AEP Industries' (AEPI) CEO Brendan Barba on Q2 2016 Results - Earnings Call Transcript

| About: AEP Industries (AEPI)

AEP Industries Inc. (NASDAQ:AEPI)

Q2 2016 Earnings Conference Call

June 10, 2016 10:00 AM ET

Executives

Brendan Barba - Chairman and Chief Executive Officer

Paul Feeney - Executive Vice President, Finance and Chief Financial Officer

Analysts

Roger Spitz - Bank of America-Merrill Lynch

Dan Khoshaba - KSA Capital

Mike Hughes - SGF Capital

John Rolfe - Argand Capital

Operator

Good morning. My name is Laurie and I will be your conference operator today. At this time, I would like to welcome everyone to the AEP Industries Incorporated Second Quarter 2016 Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions]

Ms. Tress [ph], you may begin your conference.

Unidentified Company Representative

Thank you, Laurie. Before we get started, I would like to remark briefly about forward-looking statements. Except for historical information mentioned during the conference call, statements made by the management of AEP Industries are forward-looking statements that are made pursuant to the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995.

Forward-looking statements involve known and unknown risks and uncertainties which may cause the company’s actual results and future periods to differ materially from forecasted results. Those risks included, but are not limited to risks associated with pricing, volume and conditions of the markets. Those and other risks are described in the company’s filings with the SEC over the last 12 months, copies of which are available from the SEC or may be obtained from the company.

During this call, we will also discuss a non-GAAP financial measure. Please refer to the table included in our press release for a reconciliation of this non-GAAP measure to the comparable GAAP measure and a related discussion thereof.

Today’s format will be as follows: Brendan Barba, Chairman and CEO, will discuss operations and then Paul Feeney, Executive Vice President, Finance and CFO, will discuss the financial results. After the prepared remarks, Brendan and Paul will be available for questions.

So without further delay, I would like to turn the call over to Mr. Barba. Brendan?

Brendan Barba

Thank you. Good morning, everyone. Welcome to our second quarter conference call. Our results for the second quarter were outstanding. Volumes increased over 3% and were driven by new and improved and lower cost products with better margins. EBITDA for the quarter was a record $35.4 million and also for the six months another record of $57 million year-to-date EBITDA.

Over the past couple of years, our efforts have been directed toward increasing capacities, improving operating efficiencies and creating the internal knowledge base necessary to take the company to the next level. Much of this effort was predicated by our internal forecast that due to the substantial increases in capacity being added by our resin manufacturers, domestic prices would decline and resin processes like AEP would benefit. I'm happy to announce that our plan is coming to fruition and our efforts are being rewarded.

For the first half of 2016, our sales is up slightly more than the 3% forecasted and even more gratifying, our profits are up smartly. We believe CapEx at about $20 million will be relatively modest over the next few years and it's almost the same as what we expected to be for 2016. So we think 2017 will be about the same.

Investments – well, more importantly, we think resin prices will continue to decline over the next four to five years to the benefit of AEP, along with all their domestic manufacturers. A little bit more about resin. We did see some resin spikes in March, $0.05, and in April, $0.04. We look at these as temporary. We don't expect them to last very long. They were driven by significant maintenance turnarounds, which took a lot of capacity out of the market temporarily. Of course, they did this in the high season, where demand was strong and exports moved pretty well also.

We expect most of the first increase of $0.05 to be given back over the next few months. We also anticipate further erosion on resin prices in the third and fourth quarter of 2016 as significant capacity is being added in 2016. We expect this trend to continue over the next couple of years as – about 6.5 billion pounds of capacity will be added over the next year.

A summary of those capacity additions would be Novacor is coming on with 950,000 pounds of butane in the fourth quarter of 2016. Bashkim [ph], a new producer out of Mexico will come on with 1.6 billion pounds of high density capacity. Again – well, that would be in the third quarter of this year. Bashkim [ph] has another 660 million pounds of low density capacity coming on-stream in the third quarter of this year. Total of about 3.2 billion pounds in 2016.

In 2017, Chevron comes on with 1.1 billion capacity increase in [indiscernible] for the fourth quarter of 2017.

Chevron also has another 1.1 billion in high density capacity coming on about the same time fourth quarter of 2017. Gemini has about 1 billion pounds of high density coming on in the third quarter of 2017. All told, it's about 6.5 billion pounds. That's a huge, huge amount of added capacity.

When we look at resin, we think of the resin market today as a global market and it certainly is. In 2016 to 2018, global capacity additions will exceed demand growth by about 7.6 million tons and 7.6 million tons represents about two years of PE demand growth globally. So you can see the overcapacity is going to be astounding.

Our capacity additions, we continue to add capacity in our custom films division. We have 10 million pounds of capacity that we just put on-stream in May in our Chino, California plant. That plant – that line is running full-out. It's on budget and ahead of schedule, which was – schedule date for June.

In our Waxahachie, Texas plant we're adding another 10 million pounds of capacity. It's supposed to come on right around mid – the second or third week of June. We expect it to be in on about – on time and the estimated capacity utilization is about 80%.

The last line that we're adding in our custom films division goes into our Matthews, North Carolina plant. It's 8 million pounds of capacity. The start date is also towards the end of June and the estimated utilization rate there is about 70%.

In our institutional can liner division, we are completing phase two of our automation project. This estimated reduction – this will result in the estimate of about 20 people, fewer people operating in the plant and we also expect about 10 million pounds of added capacity. Automation allows us to produce at rates more achievable than with manual labor. We expect that capacity to be on first week of September of 2016. Adding capacity is always challenging, but as you can see by our high estimate operating rates, we are very comfortable with these investments.

In closing, I'd like to say that I've been doing this for quite a long time and I've never really seen AEP in a better position to grow and prosper. We have added significant shareholder value in 2016 and we expect this strong performance to continue for years to come.

At this point, I'll turn meeting over to Paul Feeney.

Paul Feeney

Good morning, ladies and gentlemen. Net sales in our second quarter decreased about $13 million to $273 million. The decrease was the result of a 7% decrease in the average selling prices, partially offset by a 3% increase in sales volume. The selling price decrease resulted from the partial pass-through of lowers resin costs to customers in the current quarter.

Volume in the quarter was 273 million pounds, an increase of 7 million pounds over the 236 million pounds sold in the second quarter of 2015. Year-to-date net sales were about $527 million, a decrease of $34 million or 6.1% as compared to the $561 million recorded in the prior fiscal year. The decrease was the result of a 9% decrease in average selling prices, partially offset by a 4% increase in sales volume.

Year-to-date volume was 467 million pounds, an increase of 16 million pounds over the 450 million pounds sold in the first six months of the prior year. We are pleased to note the volume increases in our second quarter and year-to-date period and although our marketplace is extremely competitive we believe we are well-positioned to continue this upward trend.

Gross profit in the second quarter increased $4 million on a book basis to $54 million. Adjusting for the $9 million impact of LIFO reserve movement between the current and prior reporting periods, gross profit improved $13 million. The improvement is primarily due to improved material margins, combined with increased volumes sold, partially offset by a $600,000 increase in performance incentives cost and an asset impairment charge of $700,000. Adjusted for LIFO, gross profit per pound in the second quarter is $0.233 cents a pound. In the second quarter the prior year, adjusted gross profit per pound was $0.183 cents.

Year-to-date gross profit increased about $15 million to $98 million. This includes a LIFO reserve decrease in the current year-to-date period of about $2 million as compared to a LIFO reserve decrease in the prior year's fiscal period of $16 million. Adjusting for the $14 million net LIFO reserve movement in both periods, gross profit increased $30 million in the current period. This improvement results from increased volumes sold, combined with improved material margins, again, partially offset by the performance incentive cost and the machinery impairment cost previously mentioned. Adjusting for LIFO, gross profit per pound in the current year-to-date period is $0.206 cents, as compared to the first six months of the prior year of $0.147 cents.

The profit improvement our company is experiencing is almost exclusively driven by improvements in material margins and increases in volumes sold. The significant resin supply increases currently being put into the market by the resin manufacturers are forcing the resin price decreases, basically supply and demand. That's it. AEP's ability to benefit by these resin price developments is made possible by our recent CapEx expenditures, which were made in an anticipation of a supply dynamics that are currently under way in the market.

We believe resin supply will continue to increase over the next four to five years and we think AEP will continue to benefit by the resulting price reductions. Further, assuming there is no further change to our footprint, we expect CapEx will remain in a relatively modest $20 million to $25 million range over that time frame. Operating expenses for the second quarter of fiscal 2016 were $28 million, a decrease of $1 million, compared to the prior year. Operating expenses for the six month period of fiscal 2016 were $55 million, as compared to $56 million for the first six months of the prior year.

The operating cost decreased in both 2016 periods of $1 million is primarily due to a reduction in bad debt expenses. Interest expenses, there were minor reductions to interest expenses in both 2016 periods, resulting from decreased borrowings under our credit facility. Net income for the three months ended April 30 was $13.8 million or $2.68 per diluted share, as compared to net income of $11.1 million or $2.18 per diluted share in the three months ended April 30, 2015.

Year-to-date net income was $21.7 million, or $4.22 per diluted share, as compared to net income of $11.6 million or $2.27 per diluted share in the prior year. We run the company for adjusted EBITDA, which was a record $35.4 million in the current quarter and $57 million year-to-date, as compared to $23.1 million and $29.6 million in the same periods of the prior year. The amount of cash currently dedicated to our discounting programs remains around $28 million.

Capital expenditures in the second quarter was around $4.2 million and is $8.3 million year-to-date. We believe CapEx for the year will not exceed $20 million. At quarter end, we had about $34 million in cash and our leverage ratio based on LTM adjusted EBITDA of $103 million was close to two to one. Current availability, I mean today, this point in time, current availability is $207 million.

With that, I conclude my presentation and open this conference call up to questions. Are there any questions?

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Roger Spitz of Bank of America-Merrill Lynch.

Roger Spitz

Hi, guys. Thanks very much.

Brendan Barba

Good morning.

Paul Feeney

Good morning, Roger.

Roger Spitz

You may have discussed this a little bit in your prepared remarks, but the reported LIFO gross profit per pound material improved of course. Is there any guidance you can provide on whether, given the movement in resin that you've discussed, whether you'll be able to maintain that number or will it come back down?

Paul Feeney

We expect by year-end the LIFO reserve increase that you saw in the second quarter will disappear. That's was we think is going to happen because we believe resin prices will continue down toward the end of our third quarter or the beginning of our fourth quarter. So that's what we're thinking about the period. But we basically disclose all of the numbers on a quarterly basis and people I think can easily put it together if they want to.

Roger Spitz

Okay. And fiscal 2016 volume outlook, on the last call I think you were expecting 970. You were slightly above your expectation here, but basically was on target. Is 970 million pounds still the guidance?

Paul Feeney

Yeah, we're sticking with that. It was basically a 3%, we forecasted a 3% increase in volume. You can imagine, that's a pretty hard thing to do and we would rather - if we're off our forecast, we would rather be off on the upside than the down side. We hate disappointing the market. So we're going to keep it at 3% and we're going to basically tell everybody that we're over-performing a little bit.

Roger Spitz

Excellent. And last from me. Can you give any guidance for the rest of this year on any changes in working capital or cash taxes?

Paul Feeney

There have been basically reductions in our working capital requirement this year. Part of the cash that we have on hand is a result of a reduction in our working capital requirement. We would expect that by the fourth quarter, if resin prices continue to go down, and we think it will, there will be further cash coming out of our balance sheet.

Roger Spitz

Excellent. Anything on cash taxes?

Paul Feeney

We're a taxpayer now and we expect that - depending on where we are on LIFO, our cash tax rate is going to be in the mid-30s, 30%.

Roger Spitz

Great. Paul, Brendan, thank you very much.

Paul Feeney

Okay Roger.

Operator

Your next question comes from the line of Dan Khoshaba of KSA Capital.

Dan Khoshaba

Good morning, guys.

Brendan Barba

Good morning, Dan.

Paul Feeney

Hi, Dan.

Dan Khoshaba

I just wanted to get into some kind of higher level type stuff, Brendan and Paul. The business is obviously performing very well and I would agree with your expectation for strong performance in the future, given what's taking place. But I think we would all agree, it's still a relatively cyclical business overall and we don't expect that to completely change. Now, if we look at the business today and you kind of connect the dots of what has been record performance for the company and strong performance likely to continue, I agree with that, strong cash flow, leverage ratio that's about as low as it's been in years now, cash on the balance sheet that's strong and likely to continue, availability of credit that's more than half of your market cap, why not use these strong conditions and fundamentals to address longer term structural type issues with having to do with an under undervalued stock, which doesn’t trade much, as all it seems to be almost always kind of undervalued and certainly is very undervalued today. And while it's great to see the company performing well, you haven't - there's no buybacks. There's no special dividends. There's still an issue of a capital structure that just doesn't work. Why not use these strong fundamentals and the strong outlook to fix or to take advantage of the strong fundamentals that you have today? Brendan, that's something I'd like you to address, if you can.

Brendan Barba

Well, first of all, Dan, we have declared a dividend for shares. The dividend when the stock was $60 with the 1.6% dividend. As you know, in all of our director’s meetings stock buybacks, dividends, et cetera, even special dividends are discussed. So, I think we're always looking at that and anything we can do to create shareholder value. I tend to agree with you that the stock doesn't always reflect the right price, the right value based on earnings and we think right now it's very undervalued, very, very undervalued, although it went up to 60 - what did it hit yesterday?

Dan Khoshaba

Still under 70, but either way, based on your cash flow today and the business fundamentals, Brendan, it's still a very undervalued stock. And you run the risk of letting somebody else, I think, kind of dictate your future when you don't act on this, because I don't think it's going to go away without management acting on it. And the dividend was a step in the right direction, but he I - that doesn't cure what has perpetually been in my mind undervalued stock.

Brendan Barba

Well, we don't disagree on that, Dan, but we do look at all of the options available to improve shareholder value. We really do.

Dan Khoshaba

I would just - last thing, as a large shareholder, I would just hope that you guys would use what has been very good performance to address some of the long-standing issues that we've all talked about in the past. Anyway, good quarter.

Paul Feeney

Dan, what I can tell you is we're in a pretty good cash position. We're aware of our opportunity to restructure our debt profile. However, we would much rather restructure debt. If we're looking at combined with other opportunities. So, those are things that we're looking at now. What I can absolutely guarantee you is the cash that we have on our balance sheet and in the company at this time, we will put to the very best benefit of our shareholders and at every juncture we will try to make the moves that move our stock price so that our stock price begins to more reflect the value of the company.

Dan Khoshaba

When you say - Paul, when you say restructure the debt in association with improving the value for shareholders, what could some of those options be?

Paul Feeney

Well, I think very simply, we would get a payout if we were to basically either call some of our debt and refinance a little bit of it out of a short-term borrowings and with our cash there would be an obvious 8.25% return on that. But we would have to pay a premium and we would rather do that in conjunction with another transaction, if that were possible. At the present time, there are a number of opportunities on our desk and we are working on those things. We are aware that we could probably borrow in, say, the term B market, at a significantly lower rate than we're currently paying. By significant, I mean 1.5%, maybe 1.5% less, but does it pay us to refinance I would say $150 million or $100 million if we're looking at other opportunities. And that's really where we are at this time.

Don't forget, we have to pay a bit of a premium to call our debt at this time. And if we're going to do that sort of a capital restructuring, I mean, that's just one of the things that I think everybody will look at if they look at our balance sheet, one of the opportunities in front of us right now. There are others that, clearly, I can't talk about, so …

Dan Khoshaba

Okay. Well, thanks, Paul. I encourage you guys to take advantage of what is very strong operating conditions right now and I agree, I think it will continue and a stock that is in my mind at least very undervalued.

Paul Feeney

Okay.

Brendan Barba

Thanks, Dan.

Operator

Your next question comes from the line of Mike Hughes of SGF Capital.

Mike Hughes

Good morning. Thanks for taking my questions. I think in the past you've targeted the gross margin per pound metric of about $0.20 to $0.22. You exceeded that in the just completed quarter. From the outside, if we're kind of modeling over the next few years, is that still kind of the range we should target?

Brendan Barba

We believe. So yes, we believe that over the next four or five years, there’s going to be an excess supply condition in North America and we believe that our company and other people in our processing type business are going to benefit by that. It’s essentially a buyers market. Now, the previous person talked about the cyclical nature of our business and that’s true, but we believe that we’re going into basically beginning what’s going to be a four to five year cycle. That’s what we think.

Mike Hughes

And then at least according to my estimates your stocks trading at about 5.2, 5.3 times EBTIDA, it sounds like you’re potentially looking at doing some sort of large acquisition. So if that’s correct, what are the multiples out there? Can you actually find opportunities at discounts to where your stock is currently trading?

Brendan Barba

I wouldn’t propose to answer that question. Looking at acquisitions or that something we do all of the time.

Paul Feeney

There is always things available in the polyethylene business and we look at all of them were on the list we get or look at everything, whether or not we would do that or not obvious depends on the circumstances. So, we really can’t comment on that.

Mike Hughes

Okay. Thank you, very nice quarter.

Paul Feeney

Thank you.

Operator

Your next question comes from the line of John Rolfe of Argand Capital.

John Rolfe

Hi, guys. My question was answered thank you.

Paul Feeney

Okay, good.

Operator

[Operator Instructions] Your next question comes from the line of Shawn Noel of SVM.

Shawn Noel

Hi, good morning guys. Nice work on the quarter.

Brendan Barba

Thank you.

Shawn Noel

My question has to do - can you remind us what percentage of your volume is done it like a contractual margin and what’s done if something moreover a long line just bought us?

Paul Feeney

Around 28% I think, right. 28% of our entire business is on their contract and the rest of it is...

Shawn Noel

Sorry there Paul. And then, the other thing, given the global market for polyethylene and lot of a massive manufacturer, massive based capacity out there. Can you maybe just discuss a lit bit of how you think about how oil prices impact your business? Obviously, it’s an indirect impact into the global polyethylene markets, but kind of confused by how your stock trades along with oil sometimes and it seems kind of disconcerting.

Brendan Barba

North American companies should be following natural gas, not oil about 75% of the polyethylene made in the United States is made out of natural gas. In the global market, it’s almost the exact reverse. So if 75% of the global market produces polyethylene from oil, so as polyethylene and with all the capacity coming on stream in North America, the global oil price will affect the ability of the North American producers to export. We have a low cost position they are in a very, very good shape with that because of fracking in oil and natural gas prices, but if oil as an example, which was 100, the North American supplier should very, very, very well position to compete anywhere in the world that certainly reverse itself when oil went under $30.

So it’s how we consider polyethylene to be very volatile and so is oil.

Shawn Noel

Right. And so, if oil were perhaps to just make a number up go back to 100, I mean obviously that would drive increased exports from the stronger position in the U.S. industry, but wouldn’t that also incentivise better discount to large buyer such as yourself. I mean how do you think about the offset sort of in a big picture longer term manner?

Brendan Barba

Every market is different if they have sold out. The answer to that question is the discounts would be not as expensive, but there are huge capacities coming on stream. I gave you the numbers between 16 and 18, there is about 7.6 million metric tonnes coming on that would be enough to supply the industry, the world market for two years without any more capacity increases.

Shawn Noel

Okay. And then, I guess just one last thing. If I look at your historical margins on gross profit basis, you said you’re targeting longer term $0.20 to $0.22. I mean that would be not far off from what you’ve done historically without this cycle that is occurring in the polyethylene market. I mean I’m not sure, why you wouldn’t be expecting your gross profit to be better in the future than it’s been historically given the tailwind you have over the next five years.

Brendan Barba

That’s primarily because we predicated our forecasting on recent developments and really what we can see on the conservative basis, we don’t really like to as I said earlier in this conference call, we don’t really to disappoint very much. So, we much rather be a little bit conservative and give the number that we are pretty certain that we can hit.

Shawn Noel

Okay. That makes sense. I appreciate the prudence. Thanks for taking my question guys. Nice work.

Brendan Barba

Thank you.

Paul Feeney

No problem.

Operator

At this time, there are no further questions. I’ll now turn the call for management for any additional or closing remarks.

Paul Feeney

Well, we thank you all for joining us today. If any question should occur to you, you all know Brendan and I, feel free to give us a call, but with that we will close the meeting and again thanks for attending.

Brendan Barba

Thanks everyone.

Operator

Thank you. That does conclude the AEP Industries Incorporated second quarter 2016 results conference call. You may now disconnect.

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