International Paper Company (NYSE:IP) Q4 2022 Earnings Call Transcript

International Paper Company (NYSE:IP) Q4 2022 Earnings Call Transcript January 31, 2023

Operator: Good morning and thank you for standing by. Welcome to today’s International Paper’s Fourth Quarter 2022 Earnings Call. As a reminder, today’s conference call is being recorded. I’d now like to turn today’s conference over to Mark Nellessen, Vice President, Investor Relations.

Mark Nellessen: Thank you, Paul. Good morning and thank you for joining International Paper’s Fourth Quarter 2022 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. And a reconciliation of those figures to U.S. GAAP financial measures is available on our website. Our website also contains copies of the fourth 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’ll begin our discussion on Slide 3, where I will touch on our full year 2022 results. First of all, as I think about 2022, I’m very proud and appreciative of all the hard work our employees have done during the year. And for our strong customer relationships as we’ve managed through a very dynamic and uncertain market environment. Looking at our performance. International Paper grew revenue and earnings driven by solid commercial and operational execution, while facing significant inflation and lower demand in the second half of the year. We also made solid progress in building a better IP. We delivered $250 million of earnings benefits from our initiatives, focused on lowering our cost structure and accelerating profitable growth.

And as a result, we exceeded our full-year target and have strong momentum going forward. We’re also confident in the profitable growth opportunities across our Industrial Packaging business and have made strategic investments to support this growth. We will continue to invest to grow earnings and cash generation by building additional capabilities and capacity in our U.S. box system during the next few years. I’m also pleased with the significant progress we made towards achieving value creating returns in our Global Cellulose Fibers business. We delivered $100 million of earnings growth in 2022 and we expect significant earnings improvement this year. This past year, we also returned $1.9 billion of cash to shareowners and our balance sheet is very strong.

This allows International Paper to navigate the uncertain macroeconomic environment from a position of strength. And we believe it will give us opportunity to continue to invest through the cycle to grow earnings and cash generation while also returning cash to our shareowners by maintaining our dividend and through opportunistic share repurchases. Turning to our full year key financials on Slide 4. Revenue increased by 9% year-over-year, driven by strong price realization in our 2 business segments. Operating earnings per share improved by 32%. Operating margins were impacted by lower volumes from weaker demand for packaging and elevated supply chain and input costs. Overall, EBIT improved by about $300 million year-over-year. In terms of segment performance, both our Industrial Packaging and Global Cellulose Fibers segment contributed to our earnings growth by about $100 million each as our profit improvement initiatives and price realization offset significant inflationary cost headwinds.

Our corporate expenses were also lowered by about $100 million, primarily driven by our building of better IP initiatives and some favorable FX. And for the year, we also generated $1.2 billion of free cash flow which was above our prior outlook, driven by higher earnings and improved working capital in the fourth quarter. Turning to Slide 5. I would like to comment on the press release we issued last week regarding the progress we are making related to our Ilim joint venture. We have entered into an agreement to sell our 50% interest in Ilim SA to our JV partners for $484 million. This transaction reflects a total enterprise value for Ilim of approximately $3.5 billion and approximately 3.1x EBITDA and the EBITDA multiple for 2022 full year results.

The JV partners have also expressed interest in purchasing all of IP shares in JSC Ilim Group which represents a 2.39% stake for $24 million. We also intend to divest all other residual and nonmaterial interest associated with Ilim to our JV partners. The deal is subject to regulatory approvals in Russia. We are making good progress and will provide you with additional information when it becomes available. Upon finalizing this deal, IP will no longer have any investments in Russia. Turning now to Slide 6 and our fourth quarter results. Earnings and free cash flow for the quarter were above prior periods and came in better than the outlook we provided last quarter. Demand for our products played out as we expected. In Industrial Packaging, our U.S. box shipments were down about 6% year-over-year on a daily basis, similar to what we experienced in the latter part of the third quarter, after consumer priorities shifted towards nondiscretionary goods and services.

In addition, our customers and the broader retail channel continue to work through elevated inventories of their products which constrained packaging demand in the quarter. Underlying demand for absorbent pulp was stable. On a positive note, we did see meaningful relief from lower input costs and our fourth quarter earnings also benefited from our building a better IP initiatives and some favorable onetime items in the quarter which Tim will speak to later in the presentation. And finally, we generated solid free cash flow and returned $355 million to shareholders during the quarter. I will now turn the call over to Tim to cover our business segment performance as well as our outlook. Tim?

Tim Nicholls: Great. Thank you, Mark and good morning, everyone. I’m on Slide 7 which shows our year-over-year earnings bridge. Price and mix improved significantly with strong price realization across all channels and benefits from our commercial initiatives. Volume was lower in 2022 as consumers shifted priorities towards nondiscretionary goods and services while dealing with high inflation following a period of demand pull forward during the pandemic. Operating costs were negatively impacted by high inflation on materials and services and significantly higher supply chain cost across all of our businesses as well as lower volumes in our Industrial Packaging business. This was partially offset by improved mill performance and reliability.

Maintenance outages increased as planned, impacted by high inflation on equipment, parts and contracted services. Input costs rose sharply across just about every category with more than half of the increase directly related to higher energy and fuel costs. Total corporate expenses and other items decreased by $0.33 per share as follows. Corporate expenses declined by $0.19 per share and benefited from our building a better IP initiatives as well as some FX. Interest expense was lower by $0.14 per share, benefiting from significant debt reduction in the prior year. Tax expense was $0.20 higher per share with a normalized effective tax rate of 24% as compared to 19% in 2021. Lastly, share repurchases impact earnings by $0.20 per share year-over-year.

Moving to the fourth quarter sequential earnings bridge on Slide 8. Fourth quarter operating earnings per share were $0.87 as compared to $0.83 in the third quarter. Price and mix improved by $0.06 per share from better mix in our Industrial Packaging business and additional price realization in our Global Cellulose Fibers business. Volume was lower in Industrial Packaging as a result of softer demand across all channels. And Global Cellulose Fibers demand was stable. However, volume was lower sequentially due to higher pull-through of shipments in the third quarter as supply chain velocity began to improve. Operations and costs were impacted by the lower volume resulting in higher economic downtime and unabsorbed fixed costs as well as seasonality.

Some of the downtime in our Global Cellulose Fibers business was caused by winter storm Elliott and also some isolated reliability issues. Ops and costs also benefited from favorable onetime items in the quarter related to lower employee benefit costs, workers’ compensation expenses and medical claims. These favorable onetime items added about $71 million or $0.15 per share which is not expected to repeat in the first quarter. Maintenance outages were higher in the fourth quarter as planned. As Mark mentioned earlier, we saw a significant relief from input costs which were $144 million or $0.31 per share lower in the fourth quarter, driven by lower energy and OCC costs. Corporate and other items includes benefits from lower interest expense, favorable FX and other corporate items, partially offset by sequentially higher tax expense.

Turning to the segments and I’ll start with Industrial Packaging on Slide 9. Price and mix improved in the quarter, primarily from commercial mix initiatives focused on margin improvement. The recent publication changes did not have a material impact on the fourth quarter. As Mark mentioned earlier, demand for packaging was in line with our expectations. Fourth quarter volumes remained at lower levels due to constrained consumer demand and ongoing retailer inventory destocking. Sequentially, volume was also impacted by 4 fewer shipping days. However, in this dynamic demand environment, International Paper is well positioned 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.

Overall, our mill system ran well and we managed through winter storm Elliott very effectively. The lower demand environment impacted operations and costs in the quarter as we adjusted our system to align our production with our customer demand. These actions resulted in approximately 530,000 tons of economic downtime across the system, resulting in higher unabsorbed fixed costs. Ops and costs were also seasonally higher. However, this segment benefited from approximately $57 million of favorable onetime items, I mentioned earlier. Input costs were significantly lower and improved earnings by $139 million sequentially. About half of the benefit was from lower energy costs in North America and Europe and the remainder was primarily from lower OCC costs.

Overall, we continue to face elevated supply chain costs as well as the impact from high inflation on materials and services during the past couple of years. In a lower demand environment, when we aren’t running at full capacity, we believe there is a large opportunity to further optimize our system and take out high marginal costs. This remains a key lever in 2023. Turning to Cellulose Fibers on Slide 10. Taking a look at the fourth quarter performance. Price and mix improved by $17 million due to the previously announced price increases. Volume was sequentially — was lower sequentially due to higher pull-through of shipments in the third quarter as supply chain velocity began to improve. Operations and costs were negatively impacted by disruptions from winter storm Elliott and some reliability incidents at 2 of our mills.

These were partially offset by approximately $14 million of favorable onetime items I mentioned earlier. Planned maintenance outages were higher by $39 million sequentially, coming off of the third quarter which represented the lowest outage quarter of the year. In addition, input costs were lower by $5 million. As we look forward, feedback from our customers indicate they are seeing in-transit inventory pull through at a faster pace due to improvements in supply chain velocity from last port congestion and improved vessel reliability. Combined with seasonal demand decline related to the Chinese New Year, we expect some customer inventory destocking to impact demand through the first quarter. With that said, fluff pulp inventories remain below historical levels and we believe fluff demand will continue to grow.

This is due to the essential role that absorbent personal care products play in meeting consumer needs. Turning to Slide 11. Our Global Cellulose Fibers business continues to make significant progress, growing earnings and executing on our strategy to deliver value-creating returns over the business cycle. The business increased earnings by approximately $100 million in 2022 and was near cost of capital returns in the second half of the year despite significant supply chain cost headwinds. Our team successfully deployed a commercial strategy focused on building strategic relationships with key global and regional customers and aligning with most attractive regions and segments. We are focused on creating value for our customers by delivering products that meet their stringent product safety standards and deliver an innovative value.

In addition, we are driving structural margin improvement by ensuring we get paid for the value we provide. In the fourth quarter, we made solid progress in our fluff pulp contract negotiations which will provide additional commercial benefits going forward. We are committed to building on this momentum and expect to deliver significant earnings growth in 2023. On Slide 12, I’d like to update you on building a better IP set of initiatives. We’re making solid progress and delivered $75 million of earnings in the fourth quarter for a total of $250 million in 2022 which exceeded our target for the year. About half of the benefits today are from our lean effectiveness initiative by rapidly streamlining our corporate and staff functions to realign with our more simplified portfolio, we have offset 100% of the dissynergies from the printing paper spin-off.

Although most of these benefits have been achieved, we will continue to pursue additional opportunities. Another significant driver of full year results was strategy acceleration as we delivered profitable growth through commercial and investment excellence. Going forward, we continue to focus on getting our Global Cellulose Fibers business to deliver value-creating returns, we are also focused on profitably growing our Industrial Packaging business by improving margins and investing for organic growth. Finally, the process optimization initiative has the potential to reduce costs across areas such as maintenance and reliability, distribution and logistics and sourcing as we leverage advanced technology and data analytics. We believe these initiatives will deliver benefits going forward as we finish implementing new capabilities across our business.

Turning to Slide 13. I want to take a moment to update you on our capital allocation actions. As Mark mentioned earlier, we have a very strong balance sheet which we will preserve because we believe it is core to our capital allocation framework. Our 2022 year-end leverage was 2.1x on a Moody’s basis which is below our target range of 2.5 to 2.8x. Looking ahead, we have limited medium-term debt maturities with about $1.6 billion due during the next 10 years. And finally, even in this environment, our pension plan remains fully funded. Returning cash to shareholders is a meaningful part of our capital allocation framework. In the fourth quarter, we returned $355 million to shareowners, including $191 million through share repurchases which represents 5.4 million shares or about 1.5% of shares outstanding.

As a result, we’ve returned approximately $1.9 million of cash to shareowners in 2022. In October, our Board of Directors authorized an additional $1.5 billion of share repurchases. At year-end, our total authorization was approximately $3.2 billion. Going forward, we are committed to returning cash through maintaining our dividend and through opportunistic share repurchases. Investment excellence is essential to growing earnings and cash. We invested $931 million in our businesses in 2022 which includes funding for cost reduction projects with attractive returns and for strategic projects build out capabilities and capacity in our box system. As an example of this, the successful start-up of our new corrugated box plant in Eastern Pennsylvania which has an expected return on investment of 20%.

And going forward, we plan to make additional investments across our box system to support long-term profitable growth. We will continue to be disciplined and selective when assessing M&A opportunities that may supplement our goal of accelerating profitable growth. You can expect M&A to focus primarily on bolt-on opportunities in our packaging businesses in North America and Europe. Any potential opportunity we pursue must create compelling long-term value for our shareholders. So turning to Slide 14, we’ll look at our first quarter outlook. I’ll start with Industrial Packaging. We expect price and mix to decrease earnings by $65 million as a result of prior index movement in North America and lower average export prices based on declines in the fourth quarter.

Volume is expected to increase earnings by $20 million due to 4 more days sequentially in North America, partially offset by the normal seasonal decline in daily shipments in North America. Operations and costs are expected to decrease earnings by $65 million due to the non-repeat of favorable onetime items in the fourth quarter. In addition, we expect seasonally higher energy consumption and some additional inflation on materials and services. Ops and costs will also benefit from lower unabsorbed fixed costs due to higher volumes and more planned maintenance outages. Maintenance outage expense is expected to increase by $91 million. The first quarter will be our highest outage quarter this year representing approximately 40% of planned outage costs in 2023.

And lastly, input costs are expected to decrease by $70 million from lower average cost for energy, fuel and fiber. Switching to Global Cellulose Fibers, we expect price and mix to improve by million on the realization of prior increases. Volume is expected to decrease earnings by $15 million based on seasonally lower demand and customer inventory destocking and response to increased supply chain velocity. Operations and costs are expected to decrease by $30 million due to the non-repeat of favorable onetime items in the fourth quarter. In addition, ops and costs will be impacted by higher unabsorbed fixed costs due to lower volumes as well as seasonally higher energy consumption and some additional inflation on materials and services. Maintenance strategy expense is expected to increase by $13 million which is largely associated with the Georgetown mill printing paper out.

This cost will be fully recovered as part of the transfer price to Sylvamo over the course of the year. Again, the first quarter will be our highest maintenance outage quarter this year, representing almost 40% of total planned outages in 2023. Lastly, input costs are expected to decrease by $15 million, mostly due to lower energy and fiber. Moving to our full year outlook on Slide 15. We are projecting full year 2023 EBITDA for the company of approximately $2.8 billion. As I mentioned earlier in this presentation, we believe we have significant opportunities to reduce high marginal costs across our system and capture more benefits from our building a better IP set of initiatives. This includes meaningful earnings growth in our Global Cellulose Fibers business as a result of our commercial strategy execution, I would also note that our outlook includes only the impact from previously published price changes.

Free cash flow is expected to be between $900 million and $1.1 billion which includes a onetime tax payment of $190 million related to our timber monetization settlement. In addition to free cash flow, we expect to receive approximately $500 million of cash proceeds from the Ilim sale. Regarding this transaction, for reporting purposes, the Ilim JV has been classified as discontinued operations. And in the fourth quarter, we took an impairment charge which was treated as a noncash special item. For 2023, we are targeting capital spending of between $1 billion and $1.2 billion with increased investments in our U.S. box system to build additional capabilities and support profitable growth with our customers. We will also focus on high-cost cost reduction projects across our system.

And with that, I’ll turn it back over to Mark.

Mark Sutton: Thanks, Tim. Now I’ll turn to Slide 16. I want to reinforce my confidence in the resiliency of International Paper and our ability to navigate through this dynamic environment from a position of strength. As Tim mentioned earlier, we’re well positioned 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. Also, our teams at IP know what it takes to successfully manage through a business cycle by leveraging options and capabilities across our large system of mills, plants and supply chain to optimize cost while continuing to take care of our customers. In addition, our building a better IP initiative initiatives are focused on continuing to invest in projects to drive structural cost reduction through efficiency improvements and accelerating profitable growth.

We exceeded our target in 2022 and we have solid momentum as we enter 2023. And finally, as I mentioned earlier, we have significantly enhanced our financial strength and flexibility. This strong foundation makes IP well positioned for success across a spectrum of economic environment and to deliver profitable growth over the long term. And turning to Slide 17. As we look to 2023 and all of the dynamic conditions at hand, I draw confidence from an incredible milestone that reflects the resiliency of our company. To be precise, today marks our company’s 125-year anniversary. On this date, in 1898, 17 pulp and paper mills in the northeastern part of the United States joined to form International Paper Company. I think our founders would be amazed at how our enterprise has evolved through the years, including the incredible products we make and the expansive list of customers we serve.

I would also appreciate our long-standing commitment to the pursuit of excellence in safety and environmental stewardship. While the world has changed, our commitment to providing essential products, people depend on every day and the talent and dedication of our team has not changed as we embark on our next 125 years. Our principles and resilience will continue to serve us well. I’m excited about how we are reengaging our company. We haven’t performed to our full potential but that’s behind us. We are committed to take our performance to a higher level. We recently made talent and leadership adjustments to match the right skills to the right opportunities we have in front of us. It’s the right team to execute our strategy. We continue to make a lot of traction on our build to better IP focus areas.

The things we’re going after will set us apart and will drive our results. In essence, we are proud and well positioned to build on our 125-year legacy in the days, months and years ahead. I’m confident you’ll like what you see. With that, operator, we’re ready to take questions.

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Q&A Session

Operator: And our first question will come from Wells Fargo Securities in the line of Gabe Hajde.

Gabe Hajde: I had one specific one on, I guess, energy use. And when I look at kind of the sequential math and what you guys kind of beat by in the quarter, I’d say at least in the corrugated or Industrial Packaging segment, half was from these one-timers and maybe half was from lower natural gas. Has anything changed kind of with your — so I guess, first question is, can you confirm that? And second, has anything changed with IP’s perspective on mediating risk kind of across the organization given geopolitical tensions and potential impact on commodity inputs?

Mark Sutton: I think you sound like you got it about right on the split between the one times which usually get corrected in the last quarter. But through a lot of efforts, especially on things like the medical cost and all of that. On the question about energy and geopolitical, I mean, part of the reason we have lower energy cost is our energy usage can be optimized actually when we’re running less than full capacity because a higher percentage of our energy is our own make energy. And so we can actually just stop consuming purchased — as much purchased energy whether that’s raw natural gas to power the auxiliary boilers or whether it’s the electricity we buy that we don’t make ourselves. Our view on geopolitical is no better or worse than anyone else’s.

As we look out ahead, part of it is what’s happening with weather and what’s happening in Europe in terms of demand for some of the fuel, natural gas being the main one. We feel like it’s a more stable environment going forward. But what we’ve been able to do is really manage and optimize our consumption. And as you know, Gabe, in the integrated mills, at the right output level, we are generating from wood biomass fuel most of our own steam to generate most of our own electricity. Not that we don’t want better demand but when it is lower, we can optimize our energy profile which is what we’re doing.

Gabe Hajde: Okay. And then, I mean, if I take Tim’s commentary, I think, directionally, maybe implied EBITDA for the first quarter is somewhere in that $540 range which obviously suggests a pretty significant ramp to get to your full year outlook. I wanted to know if you’d be willing to parse out, I think the term used was significant improvement in Global Cellulose Fibers, if you maybe put a finer point on what’s implied there. And then I appreciate, again, some of the maintenance costs are somewhat front-end loaded but — so we’ve got visibility there. But then it sounds like a lot of this improvement in the back half maybe or as the year progresses is based on your ability to run more efficiently and take these costs out that seemingly kind of crept into the system and to use your words, Mark and you guys were kind of not pleased with the performance necessarily.

So just maybe the building blocks of how you think about maybe magnitude of getting to that full year number?

Tim Nicholls: Gabe, it’s Tim. And I think you actually summarized it quite well. We are front-end loaded in the first quarter on maintenance outages, so we get a step down. If you look at it on average across the quarters 2 through 4. But really, the benefits to GCF come through, the contract negotiations that were closed in the fourth quarter. And so we’re going to see a step-up in profitability based on those. And then given build a better IP and what we expect to achieve this year and just flowing back some of these marginal costs. I mean the past 2 years have been — the costs have been going up almost relentlessly across every category. Supply chain cost has proven to be a little bit stickier. But we think both from a rate and fuel standpoint, there could be an opportunity.

But the real opportunity for us is just on the operations side, just getting back to more of a normalized mode mix type of scheduling of transportation and taking out the premium freight and higher marginal supply chain and logistics costs to move product to customers.

Operator: Next we go to Bank of America in the line of George Staphos.

George Staphos: Congratulations on the quarter. Much better than we were looking for. One thing first point of clarification for Cellulose Fibers, did you say price and mix in the quarter would be a plus 5-0 or plus 1-5? I couldn’t quite tell.

Tim Nicholls: Sorry about that, plus 1-5.