Avery Dennison Corporation Q2 FY2025 earnings call

Management Statement and Operational Highlights

• Business Resilience: Delivered solid second quarter with earnings above midpoint of expectations and strong free cash flow. Mitigated tariff impacts via strategic sourcing adjustments and select pricing surcharges.
• Segment Details: Materials Group showed strong productivity and margins; high-value categories outpaced base. Solutions Group margins solid despite apparel decline; Intelligent Labels sales mixed by category.
• Operational Adjustments: Adjusted global network due to trade policy, focused on improving network efficiency and innovation in Intelligent Labels (IL).
• Long-Term Outlook: Confident in long-term earnings progression, leveraging global scale, innovation, and strong balance sheet for capital allocation.

Segment Performance

• Materials Group: Organic sales down 1% due to deflation-related price reductions offsetting modest volume mix growth. High-value categories (over 1/3 of sales) up low single digits, base business down low single digits. Regional trends: North America up low to mid-single digits, Europe down low to mid-single digits, Asia Pacific and Latin America up low single digits. Graphics and Reflective sales up high single digits, Performance Tapes and Medical up low single digits. Adjusted EBITDA margin 17.8%, down slightly from prior year but up sequentially.
• Solutions Group: Organic sales down 1%. Outside apparel and general retail categories up low double digits. High-value categories up low single digits, Base Solutions down mid-single digits. Vestcom up ~10% from new program rollouts; Embelex down in the quarter. Enterprise-wide Intelligent Labels sales comparable to prior year, up mid-single digits sequentially; food, logistics, etc., up mid-teens, apparel and general retail down mid-single digits. Solutions Group adjusted EBITDA margin 17.1%, up 30 basis points from prior year.

Guidance

• Third quarter adjusted EPS expected $2.24 to $2.40, midpoint comparable to prior year. Q3 assumes typical seasonality and slight sequential currency translation benefit.
• Full year: Anticipates $7M currency translation benefit, ~$50M restructuring savings, expects earnings growth in Q4 assuming no significant macro shift.

Risks

• Trade policy uncertainty impacting volume and sourcing.
• Soft growth in Europe and Asia due to prior year pull-forward of orders.
• Muted customer sentiment and uncertainty in apparel industry.

Q: So I wanted to dig into Solutions a little bit. I understand the tariff stuff created some noise. It does look like maybe the trends were improving. But I guess, admittedly back-to-school doesn't change. Holiday season doesn't necessarily change all that much. So I guess, can you speak to whether you see pent-up demand where we may see some kind of quicker turnarounds going forward as we get into the second half, and how the profitability of that might flow through? And then I guess the other question I had on Solutions was just, you sound optimistic about, in particular, some of the excitement around the food and grocery channel at this point. Is that something where you think we could see a conversion of new business, or a new account, before the end of the year?

A: Thanks, John, for the question. Let me just deal with the first one. What we've seen really in the macro environment, John, if you take a step back, is continued kind of retail sales volume softness in Europe. There's -- and retail sales in the United States are still only projected to grow sort of above 1%. And I think the apparel industry specifically itself has hadn't been impacted by the whole tariff uncertainty. Not just the tariff rate itself, but also when and where they get applied and when they become more certain. Those two things, and when you add them together, have -- certainly had an impact on the way our customers have been thinking about their sourcing strategy. So in the early days, you may recall, we said we saw some orders being held as apparel retailers and brands trying to determine where they're going to source and how they're going to price those when they landed in the United States, particularly. That has slowly improved as we've gone through the second quarter. But the sentiment from our customers still remains fairly muted and the discussions we have with them, they're still saying they're waiting for more clarity to really understand exactly when they're going to be able to do that. Now overall, apparel consumption remains relatively robust to date. What I think we're going to see as we move forward, at least anecdotally, what I hear from customers, is that they're going to continue to watch how inflationary pressures impact the consumer demand, particularly in apparel, because likely we're going to see inflationary pricing in the apparel industry as we move forward in the second half. And they're trying to judge how much sourcing volume they then anchor themselves on relative to support that demand. And those ranges that we get from customers tend to vary as well, John. So we're taking an approach we say that we're assuming in the third quarter continued sort of low single-digit demand in our business for apparel and general retail overall. To your second question around food and grocery, I am very optimistic because while the impact that we've seen on apparel and general retail has been to have sort of mid-single-digit declines in the second quarter, outside of that, food, logistics and other categories are actually growing mid-teens and really good strong growth in food and logistics as well in both of those specific categories. And what we do know, and what we believe at the moment, is that outside of the impact that tariffs have had largely on apparel and general retail, the rest of our business is largely on track to where we originally assumed. And in particular the rollout that we had assumed as we went through this year on track. Some of those rollouts in food and logistics, or particularly in food, include also new customers as they go from pilot stage to rollout as well. And the results that we're seeing, particularly in food, from an ROI perspective, we're exceeding both the existing customers and some of our pilot customers' expectations. This gives us confidence in the fact that we're going to continue to see adoption as we go through the second half of the year into the start of '25 -- '26 apologies.

Q: Just following up on the last question and your comments, Greg, just in terms of the apparel improvement in 3Q. What are you baking in for RFID specifically in terms of volumes for the back half of the year? And then second, your confidence underpinning the expected improvement in 4Q earnings on a year-over-year basis, what are some of the drivers we should consider as relates to that assumption?

A: Ghansham, let me deal with the first question. Just reiterating, we continue to see the impact of apparel and general merchandise, those two categories through the tariff environment. And as I said, outside of those, our business is largely on track in the way we thought it would be. We have two things that are going to happen in the second half of this year. I anticipate all things being equal, there's no further deterioration, we should see growth in IL in the third quarter. And then in the fourth quarter, we expect to see some of those new programs, or the rollouts that we're seeing take traction in the fourth quarter as well.

Q: Your graphics and reflective volumes has been up high single digits for the first 2 quarters of the year. Do you expect a continuation in that trend? And what do you see as behind it? And then secondly, your SG&A expense has been lower year-over-year for the first 2 quarters and sort of nicely lower in the second quarter. When I look at your 10-K, it doesn't seem that your overall employee levels are so different. What's behind the decrease in SG&A? If you could answer those two questions.

A: Thanks, Jeff. Yes, we're pleased with our graphics and reflectives combined growth overall being sort of mid- to high single digits across the 2 quarters. It's largely driven actually on our graphics business with particular strength in Asia and North America. We continue to see some new customer acquisition in Asia, where we're getting more traction with what we call our paint protection films overall. And similarly, in North America, where our, what we call, our cast color change films are having stronger attraction as the auto market moves into more and more customization of colors and so forth as they look forward. And we expect largely this trend to continue through the remaining part of this year. In line with our expectations that our high-value categories, particularly in Materials Group and also in Solutions Group will continue to deliver a greater, greater share of our portfolio in time to come.

Q: Deon, in your prepared remarks, you talked about not being satisfied with the growth trajectory in IL. And I think you talked about efforts to improve network efficiency and expand innovation. And I'm wondering if you could give a little bit more detail about sort of what activities you're pursuing there. And then just generally, in terms of IL, maybe competitive intensity, I mean do you feel that you're missing opportunities, or growth industry-wide has slowed? Or if you could just give us some kind of context for those comments and the activities that you're pursuing?

A: Sure, Anthony. And let me reiterate, I'm not satisfied where we are with our IL platform overall in terms of its growth. And actually, our earnings trajectory as it stands at the moment, and that's the reason we're so focused on executing against our strategies and particularly driving our innovation as well. As we specifically focus on IL, I made the point that when we were moved -- when the initial tariff environment started to emerge, and there was initially tariffs that were set in Mexico relative to other countries and that changed, we were moving -- using our network to try and move around our -- not our assets, but our actual manufacturing volume to make sure that we're taking advantage of whichever was the most tariff-friendly place at that time. Now of course, that switched quite dramatically during that period as well. And while we have a very resilient network, we can move things around, there are always associated costs. We've learned a lot out of that, Anthony. As we move forward, we're taking some additional steps to make sure where at the macro level, we're improving the resilience of how we use that network. We're also thinking through how we use working capital to also make sure we continue to deliver superior service and meet the opportunities that are there. The second part of that is specifically innovation. For me innovation is always going to drive differentiating ourselves in the market relative to competition. That's where our focus has been. And we have accelerated our innovation outcomes, not just at the product level, but at the solution level as well. And I'll give you a couple of examples of that. At the product level, as we look forward to what is going to be the bigger categories, which is largely food and the logistics, we continue to really innovate. Recall, we were the first people in food to bring out a microwavable tag as an example, something that's needed when you get to stuff that is effectively frozen. But we've also recently launched the first APR, association of plastic recyclers' recyclable tag, which is important when you get to perishable items that are contained in plastic containers. And then the third element is as we look forward for innovation, where we're going to be launching in the second half of this year, some really strong new proprietary IP to do with the category expansion in food, as you go beyond bakery into some of the other categories like protein and perishables, they will need more specific technology innovation. And I think we're going to be able to really differentiate ourselves in that regard. I think on your second point around competitive intensity, I don't see a change in competitive intensity overall. This is a space that continues to track capital, and we see balanced competition all around the world. But we remain in that regard, the market leader. We have the majority share. And I'm anticipating actually this year for our share to slightly increase as we not only roll out, for example, in apparel loss detection mechanism. We've spoken openly about with Inditex that will actually gain us share as we move forward, but also some of the new rollouts that are coming that I spoke about will also be largely where we are the significant majority of providers. In my anticipation that our share overall will continue to expand as we go through the second half of this year. At a broader level in the industry. I think the industry, given that the industry like us is still anchored in 70% general merchandise, general retail and apparel, I think we're seeing some of that impact that we're seeing probably across the rest of the industry as well. That said, I still think the industry has significant growth opportunities. Our conviction in our growth trajectory remains undimmed. We still see this as a 300 billion units, or put differently, $8 billion opportunity right there and thereabout, as we move forward. And we are seeing what we need to do to see for -- from an adoption process. We've had the first food customer go. We have a very, very strong pipeline for grocery retail coming up on that. We've had the first logistics customer go. We're in active pilots, expanded pilots with logistics customers. And so while that growth over the years, as I've said consistently, maybe a little episodic, I still have strong conviction in our ability to grow that platform significantly as we move forward over the next decade.