Earnings Call Transcript - FBIN Q4 2020

Operator, Operator

Good afternoon. My name is Jason, and I will be your conference operator today. At this time, I would like to welcome everyone to the Fortune Brands Fourth Quarter 2020 Earnings Conference Call. Thank you. I would now like to turn the call over to Mr. Brian Lantz, Senior Vice President of Communications and Corporate Administration. You may begin your conference call.

Brian Lantz, Senior Vice President of Communications and Corporate Administration

Good afternoon, everyone, and welcome to the Fortune Brands Home & Security fourth quarter and full year 2020 investor conference call and webcast. Hopefully, everyone has had a chance to review the news release issued earlier. The news release and the audio replay of the webcast of this call can be found in the Investors section of our fbhs.com website.

Nick Fink, CEO

Thank you, Brian, and thank you to everyone for joining us on the call today. I hope that you and your loved ones are all staying safe. I could not be prouder of what we’ve achieved in 2020, strong fourth quarter results mark a remarkable full year performance by our teams. Facing unprecedented challenges, we drove market-beating growth and delivered on our margin expansion strategy ahead of schedule. During the year, we deployed over $1 billion in capital towards M&A, share buybacks, and dividends, generated excellent free cash flow, and exited the year with attractive leverage. Amidst all of this activity, our teams worked tirelessly to keep consumers and customers supplied while maintaining industry-leading safety performance. It has truly been an extraordinary year. All of our businesses saw impressive double-digit growth in the quarter, and we drove margin improvement in each segment by delivering against strong demand for our leading brands and leveraging our efficiency programs. Importantly, this past year, we also made critical long-term investments in our brands, innovation, Fortune Brands core capabilities, and supply chain capacity that will enable us to capture future opportunities and accelerate our share gains. Over the last eight quarters, we have shown that we can deliver results and create value for our stakeholders in a variety of market conditions. We are positioned to capture growth as the market accelerates and are structured to tightly manage our P&L in times of slower expansion. With the initiatives that we’ve undertaken, the investments that we have made, and the momentum that we are seeing, we expect even stronger sales and profit growth as we enter 2021. Looking forward, we are in the early stages of a long-term expansion of U.S. housing. It has been widely noted that the extent to which U.S. housing has been underbuilt is several multiples greater than the overbuilding of the mid-2000s. Yet new construction starts are far short of their peak and are only now reaching historic averages.

Pat Hallinan, CFO

Thanks, Nick. As a reminder, the majority of my comments will focus on income before charges and gains in order to best reflect ongoing business performance. Let me start with our fourth quarter results. Sales were $1.66 billion, up 13% from a year ago. Consolidated operating income for the quarter was $246 million, up 19% or $40 million compared to the same quarter last year. Total company operating margin was 14.8%, up 70 basis points over the same quarter last year. EPS were $1.25 for the quarter, up 25% versus $1 the same quarter last year. Our associates focused on safety and on serving our customers during challenging circumstances made these remarkable results possible. Our teams used the circumstances of 2020 to enhance focus on proving share competitiveness and cost efficiency, driving 2020 growth and accelerating our margin improvement trajectory, providing an excellent setup for 2021. Our advantage business model with leading brands and channel positions allowed us to navigate 2020's uncertainties to outperform the markets in which we operate. Now let me provide more color on segment results, beginning with Plumbing. Sales for the fourth quarter were $638 million, up $89 million or 16%, or up 15% adjusting for FX. Fourth quarter growth was strong double-digit across all major products, channels, and geographies. Full year 2020 sales were up almost 9% versus 2019. Plumbing operating income increased 17% to $139 million for the current quarter. Operating income for the full year was $490 million, an increase of 12% over 2019. Operating margin for the quarter was 21.8%, and over 22% for the full year. Our Global Plumbing Group concluded its fifth straight year of strong growth in margin performance. Our strategies are clearly working, and we expect another strong year for Plumbing in 2021. Now turning to Outdoors & Security. Sales for the fourth quarter were $367 million, up $35 million or 11% driven by double-digit growth in doors and decking, and a return to growth in security. Full year 2020 sales were $1.4 billion, an increase of over 5% versus the prior year. We expect all product categories to drive 2021 growth with particular strength continuing in doors and decking. Door sales were up double digits in the fourth quarter, driven by strong retail POS and accelerating single-family new construction. We expect sales growth to continue in 2021 as both retail and new construction remain strong. Decking sales were up strong double digits in the quarter, as our distribution gains achieved new performance levels. We added incremental capacity during the quarter, and more capacity will come online in 2021. The secular trends favoring composite decking remain as strong as ever. Security sales returned to growth in the quarter with retail products growing double digits, while commercial products and markets remain soft due to COVID-19. Outdoors & Security segment operating income was $58 million during the quarter, up 17% over the same quarter last year, driven by operating improvement in doors and decking. Operating income for the full year was $205 million, an increase of approximately 16% versus 2019. Segment operating margin for Outdoors & Security increased 90 basis points for the quarter over last year to 15.8%, and was 14.5% for the full year, up 130 basis points versus 2019. Turning to Cabinets. Sales for the fourth quarter were $656 million, an increase of 11% over the same quarter in 2019. Full year 2020 sales were $2.5 billion, up 3.4%. We continue to experience strong growth of value-priced products, and sales of higher price make-to-order products returned to growth this quarter, a positive signal for big ticket R&R and reflective of the stabilization of imports and consumers' increased desire and ability to invest in their homes. Operating income in the fourth quarter was $76 million, up 27% or $16 million versus the prior year, and full year operating income was $256 million, up 11% or $26 million versus 2019. Operating margin for the quarter was 11.6% and 10.4% for the full year, up 150 and 70 basis points respectively versus the same period a year ago. Full year Cabinets margin performance was very strong, given big ticket R&R, inclusive of Cabinets, experienced the most severe demand and operating impacts during the second quarter COVID shutdown. We are very pleased with Cabinets' second half margin performance of 11.9% and strong year-end exit rate. We expect Cabinets operating margin improvement to continue in 2021, as we build on our efforts in 2020 to further enact operational efficiencies and aggressively leverage our market-beating growth. For FBHS as a whole, to sum up our full year consolidated 2020 performance, sales increased approximately 6% to over $6 billion for the first time ever as a public company. EPS grew over 16% to $4.19, demonstrating our ability to deliver growth and margin improvement by outperforming the markets in which we operate in an increasingly efficient manner. Our total company operating margin was up 80 basis points to 14.1% ahead of our full year 2020 plan. Free cash flow was $742 million reflecting a conversion rate of 126%. 2021 profit growth will benefit from the efficiency programs initiated in 2020 and the continuation of a strong U.S. housing market. This will result in positive operating leverage across the company as we continue to enact Fortune Brands core capabilities across the portfolio. Before turning to the balance sheet, I want to take a moment to provide perspective on the expected size of material and cost inflation faced in the current elevated demand and amid a backdrop of a fundamentally strong housing market. We continue to deploy a multitude of tools to mitigate or offset inflation within our business. We do this through continuous cost improvement within our operations, having enacted major improvements just within the past year. We also employ cost sharing with suppliers where appropriate and continuously look for ways to add flexibility and durability to our global supply chain. Finally, when necessary, we act via pricing. Through this combination of actions, we expect to navigate 2021 inflation and achieve our margin improvement objectives. We will mitigate, offset, and overcome inflationary headwinds and deliver our goals of market-beating growth and continued margin expansion. Turning to the balance sheet, our balance sheet remains strong with cash of $419 million. Net debt of $2.2 billion and our net debt to EBITDA leverage end of the year at 2.1 times or slightly below 2 times on a pro forma basis. We now have $865 million of total liquidity available between our $1.25 billion revolver and supplemental $400 million revolver. We have the ability to make investments and deploy capital to accelerate growth and shareholder value creation, and are assessing opportunities to do so. We will also look to continue to return capital to shareholders through targeted buybacks and our dividend. Turning to the details of our outlook for 2021, based on the global market for our products growing 5% to 7%, with the U.S. housing market also growing 5% to 7%, and within this market forecast, we expect U.S. new construction growth of 10% to 12% and U.S. R&R growth of 4% to 6%. Based on those assumptions, we expect 2021 full year sales growth of 12.5% to 14.5% or 5.5% to 7.5% excluding LARSON. We expect full year EPS within the range of $4.85 to $5.5 on a before charges and gains basis of which the implied midpoint equates to 18% EPS growth versus 2020. Specifically, our outlook for each business as it relates to our overall plan: Plumbing net sales growth of 7% to 9% with operating margins of 22% plus. Outdoors & Security net sales growth of 35% to 37% or 5% to 7% ex-LARSON with segment operating margins of 14% to 15% or approximately 15% to 16% adjusting for purchase accounting and one-time integration expenses. Cabinets net sales growth of 5% to 7% with operating margins of 11% to 12%. We expect 2021 free cash flow of approximately $600 million to $650 million, which includes the accelerated investments in capacity and inventory to drive growth across all of our segments. We anticipate a cash conversion rate between 85% and 95%. The annual EPS outlook includes the following assumptions: Corporate expenses of about $92 million to $93 million; Interest expense of approximately $82 million to $86 million; a tax rate between 24.5% and 25%; average fully diluted shares of approximately 140 million to 141 million. To summarize, we have put together a 2021 plan that provides solid sales and excellent EPS growth, while we continue to accelerate investments in brand, innovation, and advantage Fortune Brands capabilities. Potential exists for upside to our plan and guidance, if some combination of the following occurs: labor is available to address in full the strong expected U.S. new construction and big ticket R&R demand, if U.S. R&R growth improves beyond the 4% to 6% assumed in our plan, government stimulus increases materially beyond programs currently in place without impacting interest rates. Better insights into these opportunities will unfold during the first half, and as this occurs, and as merited, we will apply our guidance accordingly. We expect a long runway of fundamental U.S. housing growth to result in prolonged market strength for our products. With market growth averaging 5% plus per year over the next few years, assuming the current level of unemployment continues to stabilize and improve. We expect our sales to continue outperforming the market, and our margin progressions will remain accelerated, averaging improvement above 50 basis points in 2021 in each of the next two to three years. Our balance sheet strength supports capital deployment, and while we delivered over $1 billion in M&A, share repurchases, and dividends in 2020, we are still advantageously positioned to access further opportunities to deploy capital. We see multiple paths of value creation to execute for our shareholders, and our company has never been better positioned to capture these opportunities. Our teams remain committed to driving market-beating sales performance and continued operating margin improvement. I will now pass the call back to Brian to open the call up for questions.

Brian Lantz, Senior Vice President of Communications and Corporate Administration

Thanks, Pat. That concludes our prepared remarks on the fourth quarter and for the full year. I will now turn the call back over to the operator to begin the question-and-answer session.

Operator, Operator

Thank you. Your first question comes from the line of Susan Maklari from Goldman Sachs. Your line is open.

Susan Maklari, Analyst

Thank you. Congratulations everybody on a great quarter and a great year. My first question is, kind of looking at the 2021 guide, I know historically you’ve talked to an incremental margin of about 20% to 30%, and it seems like the midpoint of the revenue guide for this year implies something that’s kind of at the lower end of that range in terms of the incremental. And Pat, I know that you laid out some of the factors that you’re kind of thinking about that could impact where you end up for this year, but can you kind of outline for us, maybe some of the things that could take you to the higher end of that 20% or 30% range and how you’re thinking about that across each of the different segments?

Pat Hallinan, CFO

Yes. In terms of margin overall, I start with, we remain committed to getting the total business above 15%, which is a target we’ve had for a while. On an organic basis, next year, we’ll be very much approaching that. We should be at 15% or very close to it on an organic basis by the end of next year, which means on an organic basis, we’ll be driving 70 to 80 basis points of margin improvement, if not more, and be on the higher side of that incremental margin. As we fold LARSON into the business, we have some purchase accounting and some integration costs. So our reported margin might be closer to 14.5% for the year. But we expect over 2020 and 2021 combined to achieve 150 basis points of total margin improvement we’ve been talking about for a while. As we get through 2021, we aim to drive for the next two to three years, 50 plus basis points for each of the following years after that. We feel good about the margin trajectory. If we continue to drive market-beating growth and manage our SG&A tightly, we could stay on the higher side of that leverage range.

Nick Fink, CEO

So this is Nick. I would just add that if you step back a little bit, we set out as a team to really accelerate the flywheel within the business. We’re investing in core capabilities across the entire platform to generate fuel for growth, with the intention that a portion of that would be seen through margin accretion and a portion of that would be generated to incrementally invest in the business to drive more top-line. Once the pandemic hit, we used it as a platform to accelerate our plans and are delighted with how we’ve emerged, basically probably about a year ahead of schedule from where we thought we were. We made far more incremental investments in the business in 2020 than I think we would have expected at the outset of the year with plans to continue that in 2021 and beyond. The spiral really is working now, and you’ll see it through our organic margin as Pat describes, but also through our investment profiles; we continue to invest in brand, innovation, capacity, and capability in the business.

Susan Maklari, Analyst

Okay. That’s helpful. And I guess when we think about the out years then, and that 50 basis points or so of margin expansion that you expect each year. You talked a lot about how it seems like housing is structurally kind of operating at a higher level, and you’ve obviously done a lot of work to really position the business to capture that growth. Do you think that 50 basis points could rerate higher? What would you need to see to really capture more of that on an annualized basis? And what kind of concerns maybe as you look out and what could kind of hold things back a bit?

Pat Hallinan, CFO

I definitely think it could rerate higher. I think that will be driven by the amount of growth you see because the growth gives you some pretty powerful leverage. Then there’s the pace at which you’re able to drive the cost improvement in pricing necessary to offset inflation. I do think we go into 2021 with our eyes wide open on inflation across multiple fronts: material, logistics, and labor. But we’ll manage it effectively, as we have managed considerable tariff inflation the last three years. I don’t think we lie awake at night on inflation or think that that’s going to hold us back. We’re committed to drive the margin improvements through that inflation, but I think there will be multiple episodes, and some of the timing of that will unfold as we pursue the next couple of years.

Susan Maklari, Analyst

Great. Thank you, and good luck.

Operator, Operator

Your next question comes from the line of Phil Ng from Jefferies. Your line is open.

Phil Ng, Analyst

Good afternoon and congratulations on a really impressive quarter. Growth has been really strong and impressive. I’m just curious how you situate from a capacity standpoint in your ability to meet some of that demand because I noticed your CapEx guidance for 2021 has a step up. So I’m curious if there were any pockets that you’re adding a little more capacity to kind of help meet that demand.

Nick Fink, CEO

Yes. Let me take that, and then Pat can give a little bit more color. Firstly, hats off to our team for being able to deliver these quarters of growth. You’re right, it does stretch capacity. When you drill down and look at pockets of the business, it really was a surge, with people working literally around the clock to make it happen. We have been stretched. I think the feedback from customers has been very satisfied with the fact that we stayed a step ahead of the competition. That has really helped fuel our share gains because we’ve been reliable through this period, notwithstanding the work it has taken. As we built out the plan for 2021, we sensitized it to both an upside scenario and a downside scenario. For the downside scenario, we’re ready to manage the P&L and expenses to deliver the kind of margin progression we discussed. But we’re also leaned into capacity investments and inventory to serve the market and capture the upside. The housing market is undeniably strong. This is a fundamental expansion, which has to continue for a long time to support this growth. We have confidence in leaning into that capacity investment because we know that the market needs it.

Pat Hallinan, CFO

You’re picking up accurately. The CapEx in 2021 will be $60 million to $80 million more than it was in 2020. Both 2020 and 2019 were lower than our normal CapEx run rate because of the COVID shutdown in the second quarter of 2020. We’ll be in the kind of $210 million to $230 million range for CapEx, going across decking, plumbing, Therma-Tru, and Cabinets. The capacity will be tight for the first part of the year, but we’ll service the demand. Our people are doing a great job utilizing the capacity they have to keep customers happy, and we’ll be getting the capacity we need to deliver on growth effectively.

Phil Ng, Analyst

That’s really helpful. And obviously, you’ve seen really strong growth in Plumbing for some time now, and that growth has accelerated nicely in the back half. Any noticeable pockets where you’re seeing some of these share gains? Is it from some of these adjacent markets, e-commerce? And just how much more runway do you have? And lastly, curious if you’ve seen any channel partners restock inventory quite yet? Thanks a lot.

Nick Fink, CEO

Yes, sure. We’re delighted with Plumbing. We’re looking at something like five years now of consistent market outperformance at increasing margins. It’s phenomenal to put up in excess of 16% growth in the quarter. The feedback from customers has been very positive, and the business has gotten so good at leveraging its twin assets of brand and channel strength to build out new adjacencies. Regarding future adjacencies, you’ll see 2021 as we continue to build a smart home ecosystem with products like Flo by Moen, which won recognition at CES. We feel really strongly about our ability to grow in these areas. You posed the question, do we see room to go? I would say absolutely.

Phil Ng, Analyst

Super helpful. Thanks a lot, guys.

Operator, Operator

Your next question comes from Stephen Kim from Evercore ISI. Your line is open.

Stephen Kim, Analyst

Yes. Thanks very much, guys. Let me also add my congratulations. I certainly wholeheartedly agree with your outlook on the housing market. It will be interesting to see how you can leverage that strength. You’ve given some really good commentary here, particularly on a multi-year basis on the margin. What I wanted to ask you, though, is closer in, it seems like this year having a little bit of guidance or maybe some handholding from you all with respect to the sequential progression of sales might be helpful just given how weird last year obviously was. Is there a way that we can think about what we might expect to see or what you all are expecting to see in terms of the sequential trajectory as you progress from Q1 through into the back half of FY 2021? Some helpful way that you could help us envision something like what you’re foreseeing?

Pat Hallinan, CFO

Yes, Stephen. It’s tricky business, even for us who watch kind of the daily order flow and shipments. From our results, the fourth quarter finished very strongly with double-digit growth across all lines of business. We’re still shipping to POS at this point, and the POS momentum for the fourth quarter has largely carried into the opening month of this year and doesn’t appear to be abating. We would expect double-digit growth for the first quarter, and that could easily continue into the second quarter, especially since last year you were shut down for half of the quarter. Then we’ll see where it goes from there. We’re seeing some wide goalposts on external data for U.S. R&R and new construction, but we think that this is underpinned by fundamental demographics that are not just episodic. I’d guide you towards double-digit growth to start the year, and then we’ll update you as appropriate.

Nick Fink, CEO

I agree with what Pat said. We asked ourselves the same question, given the unique comps. Q4 is a proper comp, going back to 2019, when the market was strengthening. The fact that we’ve carried that exit momentum into what we’re seeing now makes us feel good about the solid market.

Stephen Kim, Analyst

Yes, absolutely. It’s bullish. I wanted to ask about the Cabinets business specifically. We think of it as primarily kitchen and bath cabinetry, yet with the pandemic and working from home, a certain population would be considering converting rooms into more permanent work-from-home spaces. How much of your business in the Cabinets segment has historically been outside of kitchen and bath? And where do you think that can go?

Nick Fink, CEO

Well, I’ll start, and Pat may give you more perspective. We don’t track or buy by rooms outside of kitchen and bath specifically. However, the team has been focusing on adjacencies and areas for growth, part of their strategic plan. Their first priority is genuinely focused on the margin journey, which we intend to hit. We’re seeing good growth in the mid to high price point make-to-order business, which could be driven by people converting their rooms at home.

Pat Hallinan, CFO

I don’t know the exact percentage of our cabinet business that is in offices, but we certainly enable that with our catalogs, especially at mid to higher price points. We saw in the fourth quarter that the mid to high price point make-to-order business is growing nicely and contributing to our overall growth.

Stephen Kim, Analyst

Great. Thanks. Appreciate it.

Operator, Operator

Your next question comes from the line of Michael Rehaut from JPMorgan. Your line is open.

Michael Rehaut, Analyst

Thanks very much. Good afternoon, everyone. Congrats on the results. I hope everyone’s safe and healthy out there. First question on outdoor and security. Obviously, continued great progress there. I’m wondering about the guidance outlook for 5% to 7% organically, given the strong momentum, particularly in decking, acknowledging it’s a smaller piece of the pie still. I’m wondering if there’s any upside to that organic growth outlook? And regarding the security piece, what can be done to increase that growth rate, as it was a little lagging this year?

Nick Fink, CEO

Sure. Starting from the strong performance in decking as I said, in excess of 30% in Q4, and the same goes for doors. I would say, on decking, we’ve got a capacity plan we’re working through. There could be upside if we can bring pricing momentum into play on decking. In doors, the momentum we see continues to build in both wholesale and retail, so we could see upside there as well. On security, we agree; we want to see more growth. There were factors like the back-to-school season that didn’t happen and a commercial channel that saw shutdowns. We exited the fourth quarter with nice growth in retail, and we’re focused on getting the product assortment right, which will support innovation and improvements in our growth trajectory.

Pat Hallinan, CFO

Michael, I think you’re accurate on the points Nick made. There’s potential upside to both doors and decking based on the dynamics you mentioned. For security, it remains about capturing more seasonal events and ensuring that we get our innovations out there.

Michael Rehaut, Analyst

No, that’s great. I appreciate that. Just wanted to circle back to a prior question around cadence throughout the year. Very much appreciate the talk around the top line where you’re seeing double-digit growth likely to continue into Q1, possibly Q2. But as I look at your guidance, it shows flat to possibly up low single digits in the back half. I wanted to confirm that you are indeed looking for that cadence, and what that means for EPS distribution, typically you generate 40% to 45% of EPS during the first half and 55% to 60% in the back half. Would you expect that to flip this year?

Pat Hallinan, CFO

I think you’ve got it right for both top and bottom line. We expect a bias towards the first half of the year for EPS growth, but I wouldn’t overemphasize it. There will be nice EPS growth across the year, but it will be a bit more unusual bias towards the first half.

Michael Rehaut, Analyst

Great. Thank you.

Operator, Operator

Your final question today comes from the line of Justin Speer from Zelman & Associates. Your line is open.

Justin Speer, Analyst

Good evening, guys. Thank you. I wanted to turn the attention to the Chinese opportunity. Your growth there has been pretty special, but maybe you can remind us what it was for all of 2020. And if you could just provide some context on your 2021 guidance for that market? And maybe some color behind the dynamics there and the headroom for growth in that large market for you?

Nick Fink, CEO

Sure. First, we’re very fortunate that the two most favorable housing markets in the world are the U.S. and China. China’s market not only is growing quickly but is also quite fragmented, presenting an opportunity to build share over time. Our business there has been built organically over a long time with a home-grown team that has executed well in that market and is now very focused on driving profit. The performance has continued to power on, with growth driven by the developer side and e-commerce. Showrooms were slower as people remained cautious, but we have a leading share in developers, especially in Tier 1 and Tier 2 markets. We’re bullish about the opportunity in China; housing continues to be fundamental to their economy.

Pat Hallinan, CFO

Yes. Our business in China grew in the high teens and was consistent across the third and fourth quarters. We continue to see growth driven by developers in the e-commerce space. Our brand metrics are strong, and our team over there is doing an exceptional job.

Justin Speer, Analyst

Thanks. And I wanted to ask about the cabinets operating margin expectation, not just for 2021, but I believe you mentioned mid-teens. How do you get there in light of competition from imports?

Nick Fink, CEO

I’ll start on imports. We never counted on government assistance, focusing instead on pivoting the portfolio toward the heart of the market. We were successful in the anti-dumping suit, which wasn’t intended to shut out all imports but to eliminate illegal subsidies. We’re also happy to compete against low-cost countries. As you’ve seen those imports migrate to other countries, they are being produced at a higher average selling price. That creates an environment for us where we’re set up to compete and win.

Pat Hallinan, CFO

And Justin, you saw a 70 basis points margin improvement for the full year. The cabinet business was among the most impacted by the COVID-19 shutdown. If you look at the back half margins of that business, which are around 11.9%, this is more indicative of where they’re running. As for achieving mid-teens margins, there’s room for both the stock and the make-to-order side of the businesses. We’ll manage inflation and take actions to drive improvement, and we’re still working to optimize our existing resources. Moreover, the hard work my team has been doing to standardize products will help leverage these efficiencies going forward.

Justin Speer, Analyst

That’s excellent. Thank you for the color. I look forward to watching you progress towards those mid-teens over time.

Pat Hallinan, CFO

Thanks, Justin. Have a good afternoon.

Operator, Operator

That concludes our Q&A and concludes the Fortune Brands quarterly earnings call. Thank you everyone for joining today. You may now disconnect.