plant continues to operate in a sold-out position. In addition to the inventory swells, we have also moved away from non-contract sales in terms of third-party sales to ensure we satisfy the needs of our customers. So the new equipment is installed; we are learning to operate it. There is some downtime that we will continue to improve on, but you should see those volume changes align with each other over a broader period of time, more on an annual basis.

Okay, and then just pivoting back to demand on the Wallboard side. The robust housing starts and permits point to some really strong demand, but you're also hearing some bottlenecks from the builders about labor and things like that. So I guess just in terms of Wallboard volumes, can we typically expect low single-digit volume over time? Is this 6% trailing 12-month growth rate sustainable in the current environment, or would you think that that's a little aggressive just given some of the constraints that the market has seen?

Yes. Look, I think in our markets, and again I think we've highlighted this multiple times, our markets are continuing to outperform the national average. As we don't provide guidance specifically, given the current strength in home building, this is a pretty sustainable pace when it comes to Wallboard demand. Again, in our markets, I can't speak for the northeast or the northwest much, but we continue to see strength in our markets, and we like where we're positioned.

Great. Thank you very much.

Your next question comes from the line of Josh Wilson with Raymond James.

Good morning, Michael and Craig. Thanks for sitting in and congratulations on the quarter.

Thanks, Josh.

I wanted to circle back on the paperboard question. Margins were down a fair amount there. Is that purely a function of the timing of the recycled fiber, and is that a headwind that's yet to come to the Wallboard side but should normalize, or are there some other factors impacting the margins?

Certainly the biggest piece of that is the input costs on the recycled fibers that then get passed through to the Wallboard business on a quarterly lag, but as I said, I think we'll also continue to see efficiency improvements now that we've installed all of the equipment at the paper mill, which should benefit us as well. The other thing I do want to highlight is that when you look at operating income, realize there is a pretty decent amount of depreciation that's been added into that business. So you really have to look at it on an EBITDA margin basis on a year-over-year comparison because of that incremental depreciation.

Got it, and then your aggregates pricing slipped. Can you talk through what the driver was there?

Yes. Within aggregate pricing, you've got base pricing and sand and rock, and we just had a little bit more base sales on average or on the weighted average relative to where we were last year, and then base is generally lower-priced products. So nothing other than that. At this time, I would like to turn the call back over to Mr. Michael Haack for any closing remarks. Thank you very much for attending our call, and we look forward to talking to you at the end of the next quarter.

This concludes today's conference. You may now disconnect.