Eagle Materials Inc (EXP) Q3 2022 Earnings Call Transcript

Good day, everyone and welcome to Eagle Materials, Third 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 Third 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're 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 that the first slide covers our cautionary disclosure regarding forward-looking statements made during this call. These statements are subject to risks and uncertainties that could result – 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 off by saying this was another good quarter for Eagle. Our achievement of record earnings per share highlights the fact that our people and prudent investments make a huge difference. First and foremost, I am proud of our Eagle team. At our plant, the Eagle team relentlessly works to deliver our quality products to our customers timely and consistently. I want to personally thank each and every one of our employees who contributed not only to this quarter's success but also to the work performed during these previous two years against the COVID backdrop. Secondarily, this quarter has shown the benefits from a combination of many years of prudent investments, investments that in some ways uniquely position us to take advantage of the opportunities that are presenting themselves to us today and that we believe will continue to present themselves to us in the quarters ahead. Our performance in light of this, the notable headwinds such as Omicron disruption, supply chain disruption, and inflation is a testament to the resilience of our business model, the soundness of our strategic choices, and to our proven operational capabilities. Let me elaborate on some of the reasons for this performance. Let me start with Omicron. We are fortunate to have a longstanding safety culture. We will not do a job unless we can do it safely. This foundation has served us well as we have managed the waves of the pandemic. Those that follow us know that we enjoy an exceptional health and safety track record. I am proud to say that we achieved the best safety performance in Company history these last nine months. This underscores our deep commitment to our people and their well-being. Our health, safety, and environmental processes, which we view as actually quite closely related, are robust and our well-established safety-first operating philosophies have been applied to meet the challenges of the pandemic. Now let me turn to the other two headline concerns: supply chain and inflation. It is worth noting that we have several significant advantages here. We own or control our primary raw material inputs and our reserves are decades deep. Arguably, these resources have already been paid for and are not subject to supply chain disruption or inflation in the way that many other construction materials are, nor do we rely on key inputs that come from overseas. Moreover, our operations are not particularly labor-intensive as we have invested in process controls and reliable methods of production to relieve manual labor and improve safety. These advantages have served us well this quarter, and this was reflected in our operating results. Now let me turn to why we believe we have not achieved peak earnings, margins, or returns for our businesses this cycle. First, let me talk about the light side of our business. The underlying demand for our products is strengthening. Our volumes in gypsum wallboard could have been even stronger this quarter if homes that were started could have been completed. Supply chain issues for other products slowed the completion of these homes and admittedly, slowed some of our product distribution. This portends well for the quarters ahead as this backlog is worked through. There's a lot of evidence that the next 12 months at a minimum will be especially strong for demand on the residential front. Although home affordability is a growing concern, we are still a long way from impeding demand in our markets. We focus in the South and the Sunbelt and have no operations in the Northeast or West Coast where market affordability is most challenged. Our key southern tier markets are in fact seeing unprecedented migration from affordability-challenged areas. The outlook for repair and remodel is also robust. The combination of new housing construction and repair and remodeling accounts for the lion's share of wallboard demand. Although commercial and non-residential is a relatively small application area, it is also strengthening in our southern tier markets. Strong wallboard demand provides pricing opportunities. Wallboard prices for us were up 29% year-on-year. We do not believe the positive pricing trajectory is over, and this is evidenced with our January price increase. In addition, we have the capability to flex existing production to meet short to mid-term demand swings. Now let me turn to the heavy side of our business where we are a well-positioned heartland U.S. producer of cement. Here, all of our plants are virtually sold out, so we expect pricing will be our greatest profit lever for cement in the most immediate quarters ahead. Infrastructure spend is on an upswing, aided by federal initiatives and state and local budgets in our markets are generally strong. Infrastructure and residential construction together are the most important end-use demand segments for cement and will be important multi-year drivers. On the last call, I spotlighted our attention with respect to one of our five strategic thrusts highlighted in our environmental and social disclosure report on our website. This product is one that will help us manage our carbon footprint in cement, and it's called limestone cement or PLC. Let me bring you up to date on the latest developments here. This is a very important initiative at Eagle due to the benefits of reducing our overall carbon footprint per ton of cement produced and then making our scarce clinker go further, in effect, unlocking incremental cement production capacity. Some aspects of achieving our objectives here are fully under our control and some are not. Those that are operational considerations, those that are not include gaining approval for product use in key applications. Every one of our cement plants has now completed production trials and product performance testing. As a result of these trials, all of our cement plants have evaluated capital investment requirements to reach what we have calculated to be the target limestone substitution levels. These capital investments vary in degrees of complexity and will be completed over the coming months or years, depending on the location. Regarding our customer acceptance, we have field trials underway with our customer base and are working with DOTs in all of our relevant market areas. So far in FY2022, we have produced and sold over 100,000 tons of this eco-friendly product out of four of our facilities. We expect increased sales of this product in FY2023. We are making progress on testing and the introduction of this product at an unprecedented pace at Eagle. Progress on this and our other ESG initiatives is a personal priority of mine and is reported to our full board quarterly. I mentioned at the beginning of my remarks that we see good opportunity for expanded earnings, margins, and returns. I commented on the first two; now let me say a few words about returns. We are generating a lot of cash. Our priority for that cash is to grow the Company, recognizing we have strict financial and strategic criteria that we will always follow. During intervals wherein such growth investments are not feasible, we know what to do with the cash. Our actions this quarter speak to our convictions here fairly convincingly. We repurchased 1.2 million shares of our common stock, resulting in a total cash return to our shareholders of nearly $200 million during this quarter. Now let me turn it over to Craig for the financial results.

Thank you, Michael. Third quarter revenue was a record $463 million, an increase of 14% from the prior year. The increase reflects higher sales prices across each business unit and higher cement sales volume. The strong fundamentals in both cement and wallboard contributed to record EPS during the quarter. Diluted earnings per share from continuing operations was $2.53, a 30% increase from the prior year. This increase also reflects the reduced share count resulting from our share repurchases. 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 9%, driven by the increase in cement sales prices and sales volume. Cement prices increased 6% while sales volume was up 7%. Our aggregate sales volume, however, was down 42% in the quarter as several large jobs were delayed. Operating earnings increased 11%, reflecting higher cement prices and sales volumes, partially offset by higher energy and maintenance costs. Moving to the light materials sector on the next page, revenue in our light material sector increased 21%, reflecting higher wallboard and paperboard sales prices, as well as increased paperboard sales volume. Operating earnings in the sector increased 32% to $63 million, reflecting higher net sales prices, which helped to offset higher input costs, namely recycled fiber and energy. Looking now at our cash flow, which remained strong during the quarter, operating cash flow was $167 million. The 9% year-on-year decrease reflects the timing of working capital shifts in the prior year, primarily associated with the receipt of our IRS refund. Capital spending increased to $28 million. As Michael mentioned, we repurchased approximately 1.2 million shares of our common stock for $188 million and paid our quarterly cash dividend. Combined, we returned nearly $200 million to shareholders. Year-to-date, we've repurchased approximately 2.9 million shares or 7% of our outstanding shares. Finally, a look at our capital structure. As of December 31st, 2021, our net debt-to-cap ratio was 41% and our net debt to EBITDA leverage ratio was 1.3 times. The refinancing we completed last quarter resulted in this favorable capital structure with significant liquidity to continue pursuing our strategic priorities. Thank you for attending today's call. Josh will now move to the question and answer session.

Thank you. Our first question comes from Trey Grooms with Stephens. You may proceed with your question.

Hey. Good morning, Craig and Michael. Good work in the quarter. And thanks for taking my questions.

Thanks, Trey.

The wallboard shipments in the quarter were down a little bit, which you spoke to on the last earnings call with some of the delays the homebuilders were facing. But you mentioned that your order pace improved during the quarter. And understanding that underlying demand is there, are you seeing some easing in the log jam there? And how should we be thinking about wallboard volume in the near-term to medium-term?

Yeah. Thanks, Trey. To your point during the quarter, some of those effects of supply chains at the home builder level were still lingering, but orders were very strong and have continued to be strong. We think 2022 is set up for another strong year. You've got low inventory level of homes. Job creation continues to be very strong, and wage improvement is also a factor. So we expect to see a good calendar 2022 on the residential side, which is the primary driver for wallboard. Repair and remodel continues to be very strong as well. We're also starting to see some improvement in the private non-residential construction sector. So all of that should add up for a pretty strong 2022.

Okay. Thanks for that. And I guess maybe shifting gears a little bit to pricing. You have price increases out in the market for January on both the heavy and light side of the business. And Michael, you touched on it briefly in your prepared remarks. But to the extent you can, could you talk about what you're seeing there on the pricing front with these increases that you have out in the markets?

Yeah. Trey, I appreciate the question. Normally, we really have to wait to see. This is early in the cycle for us announcing these price increases. So we'll be able to give you more information after the next quarter. But the supply-demand dynamics look favorable.

Fair enough. Last one for me, and this is just on the comment made on what's going on within some of the Cement side with some of the large project delays. Could you go into a little more detail there as to when you expect those to maybe come back into the picture and the outlook for those big projects?

Yeah. Those were mostly on our aggregate side of the business, and it's really with some DOT projects and some other projects in the Austin area. We've grown our inventory to satisfy those projects, and it's just a matter of those starting up again. We expect those to get back on track here in this next quarter and see some movement of that product that we have in our inventory right now.

Perfect. All right. Thanks for the color. I'll pass it on. Good luck.

Thank you. Our next question comes from Brent Thielman with D.A. Davidson and Company. You may proceed with your question.

Great. Thank you. Great quarter as well. I guess first question you talked about the constraints and those that are still experiencing it. It doesn't seem like that's as much the case in the cement business and all the markets that business serves. Could you talk about what you're seeing and hearing, maybe among project owners and contractors, particularly those that rely on cement? Are they still mitigating these constraints fairly better?

When you look at the two businesses, they do have different end-use markets. But overall, demand has been very strong for our products. On the cement side, we have been and continue to be virtually sold out at our locations. The other thing that you'll see this winter was a very mild winter, which led us to not see as great of a demand reduction on that side. The one thing that is worth mentioning on that side is that also pulls down inventory that we normally build during this time frame. So the demand is there. We don't see any reason why it won't be favorable for both those businesses with what we're hearing from our customers.

Yeah, Michael. To that point, I mean, how is cement volume really strong? I appreciate the color there. I guess this is the sixth quarter of town for comparisons on the JV side. Maybe any color on what you're seeing there, light at the end of the tunnel where we might start to see some volume improvement there?

Yeah. Brent, look, as we've said, in Texas, it's a very strong market and our operating facility has been sold out now for years. The volume changes there are more about purchased products and the timing of shipments coming in and activities like that, so which are a little bit out of our control. But at an operating level, we continue to remain sold out.

Okay. Maybe Craig this might be for you, but on cement do you have the unit cost, I guess headwind or maybe just absolute dollar impact from the higher energy costs that flowed through this quarter? Just some sense there.

Yeah. It was generally a couple of million dollars. If you think about cement production, it's an energy-oriented business: fuel and electricity. We are seeing some inflation there. We were able to more than keep pace with that on the pricing front, but that is something that we are closely watching. It was a little bit of a headwind this quarter.

All right. Just lastly, on that paperboard side, it looks like you're starting to recapture those higher costs. I think previously you thought you might return to something closer to normal levels of profitability maybe by fiscal year-end. Do you think that might push a little more into the second half of the calendar year just as you're seeing costs bloom there?

Yeah. When you look at how our paperboard is structured, those costs get passed on a quarter of bagging, and it really depends on OCC pricing and where OCC price is. OCC price was flat this last quarter, pretty much a little bit down. Those costs will continue to be passed on in the subsequent quarters as OCC price changes.

Okay. Very good. Appreciate it. Thank you.

Thank you. Our next question comes from Adrian Huerta with JP Morgan. You may proceed with your question.

Thank you and good morning. Hi, Mike and Greg. Thank you for taking my question. Two questions. Number 1 is, can you just remind me if you implemented a second price increase last year for cement? And what are the chances to do a second price increase this year? And my second question has to do with the PLC cement comments that you were making. Can you just give us a rough sense on the potential investment that you will have to make on this, and these investments will basically expand your capacity by what percentage or how many more cement capacity you're planning on adding by doing these investments? Thanks.

Sure. I'll address both those for you. With respect to pricing, pricing in our businesses is really a demand-driven factor. We are continuing to monitor both our costs and our customer base with that, and we will continue to monitor that for a potential second price increase. We have not made that decision at this point, but we will continue to monitor the supply-demand dynamics over the coming months. As per the PLC side, PLC is going to be something that we will implement, as I said in the comments, over the coming months to coming years, depending on the capital. You picked up on the capital comment. If you looked across all of our cement facilities and were figuring our normal capital burn and added another $25 million to $30 million for the next two years, that would get us to where we need to be to produce that for all of our cement assets that we have. With respect to that, PLC is up to a 15% limestone addition. Each plant will have its different characteristics of how much it can put in to still meet the ASTM specifications of that product. We're looking at 8% to 12%, depending on the plant, eventual addition. Now what also needs to be kept in mind is that's not across the board for all cement because we also produce some other cements for oil wells, which is a minor section of it, and some type 3 cements and other cements. So it will be for our main core products that we produce.

Thanks, and thank you, Mike. Appreciate it. Just to clarify, last year, you did not implement a second price increase in any of your markets from cement.

The only market we did have a second price increase in was in Texas. That was a full price increase. This year, we increased the timing or sped up the timing of this annual increase to January.

Excellent. Thank you, Greg and Mike, I appreciate it.

Thanks.

Thank you. Our next question comes from Anthony Pettinari with Citi. You may proceed with your question.

Hi. Good morning. Just following up on the last question on cement volumes. I think you saw volume up maybe 1% year-to-date, or fiscal year-to-date. Maybe putting aside any investments in PLC, what level of volume growth do you think you can reasonably drive, maybe looking out to '23? Should we think about flat volumes, or do you think you can get to that long-term low single-digit target through de-bottlenecking?

Yes, so we look at our plans for capital investments all the time, and we have put in some capital investments to some additional storage facilities and some mill. But we are getting close to the end of where we can get there. Our teams have always been creative, and we've always been able to eek out that extra percent or two. But again, I do want to remind the group that this fact, wherever anybody on the call is located, this was a very mild winter. So normally, we build inventory coming into the November, December, January, February timeframe to kick off the construction season. And November and December were very busy. Our inventory side is at one of the lowest points we've seen for clinker and for cement products.

Okay. That's helpful. And then just clarifying: The PLC investment, I think you referenced the 8% to 12% capacity increase. That would be a cement capacity increase, not a clinker capacity increase. Or is there an impact on the clinker, or how should we think about that?

No, that's exactly right. It's a cement capacity increase. The product is produced in our grind with the clinker.

Okay. And maybe just switching gears, last one for me. You obviously have a lot of balance sheet flexibility. When you look at potentially M&A or the pipeline, are there any general comments you can make about the availability of assets, maybe valuation of assets on either the heavier or the light side?

Yeah. We look at anything that's available out there, but we have very strict financial and strategic criteria to make an investment. Just because we have a lot of cash does not mean we will stray from the criteria we have. The deals out there right now, from some of the deals that closed in the last bit, look a little expensive to us, but also, there's not much out there right now. But we look at everything that's coming available.

Okay. That's helpful. I'll turn it over.

Thank you. Our next question comes from Jerry Revich with Goldman Sachs. You may proceed with your question.

Yes. Good morning, everyone. Michael, I'm wondering if we could just dig in on a comment you made in your prepared remarks about opportunities to take margins higher, particularly in wallboard. Given the moves in transportation costs in gypsum – synthetic gypsum costs, how do you think about where your margins could get to in the cycle? I guess when we look at the impact on the cost structure for folks that aren't co-located, it could add 5% plus to the overall cost structure. So do you see your business getting to potentially the mid-40s margin range for wallboard with that cost structure change for the industry?

How I look at that comment that I made there is really on, unlike the cement side of our business, we still have capacity on the wallboard side of the business. We operate our plants very efficiently. We own our own raw materials. So some of the inflationary aspects are not necessarily seen from us. As I said in the comments, having multi-decade reserves at some locations that are already paid for helps us on that side. So really when I look at that, it's on a volumetric side and on some of the cost headwinds that some others are seeing, we may not be seeing with regard to reserves.

Michael, maybe to expand on that, what level of operating profit drop-through do you anticipate as you ramp up volumes? The incremental margins have been obviously super attractive in Wallboard over the past year. Do you think you could deliver 50%, 60% type drop-through on incremental sales from here based on that comment and having paid for the historical reserves?

Yeah. I'm not going to answer a certain percentage on that side. It's all going to depend on our distribution channels and what the supply-demand dynamics look like in the future. We just don't think we're at the peak yet regarding supply-demand dynamics.

Okay. And then on your price increase letter, it looks like you're not protecting orders past the January 3rd ship date. Is that correct? So the price increases will be implemented for wallboard through immediately in the March quarter?

That's right.

Okay. And lastly, Craig, could you talk about the cement price increases? As you look around the footprint, any differences in terms of the effective price increase date and the price increase amount across your plants because in the past we've had some increases staggered into March and April, and it sounds like the increases are happening earlier in cement this year. But could you expand on that?

They're largely all scheduled for early January, with one exception here in Texas, which was an April increase due to the fall increase that was recently implemented. But across the wholly-owned footprint, it was all early January. As we said last quarter, they were all double-digit increases. As Michael has said a couple of times now, with a really mild start to winter, we will enter this construction season with very low inventory levels.

Thank you. Our next question comes from Stanley Elliott with Stifel. You may proceed with your question.

Hey, guys. The PLC initiative is to free up more clinker capacity. That sounds like a home run, but curious how prevalent this is across the industry. And can your peers take similar initiatives to free up some capacity as well?

Yes, that's a great question. This is a product that can also be produced by our competitors. It involves adding limestone to cement. We believe we are taking an aggressive approach with each plant in our network. We have done our homework and research, and we know when we can have our capital ready to start realizing the benefits. I cannot comment on our competitors or their progress regarding the investment and the time it will take for them to operate in these areas.

Got it. Okay. And then for me on your wallboard business, good to hear that your orders picked up, but any color if your volumes inflected late in the December quarter, and you expect that to inflect positively in the March quarter?

I will just say, Phil, more broadly rather than going quarter-to-quarter, we just expect to see a good 2022 given the backdrop in the fundamentals that are supporting construction activity in the U.S.

Got it.

I think it's a little too early to say we've cleared the log jam of the supply chain. Things incrementally improve a little bit, but we're not done with it yet.

Thank you. Our next question comes from Josh Wilson with Raymond James. You may proceed with your question.

Good morning. Thanks for taking my questions.

Thanks, Josh.

Craig, could you spell out for us what you think capex will be both in fiscal 2022 and 2023 given the various initiatives?

Yeah. We would traditionally say our annual capital spending for all of Eagle is in the $80 million to $100 million level. We'll be a little below that here in fiscal 2022, but you can use that as a kind of a normal run rate for 2023 and 2024. But that's the sustaining capital with some incremental projects. As Michael mentioned as we're ramping up PLC across the network, there is some investment in there that could add $25 million to $30 million on top of that core number. So it's going to be in that range for '23 and '24, as we sit here today.

And then as we look at the paperboard margin, can you just peel the onion a little more about which were the biggest headwinds in this quarter and how quickly they might change or improve?

By the look of it, the OCC prices by far away are the biggest headwind there. We had a large spike in those costs in the late summer/early fall, and as Michael alluded to earlier, it takes some time for that to actually work through the pricing mechanism. The good news is that seems to have plateaued here in the last couple of months. We actually saw a drop in January, so it does look like that headwind is reversing. But that certainly is the biggest driver of this quarter.

Thanks. I'll turn it over.

Thank you. Our next question comes from an analyst with Truist Securities. Please go ahead with your question.

Hi. Good morning. This is stepping in for Keith Hughes. Congratulations on a solid quarter, and thank you for taking my questions. Can you provide more details about the increase in overall pricing and whether it is influenced by any specific geography or factors? Additionally, can you share the current wallboard capacity utilization for the company and possibly for the industry as well? Thank you.

Yes. Thanks, Dennis. On your first question, the change in pricing this quarter in aggregates had more to do with the discussion we had earlier about some of these jobs getting delayed. That was primarily around base material, which is on average generally lower priced. So you're going to see product mix skew a little bit higher. So nothing more than product mix than anything in for us in that business. In terms of wallboard utilization levels, as Michael said earlier, we do have some incremental capacity. As demand calls for it, we'll continue to ramp that up. But at effective levels, utilization rates are pretty high right now for us. I hesitate and won't talk about where the industry might be as we certainly don't know where those positions are, but for us, we've got some opportunity as demand grows.

Thank you. And can you just remind us what organic price was for the quarter?

Yeah. It was up to 6% year-over-year.

Okay. Thank you.

Thank you. 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.

Thanks, Josh. We appreciate everybody calling in today, and we'll look forward to talking to you here in the next quarter. Thank you.

Thank you. This concludes today's conference call. Thank you for participating. You may now disconnect.