Eagle Materials Inc (EXP) Q1 2022 Earnings Call Transcript

Good day, everyone, and welcome to Eagle Materials First Quarter of Fiscal 2022 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, Josh. Good morning. Welcome to Eagle Materials conference call for our first quarter for fiscal 2022. 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 this call. To access it, please go to eaglematerials.com and click on the link to the webcast. While you're accessing the slides, please note the first slide covers our cautionary disclosure regarding forward-looking statements made during this call. These statements are subject to risks and uncertainties and could cause the 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. I'll begin today with some perspectives about our business environment, one that is continuing to improve. Residential construction represents the most important single demand driver for us, driving around 80% of the demand for Gypsum Wallboard and about 30% of the demand for Cement. The outlook for housing starts, especially single-family starts, which are particularly important for wallboard demand, remains strong. As long as mortgage interest rates stay in the lower quartile, by historic standards, this should be largely sustainable as we have been underbuilding against underlying demand in the U.S. for over a decade. This underbuilding has led to a record shortage of homes at the same time that household formations have been increasing. Repair and remodeling is a very important component of residential construction, and it is a healthy component of the underlying demand engine. With a financial boost from recent federal stimulus and strong house price appreciation, homeowners are continuing to invest in the upkeep and improvement of their homes. Homeowners also seem to be undertaking larger discretionary renovations, ones in many cases were deferred during the pandemic uncertainties. People are buying homes in record numbers, and I should emphasize where availability allows. And the knock-on effect for repair and remodel is significant. Whether it's getting a home in tip-top condition to sell or personalizing the home after purchase, there is a demand relationship between home buying and repair and remodeling. It was notable that President Biden said this month that he planned to make a historic investment in affordable housing by building and rehabilitating more than 2 million homes. The National Association of Realtors said that there is a cumulative demand-supply gap of 6.8 million homes. The loss of existing units through demolition, natural disasters or functional obsolescence has contributed to this shortfall, along with the underproduction of new housing units. These intentions, if acted upon, represent upside to our already robust outlook for Gypsum Wallboard. Cement demand is driven most heavily by infrastructure. There's also been a lot of discussion about President Biden's intentions around federal funding for infrastructure, and this is needed, and it is, of course, welcomed. Implementation will further challenge U.S. cement supply in many parts of the U.S., which is already straining to meet current demand. It is also important to emphasize, as I have in the past, that the lion's share of funding for infrastructure comes from states, not the federal government. There was quite a bit of concern about state budgets being impacted by the pandemic. But as we shared in the prior earnings calls, our analysis of sources of state funding suggests the impact would not be as great as some feared, especially in the U.S. Heartland states in which we operate. As it turned out, state and local revenues are, in fact, healthy. At Eagle, we remain virtually sold out of our manufactured cement. Our entire U.S. Heartland system is now starting to tension more than it has over the last decade. I'd emphasize that our cement volumes this quarter were slightly impacted by wet weather and not by the lessening of demand. The point of this is that the demand picture is robust today for both of our businesses. The factors driving this strength should be sustainable at least through the midterm. That is the demand side. Now let me spend some time on the supply side. I want to start the supply side discussion with some comments I made in the last earnings call, as I think they are important to reiterate. The first item is around the diminishing supply of synthetic gypsum in the eastern half of the U.S. This is due to less burning of coal as power plants change fuel sources from coal to natural gas and from their outright closure of coal-fired power plants. With a diminishing supply of synthetic gypsum, existing synthetic wallboard plants will be limited in their ability to fully utilize their current capacity, increase current capacity or build new capacity. Conversely, almost all of Eagle's plants have many decades of raw material supply, which are primarily our natural gypsum deposits. We are largely insulated from the direct effects of this diminishing synthetic gypsum trend, while our plants are also in a position to indirectly benefit from the supply dynamics that this trend creates. In this way, it is notable that the Gypsum Wallboard industry is increasingly looking more like the cement industry. The second point we discussed in the last call was around the significant regulatory and capital barriers to U.S. cement capacity expansion, whether it be existing facilities or through the construction of new ones. This is why in the face of increasing demand and with industry capacity now nearing full utilization, clinker capacity and the number of cement kilns has not only not expanded since 2010 but since the clinker capacity and the number of cement kilns has actually been reduced in the U.S. Against this backdrop, high-cost imports are increasingly required to serve U.S. coastal markets. Eagle is well-positioned in the Heartland of the U.S., away from the coast, and accordingly, Eagle will be positively impacted by this trend. These imports also carry with them a much larger carbon footprint than even the most inefficient domestic cement producers. This carbon footprint is not only from their in-country manufacturing processes but also from the logistics associated with delivering their product to their end-use customers. It is worth a reminder that Eagle operates some of the most modern and efficient plants in the U.S., and all of our plants operate within established stringent U.S. environmental limits. If you'd like to learn more about our ambitious cementitious materials agenda and our role in creating a net-zero carbon future, I'd invite you to review our recently released Environmental and Social Disclosure Report featured on our website. At Eagle, we are exceptionally well positioned to take advantage of opportunities that this current business environment provides us. Our balance sheet is strong, giving us substantial financial firepower when growth opportunities arise. We have also restarted our share repurchase program and completed the issuance of 2.5%, 10-year senior notes that will further strengthen Eagle's capital structure. In short, as we stated in past quarters, favorable demand outlooks, constrained U.S. manufacturing supply capability, and limited practical substitutes for our products in both of our businesses add up to a very bright future for Eagle Materials. With that, let me turn it over to Craig to discuss the financials.

Thank you, Michael. First quarter revenue was a record $476 million, an increase of 11% from the prior year. The increase reflects higher Wallboard and Cement sales prices as well as increased Wallboard and Paperboard sales volume. First quarter earnings per share was $2.25. That's a 3% decrease from the prior year. However, the prior year included a $0.93 per share gain from the sale of our Northern California businesses. Turning now to segment performance. This next slide shows the results in our Heavy Materials sector, which includes our Cement and Concrete and Aggregate segments. Revenue in the sector increased 3% driven by the increase in cement sales prices. The price increases range from $6 to $8 per ton and were effective in most markets in early April. These price increases were partially offset by lower cement sales volume, which was largely the result of heavy rainfall in Texas and reduced inventory levels across our cement network. Operating earnings increased 3%, again, reflecting higher cement prices, which were partially offset by higher maintenance spending in the first quarter of fiscal 2022. As we mentioned in the earnings release, during the initial stages of the pandemic last year, we modified the timing and extent of our annual maintenance outages, and we had lower-than-normal maintenance expense last year. However, this year, we completed full outages at each facility during the quarter, which increased maintenance spending during the quarter. The impact and the shift in timing and extent of the outages was approximately $10 million. Moving to the Light Materials sector on the next slide. Revenue in our Light Materials sector increased 25%, reflecting higher Wallboard sales volume and prices. Operating earnings in the sector increased 51% to $67 million, reflecting higher net sales prices and volume, partially offset by higher input costs, namely recycled fiber costs and energy. However, Wallboard margins improved to 38% versus 32% in the prior year. Looking now at our cash flow, which remains strong. During the first quarter, operating cash flow increased 17% to $111 million, reflecting strong earnings and disciplined working capital management. Capital spending declined $12 million. And as Michael mentioned, we restarted our share repurchase program during the quarter and returned $62 million to shareholders during the quarter, which equated to approximately 426,000 shares. Finally, a look at our capital structure. Eagle's June 30 capital structure remained about flat with year-end. At June 30, our net debt-to-cap ratio was 34%, and our net debt-to-EBITDA leverage ratio was 1.2x. We ended the quarter with $307 million of cash on hand. Subsequent to the quarter, we completed the refinancing of our capital structure, which included issuing $750 million of 10-year senior notes with an interest rate of 2.5%, extending our bank credit facility by 5 years, paying off the bank term loan and retiring our 2026 senior notes. The results of these actions provide Eagle with a low-cost, long-dated capital structure with significant liquidity. Thank you for attending today's call. We'll now move to the question-and-answer session.

Our first question comes from Trey Grooms with Stephens.

Congrats on a nice quarter. So first one is on the Texas weather. I mean clearly impacted the JV. But I mean, I think weather has started to clear up there. And so are you expecting a bounce back here in JV volumes in the 2Q?

Yes. Trey, everything is dependent on weather at that time of the year. And as you said, it's been dryer down there. As it’s dry, the demand is there. As I said in the comments, it was nothing to do with the demand driver on there. As we dry out, we'll be seeing cement shipments resume at a faster pace.

And kind of sticking with the JV. I believe on the last call, you had mentioned a midyear price increase in that market. Is that still on track? And are there any other markets where you could have midyear increases in the cement?

Yes. We're currently in the process of implementing that cement price increase we mentioned last time. As for other markets out there, we continue to evaluate other markets and determine if we will implement a price increase at those markets at any time, depending on our cost structure, demand and supply levers there.

Okay. That makes sense. So I guess on the margins, clearly trending in the right direction, and obviously, pricing is playing a role here. And Craig, you talked about or mentioned briefly a couple of things that you're seeing there on the cost front, OCC and energy specifically. But could you give us a little bit more detail on what you're seeing on the cost front on both sides of the business as far as inflation? And maybe any more detail you could give us around that.

Yes. On the Cement side, we have good control over our primary raw materials and our fuel and electricity costs remain stable. This quarter, we observed the timing and extent of outages at our cement plants. Last year, we adjusted the timing and scope of these outages due to the initial COVID shutdowns, and now we are returning to a more normal schedule. As a result, we expect to see benefits in the second half of the year because we shifted some outages to the latter half of last year. For Wallboard, while paper costs are increasing, the changes aren’t severe, and we typically pass those costs through at the paper mill level on a quarterly lag basis, meaning we usually take a quarter to adjust our pricing. The majority of those increased costs are passed through. Additionally, we have noticed an increase in freight costs this quarter, which we are monitoring closely.

On that front, Craig, obviously, Texas import market, you guys have a terminal there. It's a strong market from a demand standpoint. Excluding the weather impact, obviously, but strong market from a demand standpoint. It's sold out. What role is the freight having? And the increasing freight costs having there in that market as far as imports are concerned?

Yes, I would broaden the statement beyond just Texas. Domestic freight, involving railroads and trucks, has increased. Additionally, ocean freight rates have risen significantly over the past 6 to 9 months. As demand exceeds supply, imports are needed to fill that gap. These imports tend to be high-cost due to increased ocean freight rates, making them more expensive. Consequently, this situation is reducing the shipping radius for those imports and keeping them closer to the coast. This trend aligns with historical patterns we've observed.

I have one last question, and I'm glad to see that you are resuming the buyback and actively repurchasing shares. Can you discuss what your current authorization looks like? Additionally, I'd like your perspective on how you are balancing the buybacks with potential internal growth opportunities or even mergers and acquisitions.

Yes. Look, what I would tell you, the capital allocation priorities have been consistent and served us very well. And 1A is to continue to grow the company and grow Eagle in a profitable way. And as you've heard us say for years, there's a very high barrier to entry for that growth and that is both a financial return criteria as well as a strategic criteria, but that is the capital allocation, number one. 1B, which is very closely followed, is continuing to maintain our assets like new condition and keep our modern facilities and improve our low-cost producer position. To the extent there's additional free cash flow after those, we have historically returned that cash to shareholders, and we've done that generally through a share repurchase program. We did reinstitute our quarterly cash dividend this year, and it was payable and paid in July. But from a significant return of cash flow, we've generally done that through our share repurchase program. Those have been tried and true for many, many years, and we've taken out a considerable amount of the float for the last 5 years, 10 years or going back 20 years. And I would point out, we've done all of that while we've tripled the size of the company, especially on the Cement side, and we've done it all with a balance sheet that still sits in a unique position at a little over 1x debt-to-EBITDA that gives us a lot of opportunity for growth when those opportunities come our way. So with that, then I'd say from a share repurchase authorization, we've got a considerable amount of shares that we can repurchase. We're right around the 7 million share level at June 30 and more than enough opportunity for us.

Nice work and good luck with the quarter.

Our next question comes from Brent Thielman with D.A. Davidson & Company.

Great. Just on Cement, the dip in JV Cement volume makes sense just given the inclement weather. I was more curious about the flat to slightly lower sales volume and wholly owned. It seems like a pretty tight demand environment right now just the way you guys are describing it, and decent weather elsewhere in the country. And just wanted to get your thoughts around that.

Yes. And we've talked about this a little bit in some of the past calls with it. We did have a substantial amount. We did an investment in our Sugar Creek facility. And we put in a grinding mill there, and we had some inventory that was in place last year that led us actually to grind that into the finished product and sell that and do an inventory reduction with it. So what you're seeing in some of the areas with it is that our facilities are manufacturing tonnage pretty much at the sold-out levels with it, and that we don't have those levers to pull necessarily with those inventories. That being said, we continuously look for opportunities to expand any one of our plants and get the next clinker ton out of it that we can get out of it. And we have several projects that we're looking at on how we do that across our facilities, but we are manufacturing sold out at this time.

Okay. Regarding the Wallboard, how should we consider the price increase in June? How much of that is reflected in this quarter? Additionally, as we look towards the September quarter, is there any indication of a higher level of pre-buy associated with the price hikes in April and June?

Yes. Brent, look, as it comes to prebuy activity, that's largely kind of come and gone with economic activity and specifically residential construction activity, where it's a strong market demand environment for us. And to your point, though, we did implement this price increase in June. So it's partially reflected in this quarter's average price, but there will be some more upside as we fully implement it or get the full effect of it in the September quarter.

Okay. That's helpful. And then the Paperboard profit contributions. You mentioned recycled fiber energy expenses planned to that. I guess just kind of wondering if we're at an inflection point here where those headwinds should gradually abate and we should see some better bottom line contributions here going forward.

Yes. On the Paperboard, what to remember too with that is, we should see some leveling out in that, but we also need to remember too that we have a quarter lag with passing on some of those costs with how our contracts are structured. So where you may see some noise in one quarter, you'll see the rebound of that noise in the next quarter. If it continues to go up, you'll see noise in a couple of quarters in a row. But at the end of the day, that cost is predominantly passed on through our contracts.

Your next question comes from Adrian Huerta, JPMorgan.

With the Cement, there was a very strong quarter-over-quarter increase on cement prices. Was there any impact from mix because we haven't really seen an increase of this magnitude on a sequential basis in the second quarter? And the second question is on spending propriety prices. You mentioned that ocean freight costs have increased significantly. Have you started to see cement prices in the coastal regions increasing in line versus what we have seen with freight costs as well?

Thank you, Adrian. To address your first question, the cement price increase is not really related to a mix issue. Last year, when the pandemic began, we implemented price increases around April 1 to June 1. Therefore, when you compare year-over-year, this quarter reflects the full impact of that price increase. The 7% year-over-year increase we experienced should likely appear more as a 5% to 6% increase in the September and December quarters, providing a more accurate year-over-year comparison. Regarding your second question, our only exposure to imports is in Texas, so we can't specifically comment on the East or West Coast. However, we have seen significant changes in import costs, and that will ultimately impact the overall system.

But even on Cement on a sequential basis in this quarter was up 3.2%, which is a pretty big number for the second quarter. So that's why I was wondering if there was any mix impact there.

No. Our price is always up. Well, from the fourth quarter to our first quarter as we're implementing prices in April, generally.

Our next question comes from Jerry Revich with Goldman Sachs.

Michael, really interesting comments about wallboard industry structure moving towards cement in your prepared remarks. I'm wondering if you could just talk about what capital deployment opportunities you see for you folks in that area. Because over the past 10-plus years, you've been more focused on adding cement. And I'm wondering if your common signal opportunities for M&A or otherwise to grow the wallboard footprint. Can you just expand on your opening comments in that area?

I appreciate the question, Jerry. If you look back at the wallboard industry, particularly over the last three or four years, you'll notice that there has been some consolidation in that sector. Despite this consolidation, there is still capacity within the industry, and we have some capacity as well. Our primary objective is to maximize production from our facilities and position ourselves as the low-cost producer. We achieve this by owning our raw material resources, maintaining our plants in excellent condition, and ensuring we can produce as much as possible with our existing facilities. The investments we make on the capital allocation side focus on keeping our plants in top shape and addressing any logistical distribution needs to effectively reach our current customers.

Okay. So you're not optimistic on M&A opportunities in Wallboard?

When I look at it, I would never rule out anything with it. We'll look at anything. But with the consolidations that happened in that industry, in the past, it is getting to be a more consolidated industry at this time.

Okay. And Craig, can you talk about what was Wallboard pricing exit rate in the quarter?

Yes. We were ahead of where the quarterly average was. We'll certainly give you that total number for the September quarter when we get there, but we were north of the average.

Yes. No, clearly the question is, if you're willing to comment on order of magnitude?

It was meaningfully higher, Jerry. And so we'll give you that total number when we report the September quarter.

Okay. And then in Cement, pretty sizable maintenance outage this quarter. Can you talk about, as we think about the year-over-year comparisons for Cement margins over the balance of the year, which quarters does that $10 million free up as we think about the comps where outage costs are going to be lower over the next 3 quarters?

Yes. Most of it has been pushed into the September quarter. There was a minor portion that carried over into the December quarter last year, but we expect the majority to appear in the September quarter.

Yes. And Jerry, just to provide some additional context, the reason for this is mainly due to the pandemic. I didn't feel it was prudent to shut down all of our plants at once during that time. Therefore, we staggered the shutdowns throughout the year, and now we aim to return to our normal schedule where we typically handle things in the earlier part of the year. That's the reason for the change you're observing.

Our next question comes from Stanley Elliott with Stifel.

Could you talk a little bit about what you're seeing on the rest of the M&A environment on the heavy side?

Yes, Stanley. There are opportunities in both businesses, particularly on the Wallboard side, but they are quite selective. There aren't many assets available on the market at any time. Even when there are, we adhere to stringent criteria, both financially and strategically. We are always exploring opportunities out there and have come across many more than we've actually pursued. The pipeline remains strong, and we're focused on finding the right quality at the right value, which is our top priority. Over the past decade, we've been fortunate to discover various ways to invest and grow the company profitably, and we plan to continue this approach.

Perfect. And then as it relates to the Cement business, you've blended different blends that are out there, and you guys do a nice job with that. Is it reasonable for us to think that with adoption of some of these new blends, some of the things you're doing that you can continue to kind of drive out low single-digit volume growth even though we're in effectively a sold-out sort of environment?

Yes, that’s an excellent question, and you are correct. Our current focus is on determining how many additives we can incorporate while still adhering to ASTM specifications. We are also making investments to enhance our grinding capacity alongside our clinker capacity to meet market demands during peak periods. For instance, we are working on a storage dome at our Fairborn facility, which should increase our product availability next year. However, as you mentioned, we are currently seeing low single-digit improvements in our organic growth. We are committed to maximizing every plant's potential, and we have a talented team of engineers and production staff dedicated to achieving that goal.

Perfect. And then lastly for me. Could you remind us if you all have a program in place as it relates to the repurchases?

Yes. Absolutely, Stanley. So we've got, as I said earlier, nearly 7 million shares under a repurchase authorization, and we began repurchasing shares during this quarter. It was about 426,000 shares, and we generally do that through open-market purchases.

Our next question comes from Adam Thalhimer with Thompson Davis.

Great quarter. I wanted to dig in a little bit on Wallboard margins. Kind of what drove that increase from 32% to 38%? And then how sustainable is the Q1 result?

Yes. Look, Adam, we saw a pretty meaningful price move during the quarter. I think prices were up $30, $31 per 1,000 because of the demand environment and much higher utilization rates. And on the cost side, while we saw some increases around paper and energy, we were able to raise prices ahead of that and continue to expand margins. And look, what I would also comment that while we see some of these cost pressures on the energy side and paper side. The nice thing that Michael made in his comments, we own decades’ worth of natural gypsum at the majority of our facilities. And that gypsum is close to the plants, and it's a low-cost raw material source for us. So we don't face some of the inflation pressures that you see in other industries and maybe across other geographies.

Okay. You mentioned that freight and natural gas costs are increasing. Are there any other cost concerns you have, Craig?

No. Again, no. Again, this isn't a labor-intensive business, and we own decades’ worth of natural gypsum. So it's something we're keeping our eye on frights and natural gas, but no other major changes there.

And then in Cement, are there any markets that are on allocation? And then what are the implications of that, if there are?

We've been able to work with our customers so far and provide them with our products. As we come in through this is the peak shipping time with it. We are close to allocation in some markets, but we've been able to satisfy our customers' demands and partner with those customers.

Our next question comes from Phil Ng with Jefferies.

This is Collin speaking on behalf of Phil. The cement market seems very tight. I was curious about what conditions would lead you to announce a second price increase. Have you noticed any of your competitors announcing a summer increase outside of Texas?

Yes. We continuously monitor the market to assess supply and demand fundamentals to determine when we will make an announcement. We are currently implementing this in Texas and in some other markets. We will keep an eye on these over the coming months and make our decision. Regarding our customers, I don't really comment much on our competitors' price increases. Our focus is on our own supply and demand fundamentals and our manufacturing capacity.

And then just touching on wallboard demand. We've heard from public builders that they've been reining in their orders somewhat. So have you guys seen any choppiness in your business since it's a large driver of wallboard demand? Or have you guys just been able to carry through?

We continue to see a very strong business environment for our Wallboard business.

Our next question comes from Josh Wilson with Raymond James.

Wanted to start with just making sure we have the maintenance cost down on cement. I think last year, you said the benefit was $6 million. So did you pull some extra costs in? And is everything this year now as it will be? Or could something shift next fiscal year a little bit to get truly back to normal?

Yes. Regarding the last part, I’m not sure we have every maintenance event for next year completely scheduled, and we want to remain flexible. We don’t expect any changes. However, the difference between last year and this year was not only about timing but also about scale. Last year, as COVID was developing, we made some decisions to reduce downtime at the plants. Therefore, as we return to a more typical maintenance schedule, those costs were slightly higher this year compared to last year.

Got it. And can you give us your current CapEx expectations for the year?

Yes. Frankly, not all that different than what we guided to back in May. It's going to be in that $90 million to $100 million level for the full year. It takes a while for some of the projects that had been pushed off to get spooled back up, but I'd expect to see that start to pick up again in the second half of the year.

And then last one for me. Other income has still been a little bit of a volatile piece of EBITDA and EPS. Can you give us a sense of what drove the higher-than-normal levels there this quarter and what that should look like going forward?

Yes. Those are little extraneous things that happen from time to time, whether it's a small parcel of land that gets sold in one market or some other opportunity where we have an opportunity to sell something, a piece of equipment or inventory, something like that. So it's hard to forecast that quarter-to-quarter, and so I wouldn't put much in there. It's relatively small.

And I'm not showing any further questions at this time. I would now like to turn the call back over to Michael Haack for any further remarks.

Thank you very much for joining us today, and we look forward to talking to you at the next quarter's earnings call.

Thank you. Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.