Ufp Industries Inc Q3 FY2023 Earnings Call

Good day, and welcome to the Q3 2023 UFP Industries Inc. Earnings Conference Call and Webcast. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker, Mr. Dick Gauthier, Vice President of Investor Relations. Please go ahead, sir.

Welcome to the Third quarter 2023 Conference Call for UFP Industries. Hosting the call today are CEO, Matt Missad, and CFO, Mike Cole. Matt and Mike will offer prepared remarks, and then the call will be open for questions. This conference call is available simultaneously in its entirety to all interested investors and news media through our webcast at ufpi.com. A replay will also be available at that website. Before I turn the call over to Matt Missad, let me remind you that today's press release and presentation include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties that could cause actual results to differ materially from the company's expectations and projections. These risks and uncertainties include, but are not limited to, those factors identified in the press release and in the filings with the Securities and Exchange Commission. I will now turn the call over to Matt Missad.

Thank you, Dick, and good morning, everyone. We appreciate you joining our third quarter 2023 earnings call. The third quarter showed that the structural changes we implemented in the business have also led to adjustments in our operating margin. As we transition to a more stable pre-pandemic economy, we are concentrating on structural improvements to our business to secure our place in the value chain, drive profitable growth, and enhance shareholder value. Our financial results for the third quarter aligned with our internal forecasts, and we commend our team's skill, experience, and hard work. We recognize that there is still more to accomplish and additional opportunities to positively influence our results. As always, we are mindful of the uncertainties in the economy, and recently we observed a slowdown in various segments of our customer base, particularly impacting our Packaging segment. Our earnings of $2.10 per share surpassed our internal predictions, and EBITDA margins remained above 11% despite reduced sales volumes in a sluggish economy. We have built a $900 million reserve to capitalize on opportunities we anticipate arising when acquisition targets face elevated interest expenses and more typical sales environments. Although we might feel tempted to increase capital spending aggressively, we are committed to being prudent and patient in our capital allocation, seeking the best return for our shareholders. Return on investment continues to guide our decision-making. Rather than delving into financial performance—which Mike will address later—I’d like to examine some macroeconomic indicators that affect us, review expected impacts on our business units and segments, and share opportunities for future investments. First, regarding interest rates, rather than adopting a slow and careful approach, it seems that monetary policy has been rushed. We will need to observe the situation unfold and respond accordingly. In housing, short-term mortgage rates are nearing 8%, while most homeowners benefit from existing mortgages of under 3.5%, making it challenging for many to consider relocating. Consequently, single-family home sales remain sturdy partly due to a lack of existing home resales. Regarding inflation and consumer debt, inflation is still high, with policymakers seemingly opting to increase costs for consumers through elevated energy expenses and related consumer costs. This inevitably slows down the economy and burdens consumers, particularly those least able to absorb these costs, contributing to record-high credit card debt. In February 2023, we projected that the current year would not proceed smoothly, anticipating a slowdown in the latter half of the year and possibly a rate drop in Q4. However, I now believe our prediction may be off by about six months, with a slowdown likely in 2024 and expected rate decreases at that time as well. Our teams are prepared to face uncertainties and are committed to navigating through challenges together. Now, let’s examine the performance and outlook of our individual segments. In Retail Solutions, as a value-added manufacturer and self-distributor, our products cater to the DIY market as well as professional contractors. Our brand consolidation into three product families is progressing, which we believe will enhance our focus in each category, facilitate new product development, create a better product mix, and optimize target marketing expenditures. In Q3, ProWood sales met expectations with margins following a similar trend to Q2, which, while improved from a year ago, still falls short of our reasonable margin target. The team is dedicated to strengthening the ProWood brand and collaborating with its Performance Solutions team to improve treatments, as well as the performance, appearance, and durability of its products. DecKorators also reported strong results in Q3 and is poised to expand its product offerings with new capacity coming online next year. Meanwhile, the UFP-Edge business unit is currently underperforming but has implemented significant changes in structure and go-to-market strategies, which we believe will foster future success. Big box retailers are predicting a 2% to 5% decline in unit volume for 2024, with a recovery anticipated in 2025 and 2026. Regardless, we will continue pursuing our strategy to offer innovative new products and solutions, focusing on the right brands while leveraging our national reach, purchasing expertise, and distribution network to deliver the best customer value. In construction, our Site Built business unit excelled in Q3, despite market downturns. While our order files remain solid, we expect softer demand in Q4 and the first half of 2024. Most Site Built facilities are currently operating normally with minimal overtime. Innovating and creating competitive advantages through efficiency and delivering high-value solutions remains a priority. Our new facility in Chicopee, Massachusetts is now operational and serves as a model for future automation and efficiency initiatives. In the Factory Built segment, we continue to navigate challenges associated with low unit volumes at the customer level, but we are capitalizing on opportunities to develop new products and solutions for both the manufactured housing and RV markets. Our capable management team is well-prepared to guide the business through uncertainties while achieving strong results. In the packaging segment, we have seen reduced demand from several customers recently. To address this, we are consolidating product manufacturing and optimizing capacity through automation to ensure more cost-effective operations. We also aim to enhance engineering, sales, and marketing across our packaging organization by moving away from a fragmented approach. Our sales strategies involve leveraging design expertise domestically and internationally to better serve our customers. PalletOne is experiencing pricing pressures from an oversupply of used pallets, and some competitors with high inventories and leverage may struggle due to rising storage costs and interest rates. However, the long-term prospects for UFP packaging remain positive, and we plan to continue investing in automation, innovation, and acquisitions to position ourselves as the global packaging solutions provider. Looking to the economic outlook, we anticipate growth opportunities alongside certain slowdowns. We are actively adapting our packaging operations to align production with demand and consolidating manufacturing locations to improve efficiency. On the international side, our team successfully completed the acquisition of Palets Suller in Spain during the third quarter, furthering our mission to be a leading global packaging solutions provider. Additionally, in the third quarter, our new product sales totaled $176.5 million, amounting to $548.7 million year-to-date. We are currently behind our annual target of $795 million primarily due to lower lumber market pricing. We are initiating our annual review to sunset certain new products and will elevate the criteria for continued inclusion as new products. Innovation in new products is essential for our future success, and we must ensure we focus our capital on the most promising opportunities. Furthermore, our growth strategy has shifted to prioritize strategic avenues, and we are constantly evaluating the best opportunities, whether they arise from M&A or organic growth initiatives. While the M&A pipeline is not overwhelmingly robust, we believe that opportunities for favorable acquisitions will arise in a more normalized economy with increasing future tax rates. In addition to dividends and share repurchases, we intend to allocate capital towards enhancing automation, driving innovation, and improving employee work environments. Lastly, regarding human capital, the U-6 unemployment index rose to 7% at the end of September, compared to 6.9% at the end of June. We expect an influx of job applicants in the coming quarter. We are committed to training and developing skilled positions while automating manual tasks. Our investment in the next generation of leaders is exemplified by the September graduation of 14 students from our UFP business school and the October graduation of another 14 students from our advanced leadership program, all of whom will help ensure that our talent level aligns with our strategic growth objectives. Now, I'll pass it on to Mike Cole to go over the financial details.

Thank you, Matt. Our consolidated results this quarter include: first, a 21% drop in sales to $1.8 billion, consisting of a 12% reduction in selling prices and a 9% decrease in units. The decline in selling prices was a result of the drop in lumber and more competitive pricing in certain business units. Second, a 24% drop in adjusted EBITDA to $208 million and an adjusted EBITDA margin of 11.4%. Our adjusted EBITDA margin continues to stay well above our minimum target and pre-pandemic levels. We believe our team's commitment to grow our portfolio of value-added products and our market-focused management structure continue to contribute to the structural improvement in our margins. Third, a trailing 12-month return on invested capital of 24%, nearly 2.5x our weighted average cost of capital. Next, a $179 million improvement in operating cash flow to $712 million, as lower volumes in lumber prices reduced our investment in net working capital. And finally, a balance sheet that continues to gain strength with a net cash surplus of $682 million this year compared to $128 million last year. By segment, sales in our Retail segment dropped 16% to $711 million, consisting of a 9% decline in selling prices and a 7% decline in unit sales. Given more challenging market conditions, our unit sales held up well this quarter, driven primarily by our ProWood and DecKorators business units, which each experienced slight declines. Our unit sales to big box customers were up 1% for the quarter, while our business with independent retailers, which we believe is more closely correlated with new housing starts, dropped by 22%. Our retail operating profits increased to over $45 million this year, a 57% increase from last year. Last year, our retail segment, which has a sales mix heavily weighted toward variable priced treated lumber, was adversely impacted by sequential trends in Southern Yellow Pine prices that dropped from nearly $1,200 per thousand at the beginning of April to almost $500 at the end of Q3. Fortunately, we haven't had the same challenge in 2023. At the beginning of this year, we indicated our retail segment was well positioned to report an increase in operating profits for the year. The strong performance so far has resulted in a $22 million year-to-date increase, and we believe retail is well positioned to build on that progress into Q4. Moving on to Packaging. Sales in this segment dropped 23% to $450 million, consisting of a 16% decline in selling prices and a 9% organic unit decrease. These decreases were partially offset by acquisitions, which contributed 2% to unit volume. With respect to selling prices, customer demand continues to be softer than we anticipated, which has contributed to more competitive pricing. As a result of these and other factors, operating profits in our Packaging segment dropped to $41 million, a 46% decrease from last year, resulting in a decremental operating margin of nearly 27% this quarter as we continue to see volume and competitive price pressure. We expect these trends to continue into Q4. Turning to construction. Sales in this segment dropped 25% to $584 million, consisting of a 12% decline in selling prices and a 13% decrease in units. As expected, the unit decline was due to our Site Built and Factory Built businesses whose units declined 15% and 8%, respectively, resulting from a decline in starts and industry production. Lower volumes and more competitive pricing caused the operating profits in our construction segment to drop to $70 million, a 37% decrease from last year, resulting in a decremental operating margin of nearly 21% this quarter. Given the higher interest rate environment, we anticipate the pressure on volume and pricing to continue into Q4. As we manage through this cycle, each segment continues to focus on executing our strategies to grow our portfolio of value-added products, and we're pleased to report an improvement in our year-to-date ratio of value-added sales to total sales to 68% this year from 62% last year. Similarly, our year-to-date ratio of new product sales to total sales improved to 9.6% this year from 7.3% last year. We're confident these efforts will not only help us maintain the structural improvements in margins we've realized to date but enable further improvements in our EBITDA margins over time. We're also mindful of our cost structure in this environment as we ensure the company is appropriately sized relative to demand while still providing the resources needed to execute long-term strategies that enhance our ability to offer value-added solutions and drive innovation. Our SG&A expenses came in under plan and declined nearly $19 million or 5% this quarter, primarily due to lower bonus and other incentive expenses and a reduction in bad debt expense. Sequentially from Q3 to Q4, we anticipate a typical seasonal reduction in SG&A as we move into the slower part of the year, and our variable and incentive costs decline. Moving on to our cash flow statement. Our cash flow from operations was $712 million, a $179 million improvement over last year as our investment in net working capital declined as a result of lower volumes in lumber prices. We anticipate further reductions in net working capital in Q4. Our cash cycle for the quarter decreased to 62 days this year from 63 days last year due to a slight improvement in our days supply of inventory. Our overall receivables remain healthy with over 94% current. Our investing activities included $131 million in capital expenditures. Our expansionary investments are primarily focused on 4 key areas: first, expanding our capacity to manufacture new and value-added products primarily in our structural packaging, Protective Packaging and DecKorators business units; second, geographic expansion in our core businesses; third, achieving efficiencies through automation; and lastly, increasing our transportation capacity as we continue to transform this function from a cost center to a profit center. We also spent $52 million to acquire Palets Suller, a leading manufacturer of machine-built pallets in Spain that gives us an attractive runway for future growth. Finally, our financing activities included returning capital to our shareholders through almost $50 million of dividends and more than $62 million of share buyback so far in 2023. Turning to our capital structure and resources, we continue to have a strong balance sheet with $682 million in surplus cash in excess of debt compared to $128 million last year. Our total liquidity was $2.2 billion, consisting of surplus cash and availability under our credit facility and a shelf agreement with certain long-term lenders. With respect to capital allocation, we continue to pursue a balanced and return-driven approach between dividends, share buybacks, capital investments, and M&A. Specifically, our Board approved a quarterly dividend of $0.30 a share to be paid in December, which represents a 20% year-over-year increase in the quarterly rate. Share repurchase program our board approved in July, provides us with authorization to repurchase up to $200 million worth of shares until the end of July 2024. Since the approval, we repurchased almost 212,000 shares at an average price of $97.87 resulting in $179 million in remaining authorization. We continue to plan for capital expenditures of $175 million to $200 million this year. And finally, our balance sheet allows us to continue to pursue a pipeline of M&A opportunities. We'll continue to target companies that are a strong strategic fit and enhance our capabilities and competitive position while providing higher margin return and growth potential.

Thank you, Mike. Now I'd like to open it up to any questions that you may have.

Our first question will come from Julio Romero with Sidoti & Co.

So I wanted to maybe start on the Packaging segment. Can you maybe expand on the comments you gave earlier about structural packaging seeing some softer demand? Any particular trends you can dig into particular customers or verticals where you are seeing the drop-off? And was there maybe a particular catalyst aside from the broader uncertainty that's maybe causing that?

Yes, that's a good question, Julio. The situation varies across different customer bases. There is a general slowdown, which I would attribute to an overall economic downturn. Some customer bases are still performing well, while many have experienced a slowdown. This is not due to any fundamental or long-term structural issues; it seems to be linked to a broader slowness in the economy.

Okay. Got it. And then how is the initiative to pursue larger projects within Packaging going? And maybe can you talk to when you expect the benefits of some of those sales changes you made to hit the P&L from a timing perspective? Would that be a '24 event or maybe further out than that?

Yes. I believe you'll begin to see some of that in the first quarter of 2024, with most of it expected to come later in the year. As you know, the selling process often takes longer for these larger projects. However, we are very positive that our team will secure new and additional business with our national customer base. That said, you likely won't see the impact until the early part of 2024, with the majority coming later in the year.

Okay. That's very helpful. And then just last one for me would be just on the balance sheet. As you said, you have a war chest of almost $1 billion in cash, but also you mentioned an M&A pipeline that's maybe not as robust currently. So given the fact you guys have always invested prudently with ROIC in mind, would you just continue to kind of build that cash balance if nothing changes? Or does the cash balance allow you to maybe play in a larger sandbox from an organic growth perspective?

Yes. I think there's a lot of options available, and the challenge, as we mentioned, is we want to maintain our prudence in how we allocate that capital. We have the ability to repurchase shares, and again, the way we look at it is trying to use the return on invested capital as our guide. So whatever provides us with the best return, not just immediate but longer-term return, that's where we'll allocate that capital. We have a number of opportunities, and when we talk about the pipeline being smaller, part of that is due to us being more focused on the runways as opposed to looking at everything. The other part of it is, frankly, a timing issue that I believe is going to become a little easier as people come off of the pandemic highs in sales and profitability and kind of adjust to the new normal for what their future returns will look like as well. And then the last piece that I added was on the income tax rates, which will increase automatically in '25, I believe. So those may help drive some of the sellers' decisions.

One moment for our next question. And that will come from the line of Kurt Yinger with D.A. Davidson.

Obviously, a lot of volatility from the impact and changes in lumber prices the last couple of years. But I guess as you look across the segments and think about the normalization and pricing, kind of leverage, competitive pressures and relatedly gross margins, what kind of areas, whether it's segments or business units, do you feel like still have yet to bottom and you're kind of waiting to see that inflect in a positive way?

Yes. I guess the way we're looking at it, Kurt, is I would take an overall view, the sales are down pretty dramatically year-over-year. A lot of that is lumber market related. But the part that I take encouragement in is that overall, if we look at historical EBITDA margins, for example, we're at a much higher plateau than we've been in the past. And I think that's really our focus. We understand that markets may slow, the economy may slow, but being able to continue to work on our margins and keep our margins at a higher than historical level is really critical for us. And using the value-added product mix and focusing on those areas is how we're going to combat it. I'd also add that if you look specifically at the segments, packaging has shown a little more softness relative to where they were housing starts are at a lower level for sure, but we're still able to perform well at that level. You just never know what's going to happen with interest rates and what the economy is going to do in those factors. But our ability to scale up and down to meet whatever the actual demand is, I think, is really going to be critical. And I'm really confident that our team can do that as well as anyone.

And then on retail volume trends, those were weaker than at least I expected. Mike, I know you touched on some color on kind of the different business units, but maybe you could provide a little bit more detail there, particularly around what's going on with Edge and what you think is kind of driving some of that underperformance? And sorry if I missed it, but in regards to expectations into Q4, how are you thinking about that segment?

Yes, the Edge business unit definitely contributed to our challenges with unit shipments this quarter. They are currently undergoing a reset process, and we remain optimistic about the long-term prospects. I anticipate that the demand trends we observed this quarter in retail will persist, as our customers indicate low single to mid-single digit declines in their business. There may still be more adjustments to come, and I believe this situation also applies to other business units. Referring back to the previous question, we may continue to see pressure on the packaging side, and with the higher interest rates, I expect those trends to carry over into the construction sector next quarter as well.

And then just lastly, on DecKorators. I mean that's been a terrific business for you guys in the past several years, as you look into next year with more capacity at your disposal, I guess, what are the key pieces to the strategy to continue to gain share in that category? Is it focused on the dealers and converting shelf space? Is it working with new contractors? How do you keep pushing that business forward?

Yes, it's a good question, Kurt. I guess we rely very heavily on our certified professional installer base to be our best brand advocates. So continuing to market the product to create more consumer awareness of the brand is something that we're committed to. We also believe, and I alluded to some new products that we can make using the technology that we're very excited about, which will certainly enhance not just short-term but long-term growth potential of that product. So that's why the capacity is helpful because we haven't really been able to launch new products because we've been utilizing the capacity for existing products. So those would be two factors that I would say are going to help drive it. We are getting more traction with some existing dealers, and I think there's still more big box opportunity to come as well.

One moment for our next question. And that will come from the line of Ketan Mamtora with BMO Capital Markets.

To start, I’d like to hear your overall perspective on how some of these businesses are performing. The economy shows strong GDP, but we're seeing some weakness in packaging. New residential construction seems to be holding up reasonably well, despite mortgage rates being at their highest in decades. Can you discuss the factors at play in these trends and whether you are surprised by their evolution or anything else you'd like to mention?

Yes. That's a really good question, Ketan, and what I would start with is we're probably being unfair to the packaging group in terms of how we look at it. Their performance is being compared to pandemic-era performance, which was off the charts. So I think if we go back and look at 2019 and before that, the packaging returns have still been much better than they were back then. And I think that's a fair trend line to look at. So while they're coming off of historic highs in terms of volumes and profitability, I think they still have settled in at a level that's higher than historical for us. So while we'll continue to push and strive and try to make sure that we're doing the best we can do, they still have reached a higher elevation in their structure, so that's a plus. On the construction side, the resilience of the housing market has been a pleasant tailwind for us. So I think that's terrific. And again, as we've talked before, the volume of housing starts as long as it's at a reasonable level, we can still be very profitable and do very well. And it appears to me that it should stay within those ranges, at least at present for the information we have. And on the retail side, I guess what I would say is while some of the big box customers are predicting maybe a 2% to 5% decline in volumes for '24. They also predicted a down volume in '23, and our product mix has benefited, and our units are actually doing very well relative to what other products in the stores are doing. So there's a bit of an anomaly that we have to be careful of, and just because they're predicted down 2% to 5%, that may not be the same in our product categories. But I would tell you, Ketan, that it is a mixed bag, so to speak, and it's going to affect different markets differently. But overall, I'm still very pleased that we're at a higher level than historical in terms of margins on the sales volumes that we have. And I think we're well positioned, as I said before, to adjust to whatever the economy tends to throw our way.

I have one more question. Looking at the Site Built business, I know Q4 is usually slower due to seasonality. Outside of that, are you noticing any signs of stabilization at our current levels, or is there further pressure? What feedback are you getting from your customers? Please address both the single-family and multifamily aspects.

Yes. So on the single-family side, I think there's a slight decline that's predicted. On the multifamily, from where we are, we're looking at pretty good order file through '24, probably more softness than '25, and so that's the macro view. I would tell you that in our markets, and as you know, we're not in all the national markets so using national figures doesn't necessarily describe where we are. So I would tell you that the mid-Atlantic area has been very resilient, still is. And Texas is still a good market, upstate New York and Colorado are still holding firm on where they are. So that's obviously subject to change, but I would expect there to be some continued softness on single-family starts or smaller homes, some way to make them more affordable in the near term.

I'm showing no further questions in the queue at this time. I would now like to turn the call back over to Mr. Matt Missad for any closing remarks.

Well, thank you again for spending the time with us today. We really appreciate it. As Felix Cornell says, nothing good is easy, but our team is strong and has faced much bigger challenges in the past and overcome them. Thank you for your investment in us, and we'll keep working hard to ensure great long-term returns. Have a great day and Go Lions.

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