Masco Q3 2022 Earnings Call Transcript

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Provided by AlphaStreet
October 26, 2022
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Operator

Good morning, ladies and gentlemen, welcome to Masco Corporation's Third Quarter 2022 Conference Call. My name is Alex, and I'll be your operator for today's call. As a reminder, today's conference call is being recorded for replay purposes. [Operator Instructions]

I will now turn the call over to David Chaika, Vic -President, Treasurer and Investor Relations. You may begin.

David Chaika
Vice President, Treasurer and Investor Relations at Masco

Thank you, Alex, and good morning. Welcome to Masco Corporation's 2022 third quarter conference call. With me today are Keith Allman, President and CEO of Masco; and John Sznewajs, Masco's Vice President and Chief Financial Officer.

Our third quarter earnings release and the presentation slides are available on our website under Investor Relations. Following our remarks, we will open the call for analyst questions. Please limit yourself to one question with one follow-up. If we can't take your question now, please call me directly at 313-792-5500.

Our statements today will include our views about our future performance, which constitute forward-looking statements. These statements are subject to risks and uncertainties that could cause our actual results to differ materially from the forward-looking statements. We describe these risks and uncertainties in our risk factors and other disclosures in our Form 10-K and a Form 10-Q that we filed with the Securities and Exchange Commission. Our statements will also include non-GAAP financial metrics. Our references to operating profit and earnings per share will be as-adjusted, unless otherwise noted. We reconcile these adjusted metrics to GAAP in our earnings release and presentation slides which are available on our website under Investor Relations.

With that, I'll now turn the call over to Keith.

Keith Allman
President and Chief Executive Officer at Masco

Thank you, Dave. Good morning, everyone, and thank you for joining us today. Please turn to Slide 5. In the third quarter, sales matched prior year with significant pricing actions of 19%, offsetting volume declines of 6% and currency headwinds of 3%. Demand moderated more than expected in the third quarter with most categories experiencing declining volumes year-over-year. Our operating profit was impacted by these lower volumes, higher operational costs, and unfavorable foreign currency. Partially offsetting these headwinds, SG&A as a percent of sales improved 110 basis points to 15.6% as we continue to manage our SG&A and discretionary spending. Operating margin was 15.9% for the quarter and earnings per share was $0.98.

Turning to our segments. Plumbing grew 5% in local-currency against a 15% comp, with 4% growth in North America and 5% growth in international. Our spa business and international plumbing delivered positive volumes for the quarter. International plumbing sales were led by strong growth in China, as we continue to gain share. European markets in the quarter were flat in local currency against a double-digit comp in the third quarter of 2021. While incoming orders have moderated in Europe, we saw good demand in sub markets such as China, India, and the Middle East, demonstrating the benefit of selling to over 100 countries. We were price cost positive in the third quarter in Plumbing and we expect that relationship to continue to improve in the fourth quarter as our pricing actions are in place and we continue to anniversary the higher costs from last year.

In our Decorative Architectural segment, sales grew 1%, led by PRO paint sales, which increased mid-teens against a more than 45% comp in Q3 of 2021, more than offsetting sales declined, DIY paint, lighting and hardware. PRO paint volumes increased low-single digits as we continue to see good demand from PRO paint contractors. We are retaining the significant share gains we have achieved over the past 12 months and we continue to increase the rollout of additional capabilities and services along with our channel partner to strengthen our value proposition to the PRO painter. This strong performance is a testament to the satisfaction that PRO painters have with our high-quality products, competitive PRO offering and our partnership with the Home Depot. We are pleased with our performance in PRO paint and we'll continue to capitalize on the significant growth opportunity.

Moving on to the overall demand picture. POS and incoming orders slowed more than expected late in the third quarter across most of our product categories, and we anticipate this slowdown to continue into the fourth quarter. In the third quarter, we also experienced higher operational costs mostly in Plumbing, that will continue into the fourth quarter. These operational costs include higher-than-expected freight material costs due to persistent inflation, as well as production and absorption inefficiencies associated with changing volume levels. Lastly, the US dollar continues to strengthen, which will result in lower revenue and operating profit dollars than we previously forecasted. Because of these dynamics, we are lowering our earnings per share expectations for the year to $3.70 to $3.80, from our previous expectation of $4.15 to $4.25. We are enacting plans to address lower volumes and elevated operational costs.

While market conditions are softening, we believe we are well-positioned to outperform in more challenging times and deliver long-term shareholder value. Our portfolio of lower ticket repair and remodel oriented products serves both DIY and PRO customers, and we have product channel, geographic and price point diversification to provide stability and resilience through the cycle. We've taken significant pricing actions and what continue to recover cost inflation experienced in 2021 and 2022 as certain commodities and cost pullback from their highs such as copper, zinc, and ocean freight.

We continue to invest in our leading brands and innovation to capture share. We have experienced, agile management teams that have successfully navigated uncertain economic environments before, and we have a strong balance sheet, cash flow and liquidity that can be used to our advantage. This confidence in our business is exemplified by the new $2 billion share repurchase authorization approved by our Board of Directors. This authorization is a continuation of our capital allocation strategy. First and foremost, reinvest in our business to drive profitable growth. Second, maintain a strong investment-grade balance sheet. Third, pay a relevant dividend with a targeted 30% payout ratio. And fourth, deploy excess free cash flow to share repurchase or bolt-on acquisitions. We have consistently executed on this strategy to drive long-term shareholder value and we'll continue to do so.

I'll now turn the call over to John for additional detail on our third quarter results and full year outlook. John?

John G. Sznewajs
Vice President and Chief Financial Officer at Masco

Thank you, Keith, and good, morning, everyone. As Dave mentioned, my comments today will focus on adjusted performance excluding the impact of rationalization and other one-time items. Turning to Slide 7. Sales in the quarter matched prior year and excluding currency, grew 3%. Net selling prices increased sales by 9%, partially offset by lower volumes, which decreased sales by 6%. In local currency, North American sales increased 3%. This performance was driven by strong growth in PRO paint as well as in spas. Higher net selling prices increased sales by 11%, partially offset by lower volumes, which decreased sales by 8%.

In local currency, international sales increased 5%. Net selling prices increased sales by 4% and higher volumes increased sales by 3%, partially offset by a mix impact of 1%. Gross margin of 31.5% was impacted by higher year-over-year operational costs in the quarter. We anticipate that gross margin will continue to face pressure in the fourth quarter, but will improve year-over-year. Our SG&A as a percentage of sales improved 110 basis points to 15.6%. Operating profit in the third quarter was $351 million and operating margin was 15.9%. Operating profit was impacted by lower volumes, higher operational costs and currency, partially offset by higher net selling prices. Lastly, our EPS in the quarter was $0.98.

Turning to Slide 8. Plumbing sales were flat to prior year. Excluding the impact of currency, segment sales grew 5% against a healthy 15% comp in the third quarter of last year. Pricing contributed 7% to growth and volume decreased sales by 2%. North American sales increased 4% in local currency. This performance was driven by strong spa volumes and pricing actions across the segment, partially offset by lower volumes in other product categories. International plumbing sales increased 5% in local currency against an 18% comp from last year. Growth was led by strength in China with most European markets roughly flat versus prior year. Segment operating profit in the third quarter was $220 million and operating margin was 16.6%. Operating profit was impacted by lower volumes, higher operational costs and currency, partially offset by higher net selling prices.

Turning to Slide 9. Decorative Architectural sales increased 1% in the third quarter. Our PRO paint business continued to deliver outstanding performance, with sales up mid-teens, I guess a robust comp of over 45% in the third quarter of 2021. We continue to gain share and drive conversion as our PRO paint offering, strong brands, and high quality products resonate with PRO customers. Our DIY paint business declined low-single digits versus prior year, largely as expected. Additionally, our lighting and builders hardware businesses declined in aggregate mid single-digits in the quarter. Operating profit was $151 million in the quarter and operating margin was 17.2%. Operating profit was impacted by lower volumes and higher freight and material costs, partially offset by higher net selling prices.

Turning to Slide 10. Our balance sheet is strong with net debt to EBITDA at 1.9 times. We ended the quarter with approximately $1.5 billion of balance sheet liquidity. Working capital as a percent of sales was 18.5%. Working capital was impacted by higher inventory levels at many of our businesses, cost inflation, and delays in receipt and delivery of material. We continue to balance our inventory levels with demand and expect working capital as a percent of sales to be approximately 16.5% at year end.

In the quarter, we also paid down a $100 million of the $500 million term loan that we borrowed in the second quarter. Additionally, our Board authorized a new $2 billion share repurchase program effective October 20, 2022, replacing the existing authorization. This action underscores Masco's strong financial position and our Board's confidence in Masco's future. We do not expect further share repurchases this year as we will use our free cash flow to repay the balance of the $500 million term loan that we took out in the second-quarter.

Turning to Slide 11. Let's review our outlook for 2022. Given moderating demand and additional foreign currency headwinds, we now expect our full year sales growth for Masco to be in the range of 3% to 4% versus our prior guidance of 5% to 7%. We now anticipate full year operating margins to be approximately 16% given lower volumes and higher operational costs. While we continue to expect year-over-year margin expansion in the fourth quarter, it will be lower than previously anticipated.

In our Plumbing segment, we now expect 2022 sales growth to be in the range of 1% to 2%, including foreign currency versus our previous guidance of 3% to 5%. Given current exchange rates, foreign currency is expected to unfavorably impact plumbing revenue by approximately 4%. We now anticipate the full year Plumbing margins will be approximately 16.5%.

In our Decorative Architectural segment, we expect 2022 sales to grow in, the range of 7% to 8% versus our previous guidance of 9% to11%. Looking specifically at paint growth for 2022, we currently anticipate our DIY paint sales to increase mid single-digits and our PRO paint sales to increase strong double-digits. We now expect the full year Decorative Architectural margin to be approximately 17.5%. This is lower than our previous guidance due to lower-than-anticipated volumes and higher advertising spend. Finally, as Keith mentioned earlier, our updated 2022 EPS estimate is $3.70 to $3.80. This assumes a $233 million average diluted share count for the year. Additional modeling assumptions for 2022 can be found on Slide 14 in our earnings deck.

With that, I'd like to, open the call for Q&A. Operator?

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Operator

Thank you. [Operator Instructions] Our first question for today comes from Michael Rehaut from J.P. Morgan. Michael, your line is now open.

Michael Rehaut
Analyst at J.P. Morgan

Thanks. Good morning, everyone. Appreciate it. Wanted to focus for a moment on not just the changing demand backdrop, but how you're looking at your own inventory levels as well as inventory levels in the channel? And how much to the extent that you're able to get a sense how much of the change in demand trends that you're expecting in the fourth quarter are being driven by any types of channel inventory destocking relative to consumer trends, end-market demand trends, and how you think of that perhaps persisting into the first quarter of the year?

Keith Allman
President and Chief Executive Officer at Masco

Thanks, Mike. This is Keith, I'll take that one. We did see moderating demand, POS in the quarter, a bit more than we expected. It was fairly broad-based I would say across categories in terms of incoming orders and POS which we think is most important. Most categories saw this decline across channels. So broadly speaking, we did see moderating POS demand on the consumers -- on the customer side across channels and categories. We do expect volumes to be down in both segments for Q4 understanding that Decorative had a 15% comp in Q4, PRO paint I think was like 50% comp. So we do expect volumes to be down in the fourth quarter across both those segments. In spite of this, we do have backlogs in some of our business, wellness in particular. And we did, as John and I both mentioned, we had another solid quarter of PRO paint growth.

In terms of your question with regards to inventory and inventories in the channels, I would say that inventories are in pretty decent shape. I wouldn't say that they're over stocked or excessive. Some destocking is occurring across categories and channels for sure, but there's always movement in inventory levels, particularly in changing macroeconomic environments and changing markets like we have, evens out usually around the end of the quarter, we do see some destocking that happens around quarter end that we've talked about in the past. So we are not really expecting inventory destocking to be a material impact for us as we think about Q4, so the majority of it, we would say is in end market demand-driven.

John G. Sznewajs
Vice President and Chief Financial Officer at Masco

Yeah, Mike, maybe to add a little bit of additional color to give you. I'd say that destocking will probably mostly in the non paint categories. Paint, we manage very closely with -- with the Home Depot. And with respect to our inventories, as I mentioned, here in the thid quarter our inventories were a little bit higher than we would like, but I think our teams are very focused on this and doing a good job of trying to match our inventories with demand. And so as I also referenced in my prepared remarks, we do think we'll get our working capital as a percent of sales down at year end to a more normalized levels, like 6.5% or so.

Michael Rehaut
Analyst at J.P. Morgan

Great. No, thank you for that. I guess secondly, maybe just shifting to raw materials. If you could just kind of give us a sense of where you were, I think on a consolidated basis if you have by segment that's obviously also very helpful in terms of price cost, and what the raw material headwinds were during the quarter itself? And looking into 2023, given more recent movements in the various inputs, how should we think about raw materials in terms of where the prices stand today if you think that, that could turn into a tailwind?

John G. Sznewajs
Vice President and Chief Financial Officer at Masco

Okay, Mike, I'll try to, a couple of questions there and let me try to break that down in and give it -- and give you a sense. In terms of price cost, I'd say across the enterprise, we are price cost favorable across the enterprise as well as breaking it down into segments, both segments. As we think about raw materials going forward, we have seen some moderation in raw material prices, particularly on the paint side of the business. Copper and zinc have come off their highs from earlier in the year, but I would remind everyone it takes a couple of quarters for that benefit to flow-through and hit our P&L. And so I'd say that we probably aren't experiencing as much of the price cost favorability as we would have anticipated in the third quarter given some of the moderating volumes that Keith just talked about.

As we think about the go forward period, we would expect, and it's always hard to foreshadow but we would expect more favorability in price cost as we go into Q4. And just given our pricing actions that we put in place, some of them were mid-year and [Indecipherable] was going on with price at the beginning of the year as they typically do that there'll be some favorable price cost as we go into 2023. So I think that covers most of the questions you asked Mike, but if I missed something let me know.

Keith Allman
President and Chief Executive Officer at Masco

John, this is Keith. If I can just insert here just a minute. You referenced some commodities that have come down in paint. I think you meant Plumbing...

John G. Sznewajs
Vice President and Chief Financial Officer at Masco

I misspoke, yeah.

Keith Allman
President and Chief Executive Officer at Masco

When you reference conferencing, that's obvious our Plumbing segment.

Michael Rehaut
Analyst at J.P. Morgan

Yeah. No, that was great, and appreciate that clarification. I think the only element of, and I apologize. I guess my multi-part question was just, on a net basis for 2023 given where commodity prices are currently if you would expect raw materials to be a net tailwind on the whole for next year?

Keith Allman
President and Chief Executive Officer at Masco

Yeah, we're not really getting in deep into '23 here. We'll talk about that next quarter, Mike. But certainly our expectation would be that we'd see some commodity relief and it's flowing through our P&L a little slower than we had anticipated because of some of the volume pullback. I would say we expect that to be a tailwind in '23.

Michael Rehaut
Analyst at J.P. Morgan

Okay. Thanks so much.

Operator

Our next question comes from Adam Baumgarten from Zelman. Please go ahead, your line is now open.

Adam Baumgarten
Analyst at Zelman & Associates

Hey, thanks for taking my questions. Good morning. Just maybe on paint. Just given the weak DIY activity that you're seeing, are you seeing or expecting, I should say, an increase in promotional activity going forward?

Keith Allman
President and Chief Executive Officer at Masco

We think about promotional activity, in general I would say that it's -- it's been more muted than in the past. I think given that where the volumes were, we have increased our advertising and planned to continue to do that in terms of promotions overall in the industry, I suspect that it will -- that, that will see a little bit of an uptick in that, but it remains to be seen. Our preference obviously is to complete on brand service and innovation and continuing to drive that. That's worked well for us. And I think if we do see increased promotions, it will be more spot promotions, if you will rather than that what was traditional pre-pandemic, say, where they were more ingrained into the market more consistent, and that's what we're currently seeing.

Adam Baumgarten
Analyst at Zelman & Associates

Got it. Thanks. And then just on the cost actions you alluded to, any specific areas that you're targeting or maybe just some more color around what the plan is there and which areas of the business will be affected?

Keith Allman
President and Chief Executive Officer at Masco

Yeah, I think when you look at what happens in an environment where there is a quick volume reduction, there is a couple of things on the cost side that are impacted. Firstly, is on the material side. The cost that we have seen that, particularly in Plumbing that have backed off a little bit from their highs take a little bit longer to flow through our P&L because of the lower volumes and that's the case for us, it's taken a little longer-than-expected, say a quarter or two to flow through the bottom because of that volume. So that's a piece of it. And that really comes with time as the -- as they roll through the P&L. It also drives absorption issues and variable overhead principally. And as we see where that'll settle in, that's going to give us the ability to better dial end our shift -- dial-in our shift patterns and balance our factories to drive productivity, and this is quite typical when you see rather rapid volume reductions and we're working that.

Inbound logistics, talking about specific in Plumbing. That's been timely deliveries. It can be challenging and drive productivity issues. Frankly, we expected to see a more rapid improvement in that. Things are improving, but not to the pace that we thought they would be. So we're continuing to work those down. So in terms of the operational costs that we're currently facing, that gives you a flavor of how we're attacking it. We expect to be through that by the end of Q1.

In terms of a more protracted recession, if that is there. As John mentioned in his calls, we have experienced management team that have been through times like this and our focus frankly is to come out of a recession stronger than when we went into it, and we were able to demonstrate that in '08 and '09, and we're going to demonstrate that again here. But the usual suspects in terms of levers we have around variable costs that we would look to in terms of either delaying spend or cutting back in marketing and advertising, travel, entertainment, those sorts of things, and then of course, there's always fixed cost levers that we we could look into.

Now given where our capacity utilization is across our own supply chain, our own factory network, etc., and the high-level demand, I don't anticipate that would involve any sorts of reconfiguration of our manufacturing footprint just because of the demand and our expectation for growth. But that gives you a few of the levers, both short-term and mid term.

Adam Baumgarten
Analyst at Zelman & Associates

Great. Thanks, Keitth. Appreciate it.

Operator

Our next question comes from John Lovallo from UBS. Please go ahead, your line is now open.

John Lovallo
Analyst at UBS Group

Good morning, guys, and thank you for taking my questions. The first one is on the implied 4Q plumbing margin, seems to be implied in sort of the low-to mid-teens versus I think expectations of closer to 20%. It doesn't seem like the sales decline explains this. So just curious if you can give us some more color on what's going on there?

John G. Sznewajs
Vice President and Chief Financial Officer at Masco

Yeah. So, John, maybe I'll start and maybe Keith can chime in on part of that so. I think our 4Q plumbing guide for profit, I agree on margins. It does imply some pull down from where we had previously guided. I think there's really two components here. One is the volume drop that you talked about. And then the second piece would be the operational costs that we alluded to in our prepared remarks. Some of that relates to higher than -- continued higher-than-expected freight material, but then also some of the production inefficiencies with the changing volume levels that Keith mentioned. So Keith maybe -- with that, I'll turn it over to you to give a little bit more color on that portion of it.

Keith Allman
President and Chief Executive Officer at Masco

Sure. I would say the biggest piece is the volumes. So we have the FX there that we talked about and the lower volumes that does a couple of things that give us challenges with regards to cost, and I've talked about this a little bit in my last response. One is the longer time for the lower material cost that we expected to hit our P&L, and then secondly is the absorption issue. So that's a factor. And then, John mentioned the elevated freight and in some cases in labor costs. So that's an area that we expected to see more relief and coming into Q4 than we have. So that's the second charge. And then thirdly, operational inefficiencies, principally in our plumbing area, driven by inbound logistics and the reliability and timely of those deliveries, it gives us labor efficiencies and challenges in the shop floors. That hasn't improved as much as we expected it to. Now, it is improving and we continue to take actions to drive that improvement at a faster rate. But as we look at that improvement and paradoxically while the lower volumes does gives us give us absorption issues, it does give our supply chain some relief. So we're getting after this and the improvements are coming, but they won't be totally behind us until Q1. So that frames up some of the margin challenges and why, while will be a little bit better in margin, it's not as good as we had previously guided to.

John Lovallo
Analyst at UBS Group

Okay. Thanks for that. And then the second question is the SG&A leverage was surprising given the sort of flattish top-line. What kind of cost do you guys take now and how sustainable is that before it begins to impact the business?

Keith Allman
President and Chief Executive Officer at Masco

Well, I think we're going to add-up. This is not a run-rate that will stay. We're starting to filter backend SG&A. We've put in -- we put in more advertising in our paint business and we're committed to continue to invest in brand service and innovation because that fundamentally is what will make us as strong as we can be coming out of these sorts of pullbacks or recession, however you want to think about it. So we're very careful in terms of how we look at SG&A. It is a dial that we have that we can turn, that we can either delay some growth spend or delay, as I mentioned, advertising, travel, entertainment, participation and shows, those sorts of things. But we're very careful with it and we're focused on the long-term exiting of this pullback so that were stronger than we went in as I mentioned.

John G. Sznewajs
Vice President and Chief Financial Officer at Masco

Yeah, John, I would add to Keith's comments. That's, right. I mean, as we start looking forward to 2023, I think we're going gonna be very focused on SG&A and trying to match that -- our investment in SG&A up with what we're seeing from demand in the marketplace. And so to Keith's point, it's a lever that we can pull. We're on-top of it. We're watching this very closely. You're right, yeah we did enjoy some better SG&A leverage here in Q3, and if something, has got our complete focus as we move forward.

John Lovallo
Analyst at UBS Group

Thank you guys.

Operator

Thank you. Our next question comes from Matthew Bouley from Barclays. Please go ahead, your line is now open.

Matthew Bouley
Analyst at Barclays

Good morning, everyone. Thanks for taking the questions. I wanted to ask about the Decorative margins and the guide for Q4. It seems like there is an expectation there for relatively significant, I guess detrimental margin. And Keith, you're alluding to everything around the challenges with a rapid reduction in volumes and perhaps that's a big piece of it, but so just kind of looking at that decrementals volume assumption in Q4, what -- just, number one, confirm if that's what it is? If that really is what's driving that Q4 guide, and then kind of what's the right way to think about the volume decrementals longer-term on the assumption that, that we do continue to see kind of weakness in consumer demand? Thank you.

Keith Allman
President and Chief Executive Officer at Masco

There's a couple of items I'd point to, and then John maybe if you want to add some color to it. Clearly, the volume moderation is a big piece of it, there's no question about it. And then secondly I'd remind you, when we talk about how we typically perform in price as it relates to commodities, we generally hold our margin dollars but when you do that, that results in margin percent pressure just by way of example, something like a 10% increase to recover only commodity costs results in almost a 200 basis point reduction in margin. So those two -- the interaction of price versus commodities and the volume reduction of the principal drivers.

John G. Sznewajs
Vice President and Chief Financial Officer at Masco

Yeah, that's, right. I think those are the two components. I think that's the third principle component of the margin degradation and in Q4, Matthew, would be -- the investment that we referenced in marketing and advertising in this segment, it's perhaps more elevated than we would have experienced a year ago and so if you take the volume drop, the cost recovery nature of the inflation and the marketing spend, the advertising spend that we referenced, those would be the three big components that would cause margin degradation. But you see, that said, I expect that that investment in marketing and advertising will be largely contained to Q4, and it wouldn't -- say, that that's going to be something we bake in longer-term.

Matthew Bouley
Analyst at Barclays

Got it. That's very helpful. Thanks for that, guys. And then second, just kind of shifting to the international business. I guess with Hansgrohe [Phonetic] it sounds like, I believe you said at the top that Europe is slowing, whereas you got some of the other geographies where we're actually a bit more supportive. I'm just curious if you can expand on that a little bit. Kind of what are your expectations for how European demand evolves in that business and to what degree can those other geographies continue to offset that? Thanks, guys.

Keith Allman
President and Chief Executive Officer at Masco

So we delivered a nice quarter internationally and local currency up 5% as we mentioned, so very pleased with that. Largely driven by Hansgrohe growth in China, as well as several other markets. Hansgrohe has done an outstanding job of positioning that brand and driving it to market leadership in terms of the premium brand in China, and we continue to grow there and expect that to continue.

European markets are starting to moderate. Modest slowdown in incoming orders. Sales overall in Q3 in Europe, I'd say we're roughly flat. Again, the broad exposure that we have across many countries that have different economies in Europe is helpful in that diversification of our risk there is very helpful and glad to have it. So it's clearly -- clearly seeing a pullback in Europe. But as I said, China, Middle East is doing well for us as I mentioned in my prepared remarks. We're seeing good growth in India. So I think that diversification as well, more broadly speaking, our diversification across price points, our diversification across channels, and of course, our geographic diversification, both US versus international and then within that international bucket are all helpful for us and why we feel that we are positioned very well to make it through these moderating times.

John G. Sznewajs
Vice President and Chief Financial Officer at Masco

Yeah, Matthew, maybe a little bit of additional color to frame this up for you. Recall that international sales are approximately 20% of our overall sales. And in that, Europe represents about two thirds of that international sales and the rest of the world represents about a third. So where -- Keith had just talked about and what we've referenced. So the two thirds is roughly flat, the one third of the business is growing nicely. So I just want make sure everyone's got that in context. There's a lot of people who think our international business is solely Europe and it's much more diversified in that. Due to the good work that the Hansgrohe team has done over the years to expand their sales base across the globe.

Matthew Bouley
Analyst at Barclays

Great. Thanks, John. Thanks, Keith.

Operator

Our next question comes from Susan Maklari from Goldman Sachs. Please go ahead, Susan. Your line is now open.

Susan Maklari
Analyst at The Goldman Sachs Group

Thank you. Good morning, everyone. My first question is dialing in a bit on the consumer. Are you seeing any pushback on pricing from them? And does that in any way impacting some of the moderation in volumes that you're seeing? And how you're thinking about the consumer and their willingness to spend overall?

Keith Allman
President and Chief Executive Officer at Masco

Well, I think the overall inflation I think is really starting to have an effect on the consumer, not just in our products but in everything, from energy to food, to -- you name it. So I think that's -- that's all part of it. Having said that, we still in -- we're seeing -- we're seeing good order rates moderating a little bit in our spa business. We are starting to come down to chip away at our backlog. I think that our backlog now is in that 10-week to 12-week range. So that's down and we're working that down. But we're also seeing some good order patterns. We are not seeing Susan a material shift down. I mean, oftentimes in times like this in my career I've seen, for example, maybe a little bit of a shift towards private label. But we really haven't seen that at this point. So we do expect -- I expect that overall inflation will ultimately have an impact on the consumer and their spending habits. But where we sit right now, I think the consumer is holding up well. They have a good good amount of home equity. Unemployment is obviously in a very good spot. So there is a mixed bag out there as it relates to that combination of of inflation and how the consumer feels, but we're not seeing a mix down and we're seeing in some parts of our business still strong order rates.

Susan Maklari
Analyst at The Goldman Sachs Group

Okay. And then turning to the balance sheet, can you talk a little bit about the ability to work down the working capital, how you're thinking about that is perhaps a source of funds in the upcoming quarters? And then any thoughts in general around capital allocation? You talked about paying down that term loan in the fourth quarter, but how are you thinking about leverage and buybacks and all the different opportunities in general?

John G. Sznewajs
Vice President and Chief Financial Officer at Masco

Yeah, sure Susan. In terms of how we're thinking about working capital, If you think about the seasonality of the business, generally the way the business operates is the first --call it five months, six months of the year where cash consumer, just given the seasonal build typically that takes place of inventory for the summer selling season, the spring selling season and like. And then, right around mid-year we turn into a much more of a cash generation as working capital comes in, and typically you see there is greatest source of cash generation in the fourth quarter is build inventories and receivables, kind of bleed down just due to the seasonal -- natural seasonal slowdown that the business enjoys. And then obviously, right on the first year, then that begins to flip back. And so I don't expect any changes to that seasonality over the course of the coming months and quarters.

In terms of focus in the business, on this -- absolutely, the businesses are focused on. And as part of our variable compensation scheme, where working capital generation is and so I would tell you the teams across the enterprise are very much focused on doing the right thing and driving working capital low for the business. At the same time, I would tell you, given my longer-term experience with the business, softer economic environments, working capital generally is a source of cash generation if volumes were to decline, and so is depending on how the economy rolls out over the course of the coming quarters, I would anticipate that to be a benefit for the organization.

Now flipping to your third part of your question about broader capital allocation. I don't think our views on capital allocation has changed dramatically. Keith articulated our capital allocation strategy and I'll just repeat it for everyone's benefit. One, first and foremost is to invest in the business because that is our highest return investment, either growth capital and/or maintenance capital with the business and so those those are naturally done. I'll remind everyone as generally the light touch. It's about 2%, 2.5% of sales. So not a significant drop on our cash generation.

The second piece is to maintain a strong balance sheet. We've done so over the years and we've done a very diligent job of making certain that we take advantage of the capital market -- debt capital markets when there's attractive peers. We did so with 2021 very effectively. And earlier this year we did the $500 million term loan to pull forward our share repurchase activity and we have a very strong commitment to live within our means, and so we would anticipate continuing to pay down that term loan fully as we foreshadow our back end, May and June when we -- when we took that on, we'd be very disciplined about how we purchase and so I don't think that is going to change whatsoever. We are committed to the dividend because we think an organization of our size, our quality should be paying a dividend and the 30% payout ratio we think is the right level to pay out for our industry and our organization.

And then lastly, because of the significant cash flow generation that we enjoy, you are able to redeploy the excess to either share repurchases or into our M&A. And I would say that both of those activities will continue. We continue to look at what is the right or the best return that we get on that excess cash that we generate and if we can find highly attractive bolt-on M&A targets for either our paint or our plumbing business, we would like to do that because we've got a great franchises in both businesses, whether it's domestically with the Delta team or whether it's internationally with a Hansgrohe team or the Behr team here, we would gladly invest behind them to continue to grow their business and whether that's product line acquisition, channel access, geographic acquisition, we look at anything along those lines to support those businesses continued growth. But to the extent we can't find those types of acquisitions, we're happy to redeploy our excess capital to share repurchases. And so I think we've been very effective stewards of our capital allocation program over the years and I think we'll continue to do so. So, Keith I don't know if there is anything else you want add.

Keith Allman
President and Chief Executive Officer at Masco

Maybe just some specific context on working capital. Business are focused on that as John mentioned, it's part of our variable compensation scheme, and I would I would estimate that we would finish the year in that 16.5% range.

Susan Maklari
Analyst at The Goldman Sachs Group

Great. Thank you for all the color and good luck with everything.

Keith Allman
President and Chief Executive Officer at Masco

Thank you.

Operator

Our next question comes from Mike Dahl from RBC Capital Markets. Your line is now open. Please go ahead.

Mike Dahl
Analyst at RBC Capital Markets

Hi. Thanks for taking my questions. Keith, my first question is just around kind of the rate of change and what you're seeing in underlying market conditions because at least our sense was that for a lot of the quarter things were probably okay but then looking at where you ended up in the quarter and now with the guidance implies it seems like things may have shifted pretty quickly, like very late in the quarter. So maybe can you speak to just the cadence and how quickly conditions changed as you've kind of gone through September and into October, and also what does that really mean in terms of your visibility even into year end, let alone, beginning of next year?

Keith Allman
President and Chief Executive Officer at Masco

Yeah, I would say that the slowdown really became apparent, as you mentioned, in September, so was late in the quarter. While it's early in October and I guess it's not early in October now, we've gone three weeks into October. We've factored that. What we're seeing into October into our guide. So our best view of where -- where the year is going to finish out is obviously incorporated into the guide based on that. We've seen some softening in DIY paint demand that we've talked about to give you a little bit of of context on that, and the overall slowdown, if you will, has been as I mentioned, pretty broad-based. It wasn't like there was one particular part of the country or one particular channel or one particular type of product. While I would say obviously that we're still continuing to do quite well in PRO, and we're working through and have good demand in our spa backlog. So it did happen late in the quarter. And I'd say it's been that -- that it's been fairly consistent since then and what we're seeing in October is incorporated into our guide.

Mike Dahl
Analyst at RBC Capital Markets

Got it. Okay, thanks. And my follow-up question just specifically around the -- this elevated spend in Dec Arc. I guess what I'm wondering is, was this -- was this kind of a pre-planned spend and the impact that it's having is just larger because the volumes haven't come through as expected or is this a newer program that where the spend is being put in place to effectively stem even greater declines versus what you're currently seeing, just at all a little more collaboration on what exactly this is, why it's in place while as volumes are falling more meaningfully would be helpful.

Keith Allman
President and Chief Executive Officer at Masco

We. As John mentioned in terms of SG&A being something that we've watched carefully and we make calls based on the most appropriate use of that. So I would say it's a little bit more accelerated than we have originally planned. If you watch any kind of sports TV, you see in our ads on for Behr paint, for dynasty specifically, it's a great product and we think that when we look at that advertising spend versus the benefit that we get from that, and that is the right thing to do so. It's something that we look at and tweak as we see different demand characteristics and what we think would be the best bang for our buck in terms of what and how we advertise and how much. As John mentioned, I wouldn't model that into ongoing at the levels that we did in Q3 here and plan to do in Q4 into the full year, and we'll talk more about 2023 next quarter and give you much more color on how we feel about our brand spend, etc., at that point.

John G. Sznewajs
Vice President and Chief Financial Officer at Masco

Mike, the other oint I might comment on in addition to what Keith just said is -- if you take a look at the spend year-over-year, it's upright. So fourth quarter of last year was relatively muted spend. So while -- and it is higher this year and I think that's probably the more significant component of it is compared the year-over-year compare.

Mike Dahl
Analyst at RBC Capital Markets

Okay. Thank you.

Operator

Our next question comes from Truman Patterson from Wolfe Research. Please go ahead. Your line is now open.

Truman Patterson
Analyst at Wolfe Research

Hey, good morning, everyone, and thanks for taking my questions. First, I just wanted to touch on the plumbing and paint margin guides in the fourth quarter. You all have gone through a variety of items already for both segments, but I was wondering if there was also a component of pricing that was previously announced that either wasn't as robust or realized as you all had previously expected in either segment.

Keith Allman
President and Chief Executive Officer at Masco

No, it's really the things that we've already talked about in terms of, and principally across both segments it's the reduce volume that obviously has issues in plumbing in terms of overhead absorption, but mainly the dropdown on incremental revenue from that volume. FX is a factor. We've had some operational issues that we're working through in plumbing will be behind us by the end of Q1 that we've talked about, but price realization has been very solid for us.

Truman Patterson
Analyst at Wolfe Research

Okay. And then just thinking your PRO paint segment, you now the share gains over the past year or two years. I'm trying to understand if this is a bit more of kind of general jack of all trades type PRO that you've gained or whether a decent portion of the success has been drawing in converting what will we'll call traditional paint dedicated PROs in the Home Depot. And then finally, embedded in the fourth quarter guidance, does that actually assume that PRO paint volumes will decline year-over-year on that tough comp?

Keith Allman
President and Chief Executive Officer at Masco

Yeah, I think it's probably a little bit of a decline when you talk volumes year-over-year because of that, but it will be modest decline in volumes. We've had good volume growth this quarter that we just finished. And PRO paint is performing very well for us. We've -- let's call it mid-teens growth against that. I think our comp last year Q3 was like 45% and we continue to get data and we watch this very carefully in terms of stickiness of the share gain that we've got both with new customers and to your point, it's a combination with the smaller painters or be the more paint focused professionals who are painting. We're getting some of that demand as well. And recent data on our net perform -- net promoter score is very strong. So feel very good about what the Behr team has done in terms of what we committed to, which is to keep this share gain going and the experience, particularly in our research are referencing the experience with our product. They get the programs that we have for PROs, and of course, the partnership and how the Home Depot is servicing, that general segment. So our confidence is reflected in the outlook. And while yeah, there'll be a modest volume, but when you look against the comp in terms of gallons, we feel we are doing a very good job of maintaining the share as we committed to.

John G. Sznewajs
Vice President and Chief Financial Officer at Masco

Yeah, Truman, the only thing 'd add is -- we're kind of in a period of some really tough comps in the PRO side. We had 45% in Q3, 50% in Q4. I think the north of 50% in Q1. So look again, the Behr team is just a terrific job at executing and taking the share. But as you go up against these enormous comps, it's always tough to post even higher comps on top of that.

Truman Patterson
Analyst at Wolfe Research

Okay. All right. Thank you All and good luck in the coming quarter.

Keith Allman
President and Chief Executive Officer at Masco

Thank you.

Operator

Our next question comes from Phil Ng from Jefferies. Your line is now open. Please go ahead.

Phil Ng
Analyst at Jefferies Financial Group

Hey, guys. 4Q guide, any color on the implied volume declines by segment and any early read on how we should think about 2023 by regions or businesses? It seems like the PRO side of things in small still holding up quite well, any color would be helpful.

John G. Sznewajs
Vice President and Chief Financial Officer at Masco

Yeah in terms of, Phil, I'd say overall volumes, as you, think about volumes. For Q4, I'd say we talked about kind of low-single digit volume declines in plumbing in Q3, and I'd say that maybe even more significant in Q4 just given the way we're seeing things right now. And then on the decorative architectural side, the implied guide for Q3 was -- volumes in the DIY side, we're down double-digits. And so if you take that into consideration with Keith just kind of commented on modest PRO decline in kind of read-through what the volume declines might be in Q4, perhaps low double-digit in Dec Arc.

Phil Ng
Analyst at Jefferies Financial Group

Okay. And then for next year? Is that like...

John G. Sznewajs
Vice President and Chief Financial Officer at Masco

Again, Keith referenced. We are not giving 2023 guidance just yet, but we'll give that at our Q4 call.

Phil Ng
Analyst at Jefferies Financial Group

Got you. And then your margins, I mean what you've addressed a little light in the fourth quarter and some of these issues are you going to flush out by 1Q rather have started to fall as well as ocean freight containers. Any color when you start seeing that flow-through more meaningfully and which is on the cost-out programs. Is that enough to kind of offset potential volume declines where your margins could potentially hold next year?

John G. Sznewajs
Vice President and Chief Financial Officer at Masco

Yeah, as we look at the volume decline, Phil, and I remind everyone is we think about our detrimental volumes generally run in the 30% range enterprise-wide, maybe a little bit higher than that in the plumbing side a, little bit lower than that in the Dec Arc side. And so as you think about volume declines is going to have an impact on profitability. That said, to your point, is as we get through some of these higher raw material costs that are as they start flowing through and hitting our P&L, that should be an offset. Will be a one-for-one offset probably. It's hard to tell at this point, but probably a little bit of margin headwind there. [Speech Overlap] Sorry. Phil, go ahead.

Phil Ng
Analyst at Jefferies Financial Group

That raw material benefit you start seeing it more early 1Q and I think John you mentioned the bigger drop-off I think it was Dec Art and maybe Keith kind of correct to use it more plumbing, just wanted to flush out the potential impact and the timing of that stuff.

Keith Allman
President and Chief Executive Officer at Masco

So are you looking for the potential impact of the tailwind from raw material prices flowing through to our P&L and comparing that to potential headwinds of volume in 2023?

Phil Ng
Analyst at Jefferies Financial Group

Keith, I appreciate you probably not go to that level of detail, but I'm just trying to with raws falling, when does that flow-through, that are early 1Q you event, anything. John, you mentioned seeing a bigger dropouts potentially in paint. Was that really more in plumbing, just wanted to flush that out in terms of potential on what raws just from a timing [Speech Overlap]

Keith Allman
President and Chief Executive Officer at Masco

We should start to see flow-through Phil in Q1 and it's Plumbing.

Phil Ng
Analyst at Jefferies Financial Group

Okay. All right. Thanks a lot.

Operator

Our next question comes from Stephen Kim from Evercore ISI. Your line is now open. Please go ahead.

Stephen Kim
Analyst at Evercore ISI

Yeah, thanks very much, guys. Appreciate all the color you provided so far. I was wondering if you could talk a little bit about whether you're seeing any meaningful mix impacts across the business, plumbing, paint, international, US that are worth calling out. And then in addition, any plans to adjust staffing or capacity in light of what you've seen and what would you be monitoring in order to make or move there in terms of capacity or staffing?

Keith Allman
President and Chief Executive Officer at Masco

In terms of mix impact, we haven't really seen one or are we expecting one. When we look across, for example, in China where we had such a strong performance in Hansgrohe, that's premium brand and that's where we stand there and that continues to do well. We monitor that, but we really aren't seeing anything [Indecipherable] is doing very well for us which is in the high-end or showroom products in. And Delta are performing well. So no real impact.

In terms of staffing, of course, we look to maintain our labor productivity numbers and we focus our businesses on our decrementals in times like this. And staffing is a piece of it and so that's capacity in the sense of a short-term capacity in terms of matching staffing. We match our inventories to our demand levels. As I mentioned earlier in the call, at this point where we expect our growth to be mid to-long-term, I wouldn't -- I wouldn't suspect that we be looking at any brick-and-mortar and we are carefully evaluating the timing of our capital and our expansion projects to make sure that we continue to drive strong return on invested capital, but our plan is to continue to go forward with those as well.

Stephen Kim
Analyst at Evercore ISI

Okay. that's very helpful. And then just generally on a related note, you talked about the abruptness of the decline that came upon us all, and I guess my thought -- my question is how you're thinking about if there's any implications for what the recovery may be. Do you think it's possible that the recovery could be similarly abrupt or is based on what -- or based on what you're seeing is it your view that the recovery would be sort of typical or even perhaps more protracted? Just kind of curious as to whether you think there's any thing to be implied from the abruptness of the onset of the weakness?

Keith Allman
President and Chief Executive Officer at Masco

Yeah, I think it's a little premature to prognosticate on the steepness of the recovery based on where we are at this point. I think when we look at the overall savings rate of the consumer, the health as it relates to the overall structure of our industry with the age of stock, with millennials coming into the the repair and remodel and specifically into the DIY market, when you look at our coverage, call it a 50:50 mix roughly in our overall enterprise between Pro and DIY, the price point coverage the geographic certainly I think we're positioned to fare better than most as it relates to coming out of this and that's how we're driving the business.

Stephen Kim
Analyst at Evercore ISI

Okay, great. Appreciate it. Thanks very much, guys.

David Chaika
Vice President, Treasurer and Investor Relations at Masco

I like to thank everyone for joining us on the call this morning and for your continued interest in Masco. This concludes today's call. Thank you.

Operator

[Operator Closing Remarks]

Corporate Executives
  • David Chaika
    Vice President, Treasurer and Investor Relations
  • Keith Allman
    President and Chief Executive Officer
  • John G. Sznewajs
    Vice President and Chief Financial Officer
Analysts

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