International Paper Company (NYSE:IP) Q2 2023 Earnings Call Transcript

International Paper Company (NYSE:IP) Q2 2023 Earnings Call Transcript July 27, 2023

International Paper Company beats earnings expectations. Reported EPS is $1.24, expectations were $0.38.

Operator: Good morning and thank you for standing by. Welcome to today’s International Paper Second Quarter 2023 Earnings Call. All lines have been placed on mute to prevent background noise. After the speakers’ remarks, you will have an opportunity to ask questions. [Operator Instructions] It is now my pleasure to turn the call over to Mark Nellessen, Vice President, Investor Relations. Sir, the floor is yours.

Mark Nellessen: Thank you, Alan. Good morning, and thank you for joining International Paper’s second quarter 2023 earnings call. Our speakers this morning are Mark Sutton, Chairman and Chief Executive Officer; and Tim Nicholls, Senior Vice President and Chief Financial Officer. There is important information at the beginning of our presentation on Slide 2, including certain legal disclaimers. For example, during this call we will make forward-looking statements that are subject to risks and uncertainties. We will also present certain non-U.S. GAAP financial information. A reconciliation of those figures to U.S. GAAP financial measures is available on our website. Our website also contains copies of the second quarter earnings press release and today’s presentation slides. I will now turn the call over to Mark Sutton.

Mark Sutton: Thank you, Mark, and good morning, everyone. We will begin our discussion on Slide 3 where I will highlight our results. In the second quarter, our operations ran very well and managed our businesses effectively in a challenging demand environment while taking care of our customers. Looking at our performance, International Paper delivered $55 million of year-over-year incremental earnings benefit from our Building a Better IP initiatives. This program contributed $120 million of benefits through the first half of the year, and we are on track to exceed our full year target for the second year in a row. Underlying demand for our products improved throughout the quarter, but remain constrained by inventory destocking as our customers and broader supply chain work through elevated inventories of their products.

Based on discussions with our customers and trends observed across the various end-use segments for packaging and pulp products, we believe consumer priority in the second quarter remain focused on services as well as non-discretionary goods. This trend has been influenced by a pull forward of goods during the pandemic as well as inflationary pressures and rising interest rates. However, based on feedback from our customers, we also believe that destocking is finally coming to the close. Margins remained under pressure due to the resulting weak volumes and lower prices across our portfolio. However, this was partially offset by lower input and distribution expenses as our team worked to reduce our marginal cost. On capital allocation, we returned $200 million to shareholders in the quarter.

And with respect to the sale of our Ilim investment, I reported last quarter that the Russian buyers received an important required approval from the Russian sub-commissioned overseeing exits by foreign companies. They are still awaiting the approval from the Russian Competition Authority. Buyers continue to pursue this approval, and we expect to close as soon as all regulatory approvals are secured. I will now turn it over to Tim, who will provide more details about our second quarter performance and our third quarter outlook. Tim?

Tim Nicholls: Thank you, Mark. Good morning, everyone. Turning to our second quarter key financials on Slide 4. Operating earnings per share increased sequentially and also came in better than the outlook we provided last quarter as we effectively optimized our system through commercial and operational initiatives. Operating margins continued to be impacted by low volumes, but improved sequentially as lower outage expense and favorable input costs more than offset the impact from lower sales prices. In the second quarter, we generated $261 million of free cash flow. Recall that free cash flow from the first quarter was impacted by $193 million final settlement payment to the IRS related to our timber monetization, which allowed us to further derisk our balance sheet.

Moving to second quarter sequential earnings on Slide 5, second quarter operating earnings per share was $0.59 as compared to $0.53 in the first quarter. Pricing mix was lower by $0.29 per share due to index movements across our portfolio. Lower export prices and unfavorable product mix in our Global Cellulose Fibers business as a result of lower absorbent pulp shipments. Volume was flat sequentially as improved demand in our North American Industrial Packaging business was offset by weaker demand in our Global Cellulose Fibers business. Volume in both businesses were impacted by customer inventory destocking. Operations and costs was also flat as our mills continue to run very well. Higher ops and costs in our Industrial Packaging business, primarily due to economic downtime, was offset by lower ops and costs in our Global Cellulose Fibers business.

Maintenance outages were lower by $88 million or $0.19 per share in the second quarter and we saw a significant relief from input costs, which were $83 million, or $0.18 per share lower, primarily driven by lower energy, wood and distribution costs. Turning to the segments and starting with Industrial Packaging on Slide 6. Price and mix was lower due to index movements and lower export prices. This was partially offset by benefits from commercial initiatives focused on margin improvement. Sequentially, volume was higher despite one less shipping day as demand continued to improve throughout the quarter from the March trough. Our U.S. box shipments were down 8.3% year-over-year in the second quarter as demand for packaging continued to be impacted by ongoing inventory destocking by our customers.

However, June was down 5.9% year-over-year as the quarter improved. Lower demand environment impacted operations and costs in the quarter as we aligned our production with our customer demand while also optimizing our inventories and taking fewer planned maintenance outages. These actions resulted in approximately 622,000 tons of economic downtime across the system, which accounted for approximately two thirds of the ops and cost variance. The remainder was primarily due to timing of spending for materials and services. Overall, our mill system ran very well. Planned maintenance outages were lower by $54 million sequentially, partially reflecting deferral or some outages in the second half of the year as we continue to optimize our outages.

Significantly lower input costs improved earnings by $66 million in the quarter. We benefited from lower energy, wood and distribution costs, some of which was due to the relentless efforts by our business teams to call back high marginal cost while optimizing our systems in the current demand environment. To give you an example of this, our mill and fiber procurement teams have made tremendous progress reducing fiber costs by optimizing mix and shedding our highest cost supplier of fiber to the mills. Our teams across the mill and box plants also are driving significant reductions in distribution costs by doing things like reducing highest cost of freight carriers, renegotiating contract rates, increasing weights per load, reducing miles per load and shedding warehouse and to merge expense.

Turning to Slide 7. I’ll share some perspective regarding how inventory destocking is progressing for our customers. Based on their feedback and our own analysis, we believe inventory destocking across the supply chain has accounted for a large portion of overall demand declines this year. It is also lasting longer than initial expectations due to the limited visibility across the entire supply chain of excess inventories built up during the pandemic. Feedback from some of our large – larger customers suggest that approximately 75% of them entered the third quarter at or below inventory levels – target inventory levels. The good news is that given feedback from our customers and looking at the data, we expect this destocking trend to be completed in the third quarter.

On Slide 8, some additional data supports our current view. We believe the majority of retailer inventory destocking was completed in the first quarter. However, manufacturers are still reducing inventories through the second quarter as a result of lower demand levels, improved supply chain velocity and focus on working capital given higher interest rates. Despite the current environment, corrugated packaging plays a critical role in bringing essential products to consumers. IP is well positioned to grow with our customers over the long-term due to our diverse portfolio of products and services and our strategic relationships with a large number of national and local customers across a broad range of attractive end-use segments. Turning to Global Cellulose Fibers on Slide 9.

Taking a look at the second quarter performance, price and mix was lower due to price index movements and a higher level of commodity grades in the quarter in response to weaker fluff pulp shipments. As a reminder, approximately 85% of the products in this business are exported as International Paper serves major global and regional customers around the world. As we entered the year, fluff pulp volumes came under pressure. First, consumer demand for absorbent hygiene products was lower driven by inflationary pressures. And second, there was significant inventory destocking across the long supply chains. This destocking trend continued in the second quarter as supply chains became more efficient and reliable. As a result, customers were able to work down safety stocks that were built up in response to the supply chain disruptions during the pandemic.

This resulted in approximately 143,000 tons of economic downtime across the system as we aligned our production with customer demand. The combined impact of lower volumes and a higher mix of commodity grades continue to negatively impact business earnings. Looking forward, based on feedback from our customers and order bookings, majority of destocking should be completed in the third quarter, and we believe fluff demand will continue to grow over the long-term. This is due to the essential role absorbent personal products play in meeting customer needs. Coming back to the second quarter, operations and costs improved sequentially as we benefited from lower distribution costs and our business teams remain focused on driving down the high marginal costs going forward.

Sequentially, ops and cost were also favorably impacted by seasonally lower energy consumption and higher residual energy sales. Planned maintenance outages were lower by $34 million sequentially, and input costs were lower by $17 million due to low energy and chemical costs. Turning to Slide 10. I’ll take a moment to update you on our capital allocation actions. We have a strong balance sheet, which is core to our capital allocation framework. Looking ahead, we have limited medium-term debt maturities and our pension plan remains fully funded. Returning cash to shareholders is a meaningful part of our capital allocation framework. In the second quarter, we returned $200 million to shareowners. Going forward, we are committed to returning cash by maintaining our dividend.

Investment excellence is essential to growing earnings and cash generation. We invested $267 million in our businesses in the second quarter, which includes funding for cost reduction projects with attractive returns and for strategic projects to build out capabilities and our box system. Going forward, we plan to make additional investments across our box system to support long-term profitable growth. And we will remain disciplined and selective when assessing M&A opportunities. On Slide 11, we’ll take a look at the third quarter outlook. I will start with Industrial Packaging. We expect price and mix to decrease earnings by $95 million as a result of prior index movement in North America and lower average export prices based on declines to date.

Volume is expected to increase earnings by $5 million due to improving demand and daily shipments in North America, offsetting one less shipping day. Operations and costs are expected to increase earnings by $95 million, more than half is due to lower cost of company paid benefits and our cost management initiatives. The balance is primarily due to lower unabsorbed fixed costs. Lower maintenance outage expense is expected to increase earnings by $28 million. And lastly, rising input costs are expected to decrease earnings by $15 million from higher average energy costs. Switching to Global Cellulose Fibers, we expect price and mix to decrease earnings by $40 million as a result of prior index movements and declines in spot pricing to date. Volume is expected to increase earnings by $10 million as demand improves from lower inventory destocking.

Operations and costs are expected to be stable relative to the second quarter. Lower maintenance outage expense is expected to increase earnings by $12 million. And lastly, declining input costs are expected to increase earnings by $10 million, mostly due to lower fiber and chemical costs. On Slide 12, we’ll take a look at the full year outlook. As we entered the year, we recognize the macroeconomic uncertainties ahead of us and that our businesses were not immune to these risks. These macro trends have shifted resulting in weaker-than-expected demand for our products and price reductions across our portfolio through the second quarter, including prior index changes that will be implemented over the remainder. I would also remind you that we – that when we provide an outlook, it includes only the impact from published price changes to date.

We are now projecting full year 2023 EBITDA for the company to be in the range of $2.1 billion to $2.3 billion. Despite the market headwinds, we are taking actions across the company to optimize our system by reducing high marginal cost and driving additional commercial and cost benefits from our building a better IP initiatives. And Mark will share more about these opportunities in the next few slides. Free cash flow is expected to be between $500 million and $600 million, which includes the onetime tax payment of $193 million in the first quarter related to our timber monetization settlement. For 2023, we are targeting CapEx of $1.1 billion to $1.2 billion, with increased investments in our U.S. box system. And with that, I’ll turn it back over to Mark.

Mark Sutton: Thanks, Tim. I’m going to turn to Slide 13 now, and I’d like to provide our quarterly update on our building a better IP initiatives. You can see the targets and the appropriate metrics on the slide. But as I mentioned earlier on the call, we’re making solid progress and delivered $55 million in year-over-year incremental earnings improvement in the second quarter for a total befit of $120 million year-to-date. Given this strong momentum, we expect to exceed our original target again this year. And these are issues and opportunities that are unique to IP that will shine through as we see the economic conditions improve. Our lean effectiveness initiative contributed $116 million of the cost savings since we began our building a better IP program in 2020.

Early on, by streamlining our corporate and staff functions to realign with our more simplified portfolio after the spin-off of our papers business, we more than offset 100% of those dis-synergies resulting from spinoff. Majority of the benefits going forward will come and are coming from our strategy acceleration and process optimization initiatives, where our business teams have intense focus on creating significant value through commercial strategies and by leveraging advanced technologies and big data across our large system to improve productivity and lower costs. I’m excited about these opportunities. And in the next couple of slides, I’d like to share more examples of what our teams are working on in some of the early results. So turning to Slide 14.

Let’s start with our Industrial Packaging business. As you can see on the slide, our teams across the business are pursuing multiple opportunities to improve margins and drive profitable growth. First, I’ll mention that we’re making good progress on reducing high marginal costs. Tim has previously referenced that input and distribution costs increased by more than $2 billion for IP over the period of pandemic. Coming into the year, clawing back these high marginal costs was an area of intense focus for us. We are accomplishing this by doing things like optimizing mix and usage of fiber and energy, reducing labor costs and over time, shifting to lower-cost suppliers, driving lower distribution costs and reducing discretionary spending and overhead expenses.

As I’ve mentioned before, we’re also invest in our box business to expand our capabilities and improve productivity for future growth. On the commercial front, we have opportunities to leverage these new investments as well as our market expertise to further improve our mix and capture additional value. As we look across our system of mills and box plants, we are seeing real potential to leverage advanced technology and data analytics. In fact, some of that work is helping us get to levels of marginal cost reduction in high economic downtime periods that we’ve never reached before. Over the past year, we’ve developed and piloted new tools and capabilities to increase efficiency and reduce cost across a broad number of categories. We’re starting to see benefits in areas such as maintenance and reliability, distribution and logistics as well as sourcing and we anticipate significant benefits as we continue to deploy these new technologies across our manufacturing system.

All of this gives me confidence in our ability to drive profitable growth over the long term. Turning to Slide 15, I’ll share some key opportunities in our Global Cellulose Fibers business. Over the past year, we have captured meaningful benefits from our commercial initiatives, and believe that there are more opportunities to capture significant value in this business as we continue to execute our revised go-to-market strategy. For example, our commercial teams finalized our fluff pulp contract negotiations which is contributing meaningful commercial benefit this year. In addition, we have earned a higher premium for fluff grades relative to commodity grades by capturing more value and aligning with those customers and segments and regions of the world who value our differentiated product and service offerings.

However, the benefits of our commercial strategy are currently being masked by a very challenging and unprecedented business cycle as well as our exposure to the commodity grades that are not our core focus. As Tim mentioned earlier, it began with major supply chain disruptions during the pandemic, followed by significant inventory destocking actions that continue to constrain demand today. This combination of elevated supply chain costs and lower volumes have had a substantial impact on business earnings. But we do not believe that these issues are structural. And as I said, we have more opportunities to capture significant value going forward and we will continue to test this strategy over the business cycle. Fundamentally, I believe there’s a good business within this business and that we can continue to grow earnings and cash flows over the cycle.

We are focused on creating value for our customers by delivering products that meet their stringent performance and product safety standards while delivering innovation. Over time, we have an opportunity to improve our mix by reducing our exposure to commodity grades. We can further align with customers in end-use markets that allow us to maximize the value of this business, while optimizing our overall cost structure. I will now turn to Slide 16. As you can see, there are several key areas of opportunity we’re working on to navigate the current economic environment while driving profitable growth over the long term. Combined with our strong financial foundation, International Paper is well positioned for success, and none of this would be accomplished or possible without our team of talented and engaged employees.

I will close by expressing my appreciation for all of our work of our International Paper employees and for our strong customer relationships. And with that, we’re happy to move to the question-and-answer section. And similar to last quarter, our senior business leaders are joining me to provide you with their perspectives. So, operator, we’ll lead you now to the question-and-answer portion of the call.

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Q&A Session

Operator: Thank you. [Operator Instructions] Your first question will come from Mike Roxland with Truist Securities. Go ahead.

Mike Roxland: Thank you. Thank you, Mark, Time and Mark for taking my questions. Congrats on a good quarter. Just can you walk us through some of the moving parts regarding the updated EBITDA outlook versus your prior target any way to kind of size how much of that reduction is driven by Industrial Packaging versus Global Cellulose Fibers? How much is driven by a change in pricing versus maybe a weaker demand environment? Or just trying to gauge how much that type of break through.

Tim Nicholis: Yes. Hi Mike, this is Tim. I think obviously, prices has published now more than what we updated in the last quarter. So the bulk of it is price is both priced on the index and then as I referenced in the speaker comments, export pricing and spot pricing in the pulp business. There is some impact from volume because of the destocking, it’s taken a little bit longer, but the bulk of it is price. And on a proportional basis, GCF has had more frequent and higher levels of price reductions on the index than what we anticipated or what had been published when we updated last quarter.

Mike Roxland: Got it. Thank you Tim. And then just quickly, just in terms of some of the initiatives that you’ve pursued in Global Cellulose Fibers, I believe looking at your prior forecast, I don’t think we anticipated that an additional 100-plus ton decline and fluff pulp pricing, obviously, get better than we expected in that segment. So, I’m wondering – I know Mark highlighted some of the things that you’re working on, but was there anything in particular that occurred in GCF during the quarter that allowed you to achieve that level of EBITDA despite the fact that prices relatively declined?

Mark Sutton: Mike, I’m going to ask Clay Ellis to talk a little bit about how they’re running in the business despite the soft demand and some of those improvements are really just in the operational side of it running well at a reduced demand environment. Clay, if you can share a couple of things about the second quarter [indiscernible] overcome some of the price headwinds?

Clay Ellis: Great question, Mike. Thank you. This is Clay Ellis. Yes, I think, you mentioned coming into the second quarter, what we thought about demand or net price and the amount of EDT that we took, we came into the – exited the first quarter, believing that we would see most of the inventory destocking issues subside through the quarter. We did not see that as we expected. We’ve begun to see some improvement June being better than May, July being better than June. And August is also looking better. So it’s improving, but it’s certainly what we’re seeing now, we hope to see earlier in the second quarter the things that we’re focused on maximizing cash generation, managing our machine downtime, you may have seen we’ve idled our Pensacola Mill to consolidate some EDT there, allow the other mills to run a little bit more of a normal ray [ph] that’s overall better for our cost.

Supply chain, aggressive supply chain cost and driving out costs there as Tim mentioned, minimizing our fiber costs, maximizing green energy sales and carbon credit sales. And then also increasing our pull byproduct sales and production. So pulling all of the levers to manage our cash costs and our marginal costs in the business as – but we see improving through the third quarter destocking, we certainly in the second half we see of the year to get out of that in the meantime, we’re doing everything that we can on cost and then also looking as Tim and Mark mentioned around our business, our mix and mitigating some of our exposure to commodity grades.